Thursday, December 4, 2008

The Rest of The Story

The present economic crisis is man made, just like the Great Depression was man made. The big difference this time around, I hope, is mass communication. In the early 1930’s, radio was in its infancy, and TV was yet to be invented. The movement of ideas traveled at a much slower pace or perhaps not at all. This time there are any number of ideas out there about how to fix the present economic crisis. Economists appear on TV, in print in the newspapers and even on their blog or web site. I also feel good about the fact that many of the people being assembled for the new Obama administration are bright and capable people. And, President-elect Obama states that there will be strong debate within his administration and hopefully this will bring out the best ideas for the measures to be taken for the economic recovery.

One aspect of all this is: what happens to our money? I am not talking about the new designs the U.S. Treasury seems to be coming up with each week. I understand that new technology can be used to safeguard our currency. The last thing we need is for another country to flood the world with bogus one hundred dollar bills, we will be printing enough of those babies ourselves.

Knowing Paul Volcker will be hanging around, and, I hope, have the president’s ear, makes me feel better about our chances for a sound recovery. But, that said, there are still some very basic things about monetary policy that I would like to address.

Whether the federal government borrows the money or just prints it, the specter of inflation is out there. Those that hang in there for the most part, I think will be fine. The stock market will go back up as earnings turn around for corporations. The idea that stocks will no longer sell at a price earnings ratio will never happen. When earnings projections start back up, the stock market will begin its recovery. Like the stock market, the real estate market will come back as well. Unless someone can make a case for a huge wave of deflation, housing prices will come back much like the stock market. But, what about those people that hold cash?

Those individuals that know they do not understand the stock market or trust a broker to put them in the right mutual fund, are left with their savings account at their bank, or, their box of money under the bed. If they were smart enough to make that gold coins in the box under the bed, then even if the house burns down, they still have their gold coins.

The amounts of money that our government is going to spend and print will cause a new round of inflation. This may not appear for a while, but it is coming. Those that know something about hedging for inflation may want to revisit their plans again. Those who will invest will see their investments move up in value over time. The prices we pay today for goods and services will go up, and while it is hard to believe this now as prices are going down today, believe me, this phase of the economic cycle will happen. My question is: what is the federal government going to do to protect all those people who will be left with much reduced purchasing power for the money they saved. The argument that Americans do not save, to me is a joke. Why save money that will buy you less goods and services the following year even if you saved it? If the government keeps interest rates low, two things will happen. The first one is that people will not save. In the 1970’s and 1980’s money market funds were all the rage because people were being compensated for giving up the use of their money for an attractive interest rate. Second, low interest rates are good for developers of real estate and other expensive or capital intensive projects. But when interest rates are held down for political reasons, like to keep the party in power and the party going, it causes investors to reach for yield, and, now do you see where I am going? Yes, reaching for yield can be spelled investing in asset-backed bonds, and, now you know the rest of the story.

Stay tuned.


LceeL said...

And now, the news!

Nice job with the rest of the story.

moneythoughts said...

I may have done a rush job on explaining the connection between monetary policy which can influence interest rates, that is what monetary policy does. And the results from a monetary policy that kept interest rate down and made the expansion of the economy possible. A long time ago, under another Chairman of the Fed, William McKennsey Martin, he made a very insightful statement. It went something like this: The job of the Fed is to take the punch bowl away just as the party is get going. Unfortunately, Greenspan thought he was smarter than Martin and kept interest rate low for too long. But that is only part of the story. But the rest of the rest of the story is a story for another time.