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Generational Dynamics Web Log for 18-Jul-2008
More questions from readers on finance and investing

Web Log - July, 2008

More questions from readers on finance and investing

Anxious readers wonder what's going on, what to do next.

Last month's "Questions from readers on finance and investing" was only the beginning. I'll try to answer these questions as well as I can, but remember that we're headed for a crisis the nature of which is not fully known. All of these answers could be affected by chaotic (in the sense of Chaos Theory) events that can't be predicted, but these answers are the best I can give, based on historical trends that I've identified.

Where should I put my money?

"It is rather amazing to me that the current environment has very little to choose from in terms of a "safe haven." Where do you put your "money?" Gold could tank, the dollar could tank, the Euro could tank, banks could fail, the FDIC insurance may not be large/good enough....Personally, I am debt free and have a good chunk in cash and a bunch of freeze dried food but still feel "unsafe" and "unsure," even though I have a good grasp (maybe too good for my own good?) on what is going on in this messed up financial landscape. Any thoughts on this would be appreciated."

It looks like you're doing pretty well, but the question you raise is a very difficult one. How do you prepare for a crisis, when you don't know exactly what form the crisis will take?

My answer in the past has been: Cash, FDIC-insured bank accounts, short-term Treasury bills. However, recent events call for additional caution.

FDIC-insured bank accounts

Previously, I've suggested putting money into an FDIC-insured bank account, because I made the following assumption: That once a financial crisis occurred, there would still be some time before there were numerous major bank failures. After all, after the 1929 crash, the bank failures didn't really begin in earnest until 1931.

However, last week we had the collapse of IndyMac Bank, against the backdrop of the GSEs (Fannie Mae, Freddie Mac) bailout. Furthermore, there has been widespread publicity that the FDIC expects numerous additional bank failures, and some analysts are predicting that they may number in the hundreds.

This has created an atmosphere of extreme anxiety among depositors in general, despite the soothing words of government officials. We now have to assume that a major bank panic could occur at any time. Unfortunately, there's no way to predict the exact nature of that panic: How soon the FDIC will run out of insurance money, and how much additional funding the government will provide once that happens.

If you keep your money in a bank, then you should at least diversify -- spread it among two or three banks. If you have a safe in your home, they you could also keep some in your home.

If you have more than $100,000 total in all your accounts in any one bank, make sure that you take the time to check the FDIC insurance rules at the following site: http://www.fdic.gov/deposit/deposits/financial/examples.html

If you have anything different from a vanilla savings or checking account, then there may be other issues.

The rules are complex for a revocable or irrevocable trust.

Seniors with "reverse mortgages" may lose everything, depending on how it's set up and whether it's insured. In the case of IndyMac, the bank owns Financial Freedom a large holder of reverse mortgages.

If you have an FDIC-insured bank account through a broker, then you should still be OK, but recovery of your funds will be delayed.

Update: If you have more than $100,000 in the bank, consider the Certificate of Deposit Account Registry Service (CDARS). This is a service offered by 2,000 banks and financial institutions, and provides FDIC insurance protection for up to $50 million. Here's how it works, according to the web site:

"Financial institutions can offer CDARS because they are members of a special network.

When you place a large deposit with a network member, that institution uses CDARS to place your funds into certificates of deposit issued by banks in the network. This occurs in increments of less than $100,000 to ensure that both principal and interest are eligible for full FDIC insurance.

Other network members do the same thing with their customers' deposits. With the help of a sophisticated matching system, network members exchange funds. This exchange occurs on a dollar-for-dollar basis, so that the equivalent of your original deposit comes back to your institution and effectively stays local (meaning the full amount can support lending initiatives that build a stronger local community). Alternatively, with your consent, network members can receive fee income instead of matching deposits. In either case, the full amount of your original deposit becomes eligible for complete FDIC protection and you receive just one regular statement detailing all your holdings."

Like anything else, you should carefully research this option for yourself before taking advantage of it. (Update added 21-July)

Treasury bills

For years, I've always recommended staying away from long-term (5, 10, 30 year) Treasury bonds. The reason is that there are trillions of dollars worth of these bonds being held by foreign governments, and with the balance of payments growing exponentially, it's been pretty clear for a long time that those bonds will never be redeemed.

The bailout plan for the GSEs (Fannie Mae and Freddie Mac) has now made these risks much more visible to the international investor community. The price of credit default swaps (CDSs) on US Treasuries has risen from 2 to 12 basis points. Translated into English, this means that investors are beginning to "bet" that the US government is going to default. As a practical matter, the US government could lose its AAA rating.

The immediate cause is that the planned bailout of the GSEs is going to add trillions of dollars of new obligations to the US government. As I said, it's been obvious for years that the US government would default, but these new obligations make it clear to a lot more people.

Of course the GSE bailout proposal is only a proposal - it still has to be approved by Congress. But it will be a big problem either way. Fannie and Freddie are "too big to fail," and so some kind of bailout is required, but the proposed bailout is a problem.

In my opinion, based on trends that I see, short-term (6-12 months) Treasury bills should still be safe investments for the near future. But the GSE problems do add a level of risk that didn't exist before. As I wrote in March, the interest being paid on Treasury bills is so low right now, that they probably are no longer worth the trouble for many people.

If you have enough money, however, then you may wish to include some T-bills as part of your diversification plan, in addition to spreading money around different banks.

Deflation and CPI

"Thank you for your extremely informative website. I'm just an average Joe trying to save my honest dollars. One thing I'm not quite certain of is exactly what you mean by deflation - or more precisely, what this deflation means to me."

Based on long-term trends, I'm expecting the CPI (Consumer Price Index) to fall, rather than increase. That means that things you buy will become cheaper, rather than more expensive. In 2004, I wrote that I expect prices to fall by 30% by the 2010 time frame, and that still seems to be a reasonable estimate, because of the financial crisis and deflationar spiral that seems to be more and more imminent.

"Thank you John, your common-sense analyses and straightforward explanations are truly one-of-a-kind. This makes me feel a little bit more secure about my dollars, but I still have my doubts about the security of US government debt (T-bills) and insurance (FDIC). What I was thinking is that the Japanese crash was like a generational reflection of the US in 1929 as creditor nation, while the incipient crash of the US market is a generational reflection of the Weimar republic as a debtor nation. In reference to your 2004 article about deflation, I'd say that you were absolutely right with the exception of gasoline. As an average joe buying regular stuff from Wal-Mart and the like, I'd say that prices for regular family stuff have decreased significantly from 2002 to 2006, especially in durable goods. Today it seems like prices are moving quickly back up, however, but it could just be my perception. I guess that's not the story that the CPI or the foreign exchange rate tells, but that's why the macroeconomic data consistently confuses me as a consumer. All that I can say is that I'm greatly more aware of the world for having stumbled onto your site and thus I will continue to learn as much as I can from it. Thank you again for such an excellent resource."

As you suggest, the CPI and the foreign exchange rate are different things. The CPI measures the rate of inflation internally within the country, while the foreign exchange rate measures inflation on international markets. The long-term trend that I described applies only to the CPI.

I do not know of any long-term trend that indicates whether the dollar's inflation rate internationally will be positive or negative (the latter being deflation). In fact, it could go either way, depending on chaotic events that can't be predicted.

The international value of the dollar depends not only on the dollar but also on competing currencies. The euro may be worse off than the dollar, for example, and in that case the dollar will become more valuable relative to the euro.

Incidentally, you mention the Japanese crash of 1990. It took 16 years for Japan to recover from that, and that provides an idea of how long it will take America to recover.

For further historical insight into what life will be like in the next couple of years, read the article on "The bubble that broke the world," which describes how things changed in 1930 and 1931.

Gold

"I know that you have been in the deflation camp and feel that gold is a bad investment for that reason. Do you thus disagree with the Bank of International Settlement's opinion that "disorderly decline in the value of the dollar cannot be ruled out"? Exchange rates and inflation/deflation are two different animals. However, in the event of a disorderly decline in the value of the dollar, it would be rather surprising to see gold go down in price."

Gold is now overpriced by a factor of 2 or so, because it's in a bubble, and when the bubble bursts, the value of gold will collapse.

However, that could change because of chaotic events that can't be predicted. As you suggest, in the case of an international emergency, such as a war or loss of faith in the dollar, then the price of gold may spike up again. If you think that might be the case, you might invest in gold, provided that you have the stomach to sell quickly, once that hoped-for spike occurs. (Many people would not do that, but would wait too long, until the price fell again.)

If you have enough money that you'd like to diversify even further than we've suggested in the preceding paragraphs, and you're willing to risk losing half your investment, then you may wish to purchase some gold. But for most people, investing in gold doesn't make sense.

Perhaps your situation is special. The issue for the next few years is survival. Will owning gold (instead of cash) help you survive? That's the decision you have to make.

Oil prices

"I read on one of your postings in June of this year that you believe speculators are not causing a big impact on oil price because they wouldn't be able to house the oil...In 2000 the CFTC (Commodities Futures Trading Commission) deregulated futures trading and as I understand it, this is what led to the Enron scandal and now to some extent, the high price of oil. It isn't required for futures contracts to be delivered, which is what allows the speculation.

As you may already know, McCain's economic adviser Phil Gramm (whose wife served on Enron's board ending sometime in the early 90's) had a hand in passing this legislation in 2000 and another bill called the Gramm-leachey-biley act I believe, which essentially repealed the Glass-Steagall Act.

Thanks for your diligent work on this site."

It is indeed possible to speculate on oil futures contracts, up to the point where it's necessary to take delivery of the oil. At that point, the price becomes real, and if there's been an artificially high futures price, then the delivery price would be significantly lower than the futures price, and apparently that hasn't been happening.

I think a lot of the confusion today has to do with confusing prices of futures contracts with prices of oil deliveries. One of them can be targeted by speculators, but the other one is real, and both of them seem to be in the $130s per barrel range.

Hari Seldon

"John, I really enjoy the website and your insights. Do you ever feel like that character from Isaac Asimov's "Foundation" [science fiction] novels, Hari Seldon? He was mapping out the future of universe, through what he called "psychohistory."

Sort of, but Isaac Asimov's psychohistory (Hari Seldon) was proven to be pretty much impossible in the 1960s and 1970s by the development of Chaos Theory. On my web site, I try to carefully distinguish between Generational Dynamics predictions (trend predictions) and probabilistic predictions (depend on chaotic events).

I discussed the whole subject in "Chapter 4 - Chaos Theory and Generational Forecasting" of my long languishing book, "Generational Dynamics for Historians." It's a bit out of date now, but it covers the subject.

How long will the crash last?

"Could we reach bottom in a matter of several months instead of years?"

The 1929 crash continued for three years. Could "modern technology" make it occur more rapidly today?

This would require many institutions to collapse very rapidly. It takes a long time period to build up an institution, and that time period can't be sped up in most cases. Similarly, it takes a long time to collapse an institution, and that time can't be sped up either, although it will typically be a much shorter time period than was spent building it up.

It's possible that major worldwide catastrophe -- such as a bird flu pandemic that kills hundreds of millions of people -- would speed things up a lot. That might bring about a bottom more quickly than three years, but this depends on chaotic events that can't be predicted.

Hiring a financial consultant

"Thank you for all the research you put out on Generational Dynamics. I just discovered it today, and I am looking forward to digging into your articles further. I came across your site after doing some research for money managers, and then started reading your stock market predictions. With a bleak outlook for the next several years, I was wondering if you have any specific advice you could share. I am 25, and my father recently passed away, and my mother and sister and looking to me to help manage his assets, but I have very little experience. Is there anyone or any firm you would recommend I get in touch with?"

I'd suggest that you hire me as a consultant, but everything I can say is already on my web site. Hopefully, the answers to the last five or six questions will provide you with some guidance.

If you decide to hire someone, then you have to understand that they have a conflict of interest. They make money only when you buy or sell. They don't care whether you make money or lose money, since they're just interested in their commission.

The winners in today's market are the ones that don't lose assets. That's the best suggestion I can give you.

Don't spend a penny

"Picture yourself a 30 year old father of 3 kids under 5. There is a lot of love in my household and not so much cynicism. What would be the best advice you could give for our immediate future? Thanks for your reply."

Picture a world where you're a 30 year old father with 3 kids under 5, you've lost your job with no hope of getting another job, so you and your family have to live for the foreseeable future on what you have today. How would you change your life?

You would save every penny, knowing that if you can save a dollar today, then that dollar may save your life a year from now. You would cut out every expense not necessary for survival - magazine subscriptions, piano lessons for the kids, clothes, movies, pizzas, wide-screen tvs, lights left on when nobody's around, driving when you can take the bus, etc., etc.

The best advice I can give you is to speak to your family now, tell them what's coming and why you have to save every penny, and then follow through.

One more thing: Many people should start thinking about moving in together. Two families sharing a home will save a lot of money. If your rich cousins have a couple of extra bedrooms in their mansion, ask them if you could live there. You'll both save a lot of money.

Conclusions

I wish I could give better answers to these financial questions, just as I wish I could give a straight answer when people ask me where the safest place is to live. Unfortunately, there are no certainties.

Actually, it's getting tougher and tougher for me to give answers to these questions, because of the way things are changing.

For example, a year ago I could unhesitatingly advise people to put their money into an FDIC-insured bank certificate of deposit. Today, because of the events last week, there is some risk attached to that advice.

All you can do is do your research and reach an educated conclusion on the best way to increase your probability of survival.

Remember that as a reader of this web site, you have a huge advantage over everybody else, because you know a lot about what's coming. If you've been reading this web site since 2003, then you knew long before other people did that there was a housing bubble, a credit bubble, and a stock market bubble. And you knew long before anyone else what was going to happen in Iraq, Darfur and other places in the world. (See "List of major Generational Dynamics predictions" for more information about these and other predictions.)

And since you know a lot more than other people, you're able to make much better decisions. Not only that, you're able to help other people, family and friends whom you would like to see survive as well as you do.

I thank the ever-increasing number of readers of this web site. I spend most of my spare time on this web site, but it's you that make it all worth it.

The amount of e-mail has been increasing, but I'm still managing to answer pretty much all of it, although sometimes it takes me longer than it used to. As usual, you're invited to send me a comment or question via the "COMMENT" link at the top of each page.

I'll end with the same message I've given many times: No politician can stop what's coming, any more than they can stop a tsunami. You can't stop what's coming, but you can prepare for it. Treasure the time you have left, and use it to prepare yourself, your family, your community and your nation.

Hopefully, this posting will help you prepare. (18-Jul-2008) Permanent Link
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Generational Dynamics Web Log for 18-Jul-2008 More questions from readers on finance and investing