Saturday, January 10, 2009

The next wave of bailouts

It's not just the banks that are short of money. Many US States and local authorities are also suffering financial problems, and this is affecting the trade in their bonds, i.e. their borrowings on the money market. ("What are bonds, exactly?" - see here.)

Michael Panzner reports that municipal bonds ("munis") offer a better yield than US Treasury bonds, but the difference is still not enough to pay for the extra risk. Professional investors are short-selling "munis". i.e. betting that they will fall in price. A steep fall may indicate imminent bankruptcy, and some say this is on the way for many authorities, as Mish reported at the end of December.

So, what will happen when the US Government is seen to be buying everybody's bad debts?

People (even here in the UK, where we tend to wait patiently for our wise rulers to solve all) are beginning to worry about inflation, and are thinking about investing again. An article in Elliott Wave International warns us not to be panicked into parting with our cash, and reminds us:

... there are periods when inflation does erode the value of cash. I mean, look at the seven years leading up to the October 2007 peak in U.S. stocks: big gains in the stock indexes, while inflation was eroding cash. No way did cash do as well as stocks during that time.


Wrong. Cash outperformed stocks in the seven years leading up to the 2007 stock market high. That outperformance has only increased in the time since.

Since this is the view I took and communicated to clients in the 1990s, you will understand that I didn't make much money as a financial adviser. But it was certainly good advice, even if it was based on strongly-felt intuition rather than macroeconomic analysis.

Not that analysis guarantees results, in a world where the money game's rules are changed at will by politicians with a host of agendas that they don't share with us ordinary types. But my current guess is that the stockmarket will halve again in the next few years, when compared with the cost of living.


James Higham said...

So, do we hang onto cash or invest it?

Sackerson said...

I can't recommend, but I can throw some ideas around.

First, read the second half of the comments on this thread:

I don't think hyperinflation will hit suddenly like a tsunami, so I think some of us could hold cash if we are thinking of a major purchase in the next 12 months and want to take advantage of distressed sellers and manufacturers. Also, we need cash for emergencies.

Longer term, more cautious people might want some NS&I index-linked certs - at least they should hold their value, approximately.

More speculative types might be interested by Marc Faber's prediction that precious metals may outperform most other asset types this year; and note that the price of silver appears to be well below its usual long-term ration to gold.

But the stockmarket looks treacherous to me. And with all this borrowing going on, bonds don't seem as secure as they did. Real estate is still overpriced, most would seem to agree on that.

Of course, many successful businesses have been started in a recession/depression...