Unless you were sheltered from all media, you know the global stock markets plunged on Monday, January 21, reportedly on fears of recession in the U.S. MSCI's All Country World Index dropped $979 billion that day (Reuters).
After the Dow slid 3.5% and the Nasdaq plunged 5% last Tuesday, the Federal Reserve cut the federal funds rate by 0.75% to 3.5% in reaction to the carnage on Wall Street. Not convinced that was strong enough medicine, Ben Bernanke cut another half point eight days later.
The stock market plunge was but another calamity in a flood of negative financial indicators. Job creation is falling, the manufacturing sector is reeling, and housing prices are tumbling while oil and other commodities are making new highs (IHT). Financial institutions from banks to bond insurers are going bankrupt. Many Americans never benefited from the last economic 'recovery' and it looks like we are heading into a new recession (Reuters).
While the U.S. Congress has been debating an economic stimulus package since last year, the volatility in the stock markets has spurred the government to action. The U.S House of Representatives passed a $146 billion plan of tax relief and other measures, about 1% of GDP.
While many Americans would welcome a government check, this would not prevent most of the imminent foreclosures. Senator Dodd of Connecticut proposed forming a government entity to spend another $10 to $20 billion to bail out distressed homeowners to refinance them at a 'more affordable level.'' These new mortgages would be insured by the Federal Housing Administration or guaranteed by Fannie Mae and Freddie Mac (Reuters).
Unfortunately, I dont think that any of these proposed measures are sufficient to prevent a recession in the U.S. In fact, I believe that if the government used accurate measurements, it would show we are already in a recession. John Williams of shadowstats.com uses the government's original methodology to calculate GDP, and he determined that the economy started contracting in 2006 (Weedenco).
At best, the stimulus package will prop up the retail and banking sectors for a short while as Americans struggle to pay their ever increasing bills. The real level of price inflation is high and will only get higher as politicians print more money to make good on their promises. It may not even energize the economy if the government checks are used to pay down existing debt instead of spent on new purchases.
There is already evidence that U.S. residents are reining in consumption, as retail sales fell 0.4% in December (IHT). Many problems in the American economy were created by excess liquidity, so pumping out more money will only make the situation worse in the long run.
A few hundred dollars per capita won't save the housing market either.
The most prominent victim of artificially easy credit, the real estate bubble was inflated by the Federal Reserve. They pushed interest rates down artificially low, and eased lending standards for banks. The banks profited by pushing mortgages on anyone who was interested, financially sound or not, and appraisers and borrowers regularly lied to help loans get approved. The excess credit caused prices to rocket by stimulating demand. If borrowers had to put 10-20% down as was customary for home loans just 20 years ago, there would be fewer mortgage applications and home prices would never have been bid up to ridiculous levels. Now millions of homeowners will suffer foreclosure or watch as the equity slowly deflates from their main asset.
Unfortunately, the imbalances in the U.S. economy are nothing new. I have been writing about them for years, but there was little fear of an economic downturn until recently. In fact, I wrote the original Cracks in the Ice in 2005 when most investors were still complacent about the state of the American economy. In my essay, I warned of the coming stagflation, heralded by accelerating price inflation, unemployment, small wage increases, and lower corporate earnings. I was especially concerned about the unsustainable housing bubble, and I predicted that banks who have invested heavily in subprime mortgages would fail. I suggested that investors sell risky assets and move to more conservative investments in order to profit from a future flight to quality. I urged my readers to get some precious metal insurance before the panicking herd causes the price to soar.
The good news is that if you bought precious metals in 2005, your portfolio is very healthy. Silver is up 144%, gold has gained 108% and the XAU has surged 121% since I wrote that article. Even though many asset classes are suffering, commodity investors have been enjoying a robust bull market.
However, it's not too late to profit. I believe this commodities bull has several years left before it's over, and the largest moves havent happened yet. Now is a great time to examine your portfolio. If you don't have enough exposure to the precious metals and other commodities, sell your underperforming equities and get more exposure to assets with a bright future. Debasing the dollar through money printing will only propel the price of commodities and related stocks higher.
Cushion your nest egg
Refinance - If you have loans at a high interest rate, try to refinance them. You may be able to get a new mortgage, or move debt to a new 0% credit card.
Buy gold and silver - They aren't going to get cheaper as inflation moves higher. Precious metals are the ultimate form of wealth and they make saving more fun.
Review your portfolio - Don't use margin as the volatility can force you into bad decisions. If your stocks have good fundamentals, especially if they are commodity-related, don't dump them in panic. However, if you've been holding on to some losers with no future, cut them loose and move on. Use the freed funds to buy something you have your eye on.
Stock up on necessities - In an inflationary environment, everything you need goes up in price. Make some extra room and buy a little extra nonperishable food every time you shop. If you see something you need on sale, buy it sooner rather than later as long as you don't rack up interest payments to do so.
If in doubt, sit in cash - It may take a few weeks until the volatility subsides. As the saying goes, don't try to catch a falling knife. Wait until it looks like your chosen asset has bottomed before jumping in. If you are looking to buy stored gold and silver, you can even hold your cash in a stronger currency like the Canadian Dollar while you wait for your entry point at goldmoney.com.
Copyright © 2008 Jennifer Barry
