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In the two months that have passed since I sent my New Year's message (which was forwarded to all of those who signed up since January 1st), events have moved swiftly to confirm my concerns over inflation and the dollar, and my advice on how to deal with those issues. In that letter, I used the term "stagflation" - a word that is now being mentioned more and more frequently. It is a word that some readers will remember from the 1970s - a combination of slow economic growth and rising inflation. This deadly duo robs you of the purchasing power of your dollars and your savings, while diminishing your job prospects and opportunities to increase your income as the economy slows. It is a particularly dangerous situation for retirees - who must live on the diminishing purchasing power of the dollars they had figured would be enough to sustain them for the future. But it also impacts the opportunities for younger people, still working to build a future retirement fund as well as college for their children. The 2008 National Auction - oops, Election! The economic problems we face are exacerbated in this a Presidential election year. This is not a political newsletter - so suffice it to remind you that every election is important. Your Congressional representatives and Senators will be voting on taxes and spending decisions that will impact your children and grandchildren. Those currently in office have agreed to buy your votes with a "rebate" that will be paid out of borrowed money. Those seeking the Presidency have each already raised and spent over $100 million - and that's just for the primaries! (Here's a link to the figures if you don't believe me! http://www.opensecrets.org/pres08/index.asp). The job of President of the United States only pays $400,000 - plus a pretty good expense account. Ask yourself: Why are these candidates spending so much money - money you've contributed - to buy your votes? It's the price of power! Think carefully before you vote, and don't ignore the importance of every decision your vote will buy. The Markets are Voting Already - Against the Dollar! As gold reaches $1,000 an ounce, the Euro breaks the $1.50 level, and gasoline pushes toward $4 a gallon, and wheat hits an all-time high price over $12 a bushel, the markets are telling us that the problem lies with the dollar - not with the "availability" of these commodities. There are simply too many dollars floating around out there - dollars created by our Federal Reserve system to "stimulate" the American economy. And now, amidst even more stimulation through the "rebate" program the rest of the world has decided they'd rather have gold, oil, euros, wheat - anything but dollars! (Please review my January letter for an explanation of the dollar creation problem caused by the Fed, and how we've been "recycling" dollars to buy stuff, leaving foreigners with a dilemma of what to do with those dollars.) There's not suddenly a shortage of oil or wheat or gold. There are simply Yes, there's also rising real demand for many commodities. As we waste money turning corn into ethanol, farmers choose to plant more corn for ethanol - and less wheat. But corn demand for ethanol means corn gets more expensive to feed to livestock, which causes rising beef and chicken prices, along with milk. And with lower plantings, wheat gets more expensive to make cereal or bread. That's just another reason to expect higher food prices in the year ahead. The CPI rose 0.4% in January - an annualized rate of 4.4% over the last year. But if you look at the trend of the most recent three months, the annualized rate is 6.8% Refer back to the "Rule of 72" in my January commentary, and you'll see that at a 7% inflation rate, the value of your dollars will be cut in half in 10 years! The Fed Takes a Stand Against Recession (But what about inflation?) Fed Chairman Ben Bernanke sits in front of Congress and tells the world that his top priority is to keep our economy from falling into recession. And to do that, he'll keep flooding the economy with more liquidity, trying to push short-term interest rates down. The futures markets are pricing in another full percentage point cut in interest rates in the next six months. Bernanke has obviously given up on the Fed's primary mission: to maintain a sound currency leading to stable prices. Congress wants to fight recession too, in this election year. Thus we have $160 billion in "rebate" checks and tax breaks - adding to the deficit dollars the government will have to borrow (from foreigners) -- but who cares? Who does care? The rest of the world. Central banks and foreigners and wise investors who have decided it's a stupid move to hold dollars that are losing value because the US central bank is creating so many of them - INFLATION! In effect, the world is "crying Uncle"! They're giving up on the U.S. dollar! But we need to borrow to finance our $9 TRILLION national debt! Plus the $400 Billion plus in deficit spending we'll be adding this year. How will we "bribe" them to keep buying our debt as old debt (treasury bills, notes and bonds) matures? We'll have to pay them higher interest rates to persuade them to lend us money to finance our old debt, and new. Hint: That's one good reason to lock in today's low interest rates on any personal or mortgage debt you will be carrying into the years ahead. Recession and Deflation: The Other Side of the Coin The worries about inflation are not to suggest that the economy doesn't have some serious recessionary problems. You've seen them in the headlines: Falling home prices, rising foreclosures, rising energy prices. New claims for unemployment are starting to move higher, while consumer confidence moves lower. Higher home heating oil, natural gas, and gasoline prices act as a "tax" on the consumer - leaving less to spend on other consumer products. Less spending leads to a slowing economy and fewer jobs. It's been a long time since we've seen this cycle. The Fed has good reason to fear a spiral of consumer pessimism that could extend a mild recession into something longer-lasting and more serious. Meanwhile the banks have taken multi-billion dollar write-downs on the bad loans they made, many of which were sold to their own off- balance sheet subsidiaries. (Enron, anyone?) Now the insurance companies that purchased mortgage securities for their investment portfolios are taking the hit. Another round of big write-offs is being announced, notably the AIG announcement last week of an $11 B write-off. All of those "writeoffs" are the "wealth" that was created by rising home prices now falling through the Alice-in-Wonderland hole in the ground, and disappearing. As foreclosures rise, banks dump housing inventory depressing prices. It impacts every homeowner - even if you never plan to sell your home or need to refinance. The Fed's Dilemma - Managing a Bath Tub of Liquidity It's as if the economy were one giant bathtub - with the Fed in charge of turning the spigots to keep the tub filled to the optimal temperature and level. And the tub is filled to the brim. But at the same time, the drain is open, and the "write-offs" are draining the water level. To make things even worse, someone's poured bubble bath into the tub - and now those frothy suds are spilling over the side! What happens when someone turns on the Jacuzzi of foreigners rushing to dump their dollars back into the tub? A real mess! (Well, if you don't like that analogy, try one of your own!) What I'm trying to say is that the Fed doesn't have a lot of room to maneuver this time around. And concentrating only on the recession - the drain - while forgetting the froth (inflation), is truly hazardous. What Should You Do? In spite of all you've just read, you need to keep your faith that the American free enterprise system is the best economic system ever tried on this planet. It has created more wealth, and a better standard of living for more people, than all of the central planners in governments around the world. Socialism and government central planning have been tested to death in countries ranging from the former Soviet Union to Cuba. We've survived tough times before - notably the miserable inflation, recession, and stock market quagmire of the late 1970s and early 1980s. We survived double-digit inflation, double-digit unemployment in many areas of the country, and double-digit interest rates (including a prime rate of 21%). And we never want to go through that again! So in addition to forcing our candidates of all parties to account for their promises, we must each plan our finances. My suggestions are unchanged from the January commentary and forecast. Hedging your dollar bets with gold shares funds or ETFs, or the Merk Hard Currency Fund or Everbank's foreign currency denominated, FDIC-insured deposits have been profitable strategies, and are still recommended. Similarly, I continue to suggest a "liquidity" cushion of bank or money market deposits, for flexibility to take advantage of buying opportunities - whether in the financial markets or personal assets. (If you are keeping large amounts of cash on deposit, this would be a good time to make sure they are all under the FDIC insured limits.) Or purchase Treasury bills directly from the government through For the long run, I am still a believer in investing in a diversified portfolio of American stocks. I refer you again to the long term charts in both The Savage Truth and The Savage Number, showing that there has never been a 20-year period where you would have lost money in a diversified portfolio of large company stocks, with dividends reinvested - even after adjusting for inflation. Thus, if you're contributing to a 40l(k) plan at work, or an IRA, this is not the time to stop investing. Continue with your regular monthly contributions, even though the stock market may decline. (Read the recent column at my website, though, about making sure your retirement plan isn't charging too much in the way of fees.) You have the long run ahead of you, and it's worth investing for your future. In that regard, the stock market is a far better bet than Social Security - and look how much they take out of your paycheck every week for that! Just make sure you're properly diversified, and do click on the "Financial Engines" link, which is free at my website, to get personalized advice from this independent service. Then make sure you've paid down your debt, or locked it in with fixed rates. And once you've made a dent in your debt (the Consumer Credit Counseling Services toll-free number is always on the home page at TerrySavage.com), then start saving and investing even more. We're going to need it! Finally, pass this common-sense message along to your children and friends, who have received a far different set of advertisements and incentives over the past decade. It's not that you can't have it all. It's just that you can't have it all on borrowed money. The American Dream is alive and well. But it is a dream, a goal, an opportunity - not an entitlement! And that's The Savage Truth! ************************************************************************
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Copyright 1999, Terry Savage Productions | The Money Lady / tm