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As investors, the question we have to focus
most of our attention on just now is what impact the credit crisis, the
bursting housing bubble and the actions of the U.S.
government will have on the economy and investment markets in the next six
months.
We have seen the Fed and
the federal government move to panic mode as they try to keep the system
afloat. As expected, they have cut rates, as well as having given away checks
and rearranged the Federal Reserve’s entire balance sheet.
The underlying problems
have not been fixed with this massive bailout. There are still many credit
pot holes out there and new lending remains highly constrained. Even the
government tax rebate checks, rather than boosting the domestic economy, were
largely absorbed by higher oil prices. The resulting cut-back in consumer
spending, coupled with ongoing constrictions in lending, will cause a severe
slowing of the economy.
But the much bigger
implication is that the Fed is busy pouring more gasoline on the fire by
fighting the collapsing housing bubble, a housing bubble created by excess
liquidity, with yet more liquidity. That is the key point that should be
taken from this mess. The dollar is now firmly on an even steeper slope to
its ultimate demise. Other currencies will be sliding down the same slope, so
another paper currency is not the answer.
This, then, is a
high-level context for many of our investment recommendations in the months
ahead.
Short Term Projections
1. The housing decline is
not yet done, because we will need another year to unwind foreclosures in the
pipeline. In addition, the exuberance shown by appraisers at the height of
the housing bubble still has a long ways to go to fully deflate. What is that
house on the market down the road really worth? At this point, no one
knows… and no one will know until it and many others are bought by
willing buyers (as opposed to unwilling lenders taking them onto their books
in a foreclosure).
2. Consumers in the U.S.
are not able to expand credit and are increasingly concerned about the
outlook for the economy, so they will slow spending both at home and on
imports.
3. The financial/banking
system is weaker than understood. The complexity of the global system and the
ubiquitous presence of interlocking financial and credit instruments and
literally trillions of dollars in derivatives has left the world’s
banks teetering on the edge.
Adding a push from
behind, we have broadly rising inflation and soon the persistently higher
interest rates that are the bane of fixed-income investors and financial
institutions in general. As the dollar continues its fall, and the banks
continue to come under pressure, the lack of confidence in these keystones of
the modern financial system will deepen. Already, the Sovereign Wealth Funds
that rushed in early in the credit crisis to prop up the big investment
houses are now signaling that, at least for the time being, they are going to
step back and watch how things shake out.
4. A slowing economy
– recession – coupled with inflation, creates a condition often
referred to as stagflation, presenting much bigger policy challenges for the
government than one or the other alone.
5. The food crisis. Shortages of food
production come from rising energy and fertilizer costs. Rising demand comes
from a shift in diet, especially in emerging markets, where increasing
prosperity leads the citizenry to add more protein to their diets. Important
shortages in grains have arisen that don’t allow for a bad crop year.
Most concerning is that these shortages are occurring despite good crop
production last year, an occurrence that can be blamed, in part, on the
diversion of some agriculture production for ethanol and bio-diesel.
These food shortages have already contributed
to a doubling and tripling in the price of grains over the last two years.
But even these elevated prices have not been sufficient to offset the higher
costs of the energy required to produce the crops. And, despite today’s
higher prices, agriculture still lags the price increases seen in many other
commodities.
[For more information on the subject of food,
watch my recent appearance on FOX Business News here.]
The result of this is
that the inflation rate, interest rate, food, energy and precious metals are
heading higher as the dollar is debased.
Higher rates are not good
for housing and stocks. In the long term, they will recover in nominal terms,
though not in actual terms. That’s because, while their nominal prices
may return to current or near current levels, the dollars used to express
their value will have much reduced purchasing power… making those assets
a mediocre investment for the foreseeable future.
Finally, it is important
to recognize that the world remains in the throes of a deep and serious
crisis. While many analysts will express the view that the worst is over or
that, after a modest downturn, things will bounce back just like they always
have, our view is that what we will actually witness going forward is a
fairly steady occurrence of crisis and panic. The crisis will accelerate,
moving faster, even, than in previous major shifts such as that witnessed in
the 1970s.
While history may find we
are too pessimistic at this point in time, in our view it is far better to
prepare for a worsening crisis and hope that it does not materialize, than to
expect business as usual.
Bud Conrad
www.caseyresearch.com
Bud Conrad is the Chief Economist of Casey Research, LLC.,
publishers of Doug Casey’s International
Speculator which provides unbiased research and recommendations on the highest
quality junior exploration companies.
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Mr. Conrad holds a Bachelor of Engineering degree from Yale and an MBA
from Harvard. He has held positions with IBM, CDC, Amdahl, and Tandem.
Currently, he serves as a local board member of the National Association of
Business Economics and teaches graduate courses in investing at Golden Gate
University. Bud Conrad, a futures investor for 25 years and a full-time
investor for a decade, is also a regular lecturer for American Association of
Individual Investors. In addition he produces original analysis for Casey
Research, including unique charts and research on the economy and investment
markets.
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