The public are gradually coming to realise that, within our countries, our institutions and businesses are not run fairly and for the general benefit of voters and investors.
Now, as the balance of economic power is shifting towards the East, we may discover that the rule of international law does not constrain the strongest. A straw in the wind is this story, about a small Chinese company that has defied a Goldman Sachs subsidiary, refusing to pay $80 million relating to derivatives contracts. The significant element is the reported preparedness of the Chinese government to support national businesses against foreign banks in the law courts.
Much more worrying, in my view, are the implications of this pugnacious stance if it is applied to copyrights and patents. Since the West cannot compete with the low labour costs of the developing world, it is placing its hope in its long-accumulated expertise and technology. Should mighty foreign nations begin to disregard intellectual property rights, we could find ourselves in a very difficult position. I raised this issue in 1997 - here, here and here. Please also see my review of James Kynge's "China Shakes the World", where Kynge is given the run-around when he tries to enquire into copyright theft in China.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Wednesday, December 30, 2009
Tuesday, December 29, 2009
The US (and UK) mortgage crisis continues
Update: China may now be experiencing a housing bubble
__________________________________________
Economist Mark Thoma comments on news (which was released on Christmas Eve - a "good time to bury bad news"?) that the US Treasury is considering doubling its line of credit to "Fannie Mae" and "Freddie Mac", from $400 billion to $800 billion. What does this mean?
Let's start with the background to these two "government-sponsored enterprises" (GSEs).
"Fannie Mae" is the familiar term for the Federal National Mortgage Association, set up in 1938 at the tail end of the American Great Depression to help make mortgages more easily available to low-income housebuyers, by buying the loans from mortgage lenders. Effectively, this was a way of guaranteeing poorer-quality loans and so it supported and encouraged lenders as well as borrowers.
In 1968, Fannie Mae was split into two companies; one private, doing the same job as before, but without an explicit guarantee against losses from defaults. The other part was a new public organisation, the Government National Mortgage Association, aka "Ginnie Mae"; this did guarantee mortgage-backed investments, but was originally intended to serve defined groups of borrowers, e.g. public employees and veterans (ex-military personnel).
In 1970, "Freddie Mac" (the Federal Home Loan Mortgage Corporation) was created to do much the same as Fannie Mae, so providing competition and helping to increase the supply of mortgages.
Given the quality of the loans that underpinned their products, Fannie Mae and Freddie Mac were particularly vulnerable to problems in the credit market and were so badly damaged in the "Credit Crunch" of 2008 that they were taken into public control, or "conservatorship". This helped maintain confidence in the banking system, but at a cost: the Treasury has, in effect, become the guarantor against losses, which now become the liability of the taxpayer. Some would say that a second cost is "moral hazard", in that reckless lenders have been shielded from the consequences of their actions, and so will not properly learn their lesson.
Returning to Mark Thoma, we find that mortgage defaults may eventually total $400 billion, which in inflation-adjusted terms is similar to the losses sustained in the Savings and Loan crisis of the late 1980s. (The root cause of the problem then was the same - treating houses as another type of speculative investment - and the trigger for the fallout was the Tax Reform Act of 1986, which (among many other changes) removed or reduced tax breaks relating to residential property investment.)
Why, after all this official support, are we expecting heavy losses on the housing market?
The answer, as I understand it, is that the wrong problem has been solved. By bailing-out banks and other lenders, governments on both sides of the Atlantic have attempted to preserve "liquidity" - the availability of money. But this doesn't tackle the real problem, which is "insolvency" - i.e. when debts outweigh assets. Housing is overpriced - valuations swiftly doubled in the four years after 2002 - and when people perceive that the prices are unrealistic in the long term, the prices have to come down. However, home loans don't come down; they are fixed amounts of debt, that is either paid or defaulted. So as house valuations decline, more and more homeowners find themselves owing more than the resale value of their property. Behind them stand many others who fear that they may find themselves in the same situation, or who realize that renting would be even cheaper than paying their mortgage.
For although interest rates have dropped to historically low levels, the capital still has to be repaid, and so the total monthly cost can't be reduced much more. In an economic downturn, the weight of this obligation is unlikely to lighten because of quickly-rising wages, and until house prices rise significantly, they will also look like a poor capital investment to the borrower. For millions, a mortgage is now a useless millstone around the neck.
Back in September 2008, I floated the wild idea of paying off all US mortgages and making all such loans illegal in future; a comment by one reader, "Sobers", suggested the more moderate approach of partial debt forgiveness. Thoma speculates that one reason for the increased Treasury line of credit for Fannie Mae and Freddie Mac may indeed be a preparation for writing-off a proportion of mortgage debt.
This would be a radical step and maybe it's more likely that the US Treasury simply wishes to make enough money available to cover all likely defaults, with enough extra to prevent the spread of panic in the housing market. After all, people who bought their houses 10 years ago or earlier, are less likely to be in "negative equity" now; unless they took out extra property-backed loans for consumer spending (known as "secured loans" in the UK, and "home equity line of credit" - or HELOC - in the US). Paying off part of everyone's debt would give help to those who didn't need it as well as those who did; and might carry its own "moral hazard" by allowing future borrowers to hope that they might one day be bailed-out, too, so encouraging them to spend too much and get into unaffordable debt. Better, on the whole, to underwrite the losses of the worst cases and discipline the defaulting borrowers with the stigma of repossession, which is a warning to other borrowers, though sadly not so much of an object lesson to lenders.
Another strategy, since interest rates are so low, would be to reduce monthly costs of borrowing by extending the term of mortages and so cutting the amount of capital that has to be repaid each month. You can play with variants on interest rates and mortgage terms here - Yahoo offers some American versions here - and as you can see, extending the term offers some relief. However, there's only so long you're likely to want to have a mortgage, unless we descend to the 100-year mortgages of Japan.
There's also not much scope for cutting interest rates further. The banks loaned out far too much money in the good times and cut their reserves to a dangerous minimum. When the governments made more cash available to them, they kept a lot of it as a temporary buffer, so borrowing for housebuyers and businesses has continued to be on difficult terms. And the banks haven't passed on much of the drop in interest rates, because they are trying to rebuild their reserves. The central banks could cut the interest rate to zero and the banks that borrow from them would still be charging us something like 4%. Until the banks are solvent, we are going to remain hard up; unless there is debt forgiveness, and I don't think that will come for quite some time yet.
In short, I expect the current half-optimistic mood to evaporate gradually in the coming year, as people realize that the problems are enduring and begin to adjust their expectations and behaviour accordingly. I anticipate a longer-term reduction in the inflation-adjusted valuations of houses, though there may be temporary rallies from time to time, just as you get them in a "bear market" in stocks and shares.
I said years ago to friends and colleagues that whatever you treat like an investment will behave like one, and not for the first time, the housing market is copying the behaviour of equities, with the added disadvantages of being less easily and more expensively sold, and of being bought with borrowed money.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
__________________________________________
Economist Mark Thoma comments on news (which was released on Christmas Eve - a "good time to bury bad news"?) that the US Treasury is considering doubling its line of credit to "Fannie Mae" and "Freddie Mac", from $400 billion to $800 billion. What does this mean?
Let's start with the background to these two "government-sponsored enterprises" (GSEs).
"Fannie Mae" is the familiar term for the Federal National Mortgage Association, set up in 1938 at the tail end of the American Great Depression to help make mortgages more easily available to low-income housebuyers, by buying the loans from mortgage lenders. Effectively, this was a way of guaranteeing poorer-quality loans and so it supported and encouraged lenders as well as borrowers.
In 1968, Fannie Mae was split into two companies; one private, doing the same job as before, but without an explicit guarantee against losses from defaults. The other part was a new public organisation, the Government National Mortgage Association, aka "Ginnie Mae"; this did guarantee mortgage-backed investments, but was originally intended to serve defined groups of borrowers, e.g. public employees and veterans (ex-military personnel).
In 1970, "Freddie Mac" (the Federal Home Loan Mortgage Corporation) was created to do much the same as Fannie Mae, so providing competition and helping to increase the supply of mortgages.
Given the quality of the loans that underpinned their products, Fannie Mae and Freddie Mac were particularly vulnerable to problems in the credit market and were so badly damaged in the "Credit Crunch" of 2008 that they were taken into public control, or "conservatorship". This helped maintain confidence in the banking system, but at a cost: the Treasury has, in effect, become the guarantor against losses, which now become the liability of the taxpayer. Some would say that a second cost is "moral hazard", in that reckless lenders have been shielded from the consequences of their actions, and so will not properly learn their lesson.
Returning to Mark Thoma, we find that mortgage defaults may eventually total $400 billion, which in inflation-adjusted terms is similar to the losses sustained in the Savings and Loan crisis of the late 1980s. (The root cause of the problem then was the same - treating houses as another type of speculative investment - and the trigger for the fallout was the Tax Reform Act of 1986, which (among many other changes) removed or reduced tax breaks relating to residential property investment.)
Why, after all this official support, are we expecting heavy losses on the housing market?
The answer, as I understand it, is that the wrong problem has been solved. By bailing-out banks and other lenders, governments on both sides of the Atlantic have attempted to preserve "liquidity" - the availability of money. But this doesn't tackle the real problem, which is "insolvency" - i.e. when debts outweigh assets. Housing is overpriced - valuations swiftly doubled in the four years after 2002 - and when people perceive that the prices are unrealistic in the long term, the prices have to come down. However, home loans don't come down; they are fixed amounts of debt, that is either paid or defaulted. So as house valuations decline, more and more homeowners find themselves owing more than the resale value of their property. Behind them stand many others who fear that they may find themselves in the same situation, or who realize that renting would be even cheaper than paying their mortgage.
For although interest rates have dropped to historically low levels, the capital still has to be repaid, and so the total monthly cost can't be reduced much more. In an economic downturn, the weight of this obligation is unlikely to lighten because of quickly-rising wages, and until house prices rise significantly, they will also look like a poor capital investment to the borrower. For millions, a mortgage is now a useless millstone around the neck.
Back in September 2008, I floated the wild idea of paying off all US mortgages and making all such loans illegal in future; a comment by one reader, "Sobers", suggested the more moderate approach of partial debt forgiveness. Thoma speculates that one reason for the increased Treasury line of credit for Fannie Mae and Freddie Mac may indeed be a preparation for writing-off a proportion of mortgage debt.
This would be a radical step and maybe it's more likely that the US Treasury simply wishes to make enough money available to cover all likely defaults, with enough extra to prevent the spread of panic in the housing market. After all, people who bought their houses 10 years ago or earlier, are less likely to be in "negative equity" now; unless they took out extra property-backed loans for consumer spending (known as "secured loans" in the UK, and "home equity line of credit" - or HELOC - in the US). Paying off part of everyone's debt would give help to those who didn't need it as well as those who did; and might carry its own "moral hazard" by allowing future borrowers to hope that they might one day be bailed-out, too, so encouraging them to spend too much and get into unaffordable debt. Better, on the whole, to underwrite the losses of the worst cases and discipline the defaulting borrowers with the stigma of repossession, which is a warning to other borrowers, though sadly not so much of an object lesson to lenders.
Another strategy, since interest rates are so low, would be to reduce monthly costs of borrowing by extending the term of mortages and so cutting the amount of capital that has to be repaid each month. You can play with variants on interest rates and mortgage terms here - Yahoo offers some American versions here - and as you can see, extending the term offers some relief. However, there's only so long you're likely to want to have a mortgage, unless we descend to the 100-year mortgages of Japan.
There's also not much scope for cutting interest rates further. The banks loaned out far too much money in the good times and cut their reserves to a dangerous minimum. When the governments made more cash available to them, they kept a lot of it as a temporary buffer, so borrowing for housebuyers and businesses has continued to be on difficult terms. And the banks haven't passed on much of the drop in interest rates, because they are trying to rebuild their reserves. The central banks could cut the interest rate to zero and the banks that borrow from them would still be charging us something like 4%. Until the banks are solvent, we are going to remain hard up; unless there is debt forgiveness, and I don't think that will come for quite some time yet.
In short, I expect the current half-optimistic mood to evaporate gradually in the coming year, as people realize that the problems are enduring and begin to adjust their expectations and behaviour accordingly. I anticipate a longer-term reduction in the inflation-adjusted valuations of houses, though there may be temporary rallies from time to time, just as you get them in a "bear market" in stocks and shares.
I said years ago to friends and colleagues that whatever you treat like an investment will behave like one, and not for the first time, the housing market is copying the behaviour of equities, with the added disadvantages of being less easily and more expensively sold, and of being bought with borrowed money.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Monday, December 21, 2009
When to invest?
This interactive resource from the Wall Street Journal (hat-tip to the Wall Street Pit blog) looks at 10-year returns from investing in the NYSE (companies listed on the New York Stock Exchange) and the S&P (Standard & Poor's) 500, i.e. the top 500 US companies. The last 10 years look like the worst decade since records began.
Now, some may say that it's a great time to get back in. But if you look at the S&P 500 graph at bottom right, you'll see that returns are calculated in both nominal and inflation-adjusted terms. Sometimes you get an apparent gain which is really much less so, or even a loss, once you take inflation into account.
This is exactly what happened in 1970-79. My fear is that all the current monetary pumping will stoke inflation and the market will rise in nominal terms, but these gains will be undermined by a general increase in consumer prices.
If we have a re-run of the 1970s, it could be years before the market yields real returns.I've covered this topic quite a few times on my old blog - in this post for example, I show that in nominal terms, the worst point was in September 1974; but adjusted for inflation, the real bottom came in July 1982:
It's said that history doesn't repeat itself, but it rhymes. If anything, that has worse implications for us, because by any measure, the levels of debt in the US and UK economies are much higher than they have ever been in history.
I can quite believe that the market will zoom up a bit more, but my feeling is that we are in what is known as a "bear market rally" - a temporary upward twist before a slump. Gamblers may make fortunes in the current rise, but the reversals in a bear market can be unpredictable, sudden and savage, just like the creature after which such a market is named.
Personally, I'm in favour of diversifying investments, and building up emergency supplies of cash and the things you need for daily life. I don't expect things to run smoothly in the next few years.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Now, some may say that it's a great time to get back in. But if you look at the S&P 500 graph at bottom right, you'll see that returns are calculated in both nominal and inflation-adjusted terms. Sometimes you get an apparent gain which is really much less so, or even a loss, once you take inflation into account.
This is exactly what happened in 1970-79. My fear is that all the current monetary pumping will stoke inflation and the market will rise in nominal terms, but these gains will be undermined by a general increase in consumer prices.
If we have a re-run of the 1970s, it could be years before the market yields real returns.I've covered this topic quite a few times on my old blog - in this post for example, I show that in nominal terms, the worst point was in September 1974; but adjusted for inflation, the real bottom came in July 1982:
It's said that history doesn't repeat itself, but it rhymes. If anything, that has worse implications for us, because by any measure, the levels of debt in the US and UK economies are much higher than they have ever been in history.I can quite believe that the market will zoom up a bit more, but my feeling is that we are in what is known as a "bear market rally" - a temporary upward twist before a slump. Gamblers may make fortunes in the current rise, but the reversals in a bear market can be unpredictable, sudden and savage, just like the creature after which such a market is named.
Personally, I'm in favour of diversifying investments, and building up emergency supplies of cash and the things you need for daily life. I don't expect things to run smoothly in the next few years.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Sunday, December 20, 2009
More on gold
During this crisis, we hear more from the "gold bugs" - people who are convinced that most modern currencies will become worthless, because they are "fiat money", i.e. the government can make unlimited amounts of them since they are not related to anything in fixed supply, such as gold (or land, when the Nazis restructured the mark).
One such is an American called Jim Willie. He reminds us of debt problems, not only in the USA and Britain, but Spain, Greece etc. Even Swiss banks are under pressure, because of loans to small European countires whose currencies have since devalued. Willie thinks the Euro will unravel because of the difficulties of a number of its member economies, and that Germany will reintroduce the mark, perhaps under some reassuringly Euro-like pseudonym.
Germany happens to have the world's second-largest official holding of gold - 3,400 tonnes compared to the USA's 8,100 (assuming we are being told the truth about how much the USA actually has in its vaults, and that is a matter of serious debate). This article reports China's ambition to increase its own holding of gold, from around 1,000 tonnes now to perhaps as much as 10,000 tonnes in 10 years' time.
The gold mania is not universal. Writing in the Daily Telegraph, Ambrose Evans-Pritchard predicts that the price of gold will actually fall next year - among other bad things such as the collapse of America's social security pension fund. He may be right. In a panic, people want ready money, so maybe cash will (for a time) be king. But when an economy is in dire straits, its government will do whatever it can to ease the pain, and many think that the strategy will be to increase the money supply, or even introduce a new form of the currency, as has just happened in North Korea.
The attraction of gold is for pessimists. It doesn't earn any interest, so mainly it is seen as a last-resort store of value when the money system breaks down (and it's nice to wear and show off). It is perfectly possible that you could make a loss on gold, but it will never be worth nothing at all, unlike the old US Continentals, or Confederate money after the North won the Civil War. In this context, it's worth noting that Reuters news agency reported back in September that Hong Kong moved its gold reserves out of London and into the gold depository at its Chek Lap Kok international airport. A sign of something, but what?
Gold is not the only tangible store of value, of course. Agricultural land, houses, food, medicines etc all have intrinsic value, i.e. they are worth something because of what they can do for you themselves, not just because they can be exchanged for something else.
Inflation remains a serious long-term threat. Comparing the past and present value of cash is difficult, because the economy has increased in size and changed in nature; but depending on the measure you use and looking at what has happened since 1971 (when I started at college), the British pound has lost 90% - 96% of its buying power. It's still (until April next year) possible to retire at age 50 in this country, so if history repeats itself, you could see a similar devaluation during a long retirement.
In short, it's not about the value of gold, but the unreliability of money.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
One such is an American called Jim Willie. He reminds us of debt problems, not only in the USA and Britain, but Spain, Greece etc. Even Swiss banks are under pressure, because of loans to small European countires whose currencies have since devalued. Willie thinks the Euro will unravel because of the difficulties of a number of its member economies, and that Germany will reintroduce the mark, perhaps under some reassuringly Euro-like pseudonym.
Germany happens to have the world's second-largest official holding of gold - 3,400 tonnes compared to the USA's 8,100 (assuming we are being told the truth about how much the USA actually has in its vaults, and that is a matter of serious debate). This article reports China's ambition to increase its own holding of gold, from around 1,000 tonnes now to perhaps as much as 10,000 tonnes in 10 years' time.
The gold mania is not universal. Writing in the Daily Telegraph, Ambrose Evans-Pritchard predicts that the price of gold will actually fall next year - among other bad things such as the collapse of America's social security pension fund. He may be right. In a panic, people want ready money, so maybe cash will (for a time) be king. But when an economy is in dire straits, its government will do whatever it can to ease the pain, and many think that the strategy will be to increase the money supply, or even introduce a new form of the currency, as has just happened in North Korea.
The attraction of gold is for pessimists. It doesn't earn any interest, so mainly it is seen as a last-resort store of value when the money system breaks down (and it's nice to wear and show off). It is perfectly possible that you could make a loss on gold, but it will never be worth nothing at all, unlike the old US Continentals, or Confederate money after the North won the Civil War. In this context, it's worth noting that Reuters news agency reported back in September that Hong Kong moved its gold reserves out of London and into the gold depository at its Chek Lap Kok international airport. A sign of something, but what?
Gold is not the only tangible store of value, of course. Agricultural land, houses, food, medicines etc all have intrinsic value, i.e. they are worth something because of what they can do for you themselves, not just because they can be exchanged for something else.
Inflation remains a serious long-term threat. Comparing the past and present value of cash is difficult, because the economy has increased in size and changed in nature; but depending on the measure you use and looking at what has happened since 1971 (when I started at college), the British pound has lost 90% - 96% of its buying power. It's still (until April next year) possible to retire at age 50 in this country, so if history repeats itself, you could see a similar devaluation during a long retirement.
In short, it's not about the value of gold, but the unreliability of money.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Saturday, December 19, 2009
House prices: the second wave down?
Edward Harrison looks at statistics for US housing and quotes Frank Veneroso*, who guesses that, on average, houses with mortgages have almost no equity left in them:
"... the flow of funds accounts tell us that the total value of residential real estate is $16.53 trillion. The share owned by households with a mortgage is probably $10 trillion to $11 trillion. Total mortgage household debt now stands at $10.3 trillion. In effect, for all households with a mortgage taken in the aggregate, their loan-to-value ratio is now close to 100% and perhaps close to half of them have a zero to negative equity."
For some US housebuyers (especially if they haven't taken out a second mortgage or secured loan on the property), the law relating to their loans says that they can return the house to the mortgage lender and if there is any debt left over after selling the house, that's the lender's hard luck - there's no pursuing the buyer. So if a homeowner is in negative equity and interest rates rise, the easy thing to do is strip the house, rent a van to move the stuff, and mail the house keys to the mortgage company (this is jocularly known as "jingle mail").
In some cases, the paperwork on the mortgage (written in haste in boom times) is so sloppy that mortgage lenders may not even be able to legally foreclose and seize the house.
I have also seen graphs (like this one) to show the large number of low-initial-fixed-rate mortgages that are going to return to variable rate in the next year or two, just as (it seems) interest rates may be on the increase.
So there are a number of reasons why banks, the housing market and the economy generally may still face very testing times.
*Veneroso also believes that for years, central banks have held far less gold than they would like us to believe. If this is correct and the currency comes under pressure, there may be a steep rise in the price of gold as the Federal Reserve and others buy back hastily, to reassure us that the currency does indeed have some kind of backing. But please remember (a) this is speculation and (b) gold has already appreciated very considerably in the last couple of years.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
"... the flow of funds accounts tell us that the total value of residential real estate is $16.53 trillion. The share owned by households with a mortgage is probably $10 trillion to $11 trillion. Total mortgage household debt now stands at $10.3 trillion. In effect, for all households with a mortgage taken in the aggregate, their loan-to-value ratio is now close to 100% and perhaps close to half of them have a zero to negative equity."
For some US housebuyers (especially if they haven't taken out a second mortgage or secured loan on the property), the law relating to their loans says that they can return the house to the mortgage lender and if there is any debt left over after selling the house, that's the lender's hard luck - there's no pursuing the buyer. So if a homeowner is in negative equity and interest rates rise, the easy thing to do is strip the house, rent a van to move the stuff, and mail the house keys to the mortgage company (this is jocularly known as "jingle mail").
In some cases, the paperwork on the mortgage (written in haste in boom times) is so sloppy that mortgage lenders may not even be able to legally foreclose and seize the house.
Others, suspecting that the market will go down further, may wish to sell to get out what equity they can while there still is any. And actual or imminent unemployment may force still others to leave - the official US unemployment rate is around 10%, but some say that if looked at properly the true rate is more like 17%. (Update: John Williams says 22%)
I have also seen graphs (like this one) to show the large number of low-initial-fixed-rate mortgages that are going to return to variable rate in the next year or two, just as (it seems) interest rates may be on the increase.
So there are a number of reasons why banks, the housing market and the economy generally may still face very testing times.
*Veneroso also believes that for years, central banks have held far less gold than they would like us to believe. If this is correct and the currency comes under pressure, there may be a steep rise in the price of gold as the Federal Reserve and others buy back hastily, to reassure us that the currency does indeed have some kind of backing. But please remember (a) this is speculation and (b) gold has already appreciated very considerably in the last couple of years.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
'Tis a gift to be simple
Via Lifehacker, I find a sane blog to counter my (and possibly your) OCD: Small Notebook. One of the principles it stresses is knowing when to stop.
I'm adding it to my sidebar as a still, small voice of calm. Maybe you should do the same.
I'm adding it to my sidebar as a still, small voice of calm. Maybe you should do the same.
How should we invest if we're back to "boom and bust?"
Edward Harrison analyses the current financial situation, and thinks that governments will continue to try to stimulate their economies by increasing public debt. This will increase (or support) asset prices, but you can't rack up all your expenses on your credit card forever: another crisis will come and then it's time to pay the bill. The money base will shrink and asset prices will decline again.
The gamblers will try to buy into the false boom and sell before the bust, but this is a risky strategy. I haven't the nerve for it, though some would say you should be prepared to speculate with 10% of your investment money.
For the ordinary investor, it's a difficult time: holding cash will seem like a losing strategy, and he/she may be tempted back into the market at exactly the wrong moment - the moment when everybody thinks that "you can't lose". We saw this in the technology boom of the 90s, and the house price boom a few years ago.
What is clear is that the system is unstable. In these wild times, fortunes will be won by some, lost by others; but the prudent saver looking for secure and steady rewards will have to diversify and consider all sorts of safety measures. Let's look at common investment options, in what used to be thought of as ascending risk order.
If governments try to counter the downturn by producing too much new cash and credit, the result may be inflation and that will punish bank and building society accounts. The insurance company I started with in the late 80s used to have a handout on the effects of inflation: it showed the real purchasing power of money placed in a bank account for 10 years from the mid-70s to the mid-80s - even letting the interest accumulate in the account, your cash had lost 50% of its buying power in a decade. And the events of October 2008 have alerted savers to the fact that money in the bank is not a risk-free option - thank goodness for the limited (up to £50,000) protection of the Financial Services Compensation Scheme.
Government bonds (or gilts) are a problem, too - their yield (their annual income as a percentage of their current traded price) is very low, but when interest rates rise the capital value of gilts will fall correspondingly. There is also mounting concern about national credit ratings and the growing risk of default. For those who still have faith in the UK government's promises, National Savings and Investments claims to offer "100% security for your money" (actually, there is no such thing, but you know what they mean). For example, it is still possible to buy National Savings Index-Linked Certificates, to guard against inflation.
I suspect that with-profits funds will continue to face huge challenges in the coming years. They were set up to deliver modest but (most importantly) reassuringly steady growth; but the volatility of modern markets has stood up in their boat and is rocking it violently. Look out for further occasions when with-profits managers have to impose "Market Value Adjusters" (MVAs) - temporary discounts on the face value of your holding if you're trying to cash-out at a turbulent period. They're trying to preserve balance in an unbalanced time, and I fear they may not succeed.
Higher interest rates (maybe higher taxes, too) and increasing unemployment will tend to affect house prices. In a recession / depression, much commercial property will stand empty and so that market will decline, too.
When the money base shrinks and interest rates increase, businesses will suffer and many stocks and shares (aka "equities") will be hit. Already, professional investors have increased their holding of "defensive" stocks - shares in companies providing things we always need, such as energy and reasonably-priced food and clothing. You can reduce investment risk further by holding shares in more than one company and in more than one type of business; you can also diversify by including foreign equities.
Which brings us to another topic: currency depreciation. The British pound has lost some of its buying power abroad, in part a response by foreign investors to our problems with debt and a weakening economy. The pound has lost ground against the US dollar (not because the US economy is strong, but because the US dollar is still - for now - the world's trading currency) and the Euro over the last couple of years, so even if prices here in the UK seem stable, you might have gained by investment in other countries, or even just holding some money in foreign currency. Of course, the key questions are, which investments, which currencies, when to get in and out?
For the adventurous, there are commodities (everything from pork bellies to agricultural land, oil and gold), emerging markets (developing economies - remember the saying, "an emerging market is one from which it may be difficult to emerge") and specialist funds/shares, such as in technology and medical research.
Further up (or off) the scale are the outright financial gambles - futures and options, derivatives etc. These things - supposedly originally designed to cover and so reduce risk - are now the instruments that threaten our security. I think the main cause of the problem is that there seems to be no notion of "insurable interest", as with life insurance. Prior to the UK's Life assurance Act of 1774, it was possible to take out insurance on a complete stranger, whereas now you can insure only against the loss you might suffer if someone dies. If modern options trading was regulated in the same way, the market would be far smaller and much more secure. Perhaps that will come, one day.
This not the place for any recommendations, but if you are lucky enough to have any investments or savings, perhaps it's a good time to review them, maybe in consultation with your financial adviser. If you don't know which horse to back, then at least you can try to bet on a wider selection, or even all of them; for unlike racecourse betting, there is (most unfortunately) no option to stay out altogether; not unless you have nothing.
UPDATE
Z. O. Greenberg looks at ideas for diversifying investments out of the dollar. This would apply similarly to those who are chary of the British pound. But beware - some say the US dollar may strengthen soon.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
The gamblers will try to buy into the false boom and sell before the bust, but this is a risky strategy. I haven't the nerve for it, though some would say you should be prepared to speculate with 10% of your investment money.
For the ordinary investor, it's a difficult time: holding cash will seem like a losing strategy, and he/she may be tempted back into the market at exactly the wrong moment - the moment when everybody thinks that "you can't lose". We saw this in the technology boom of the 90s, and the house price boom a few years ago.
What is clear is that the system is unstable. In these wild times, fortunes will be won by some, lost by others; but the prudent saver looking for secure and steady rewards will have to diversify and consider all sorts of safety measures. Let's look at common investment options, in what used to be thought of as ascending risk order.
If governments try to counter the downturn by producing too much new cash and credit, the result may be inflation and that will punish bank and building society accounts. The insurance company I started with in the late 80s used to have a handout on the effects of inflation: it showed the real purchasing power of money placed in a bank account for 10 years from the mid-70s to the mid-80s - even letting the interest accumulate in the account, your cash had lost 50% of its buying power in a decade. And the events of October 2008 have alerted savers to the fact that money in the bank is not a risk-free option - thank goodness for the limited (up to £50,000) protection of the Financial Services Compensation Scheme.
Government bonds (or gilts) are a problem, too - their yield (their annual income as a percentage of their current traded price) is very low, but when interest rates rise the capital value of gilts will fall correspondingly. There is also mounting concern about national credit ratings and the growing risk of default. For those who still have faith in the UK government's promises, National Savings and Investments claims to offer "100% security for your money" (actually, there is no such thing, but you know what they mean). For example, it is still possible to buy National Savings Index-Linked Certificates, to guard against inflation.
I suspect that with-profits funds will continue to face huge challenges in the coming years. They were set up to deliver modest but (most importantly) reassuringly steady growth; but the volatility of modern markets has stood up in their boat and is rocking it violently. Look out for further occasions when with-profits managers have to impose "Market Value Adjusters" (MVAs) - temporary discounts on the face value of your holding if you're trying to cash-out at a turbulent period. They're trying to preserve balance in an unbalanced time, and I fear they may not succeed.
Higher interest rates (maybe higher taxes, too) and increasing unemployment will tend to affect house prices. In a recession / depression, much commercial property will stand empty and so that market will decline, too.
When the money base shrinks and interest rates increase, businesses will suffer and many stocks and shares (aka "equities") will be hit. Already, professional investors have increased their holding of "defensive" stocks - shares in companies providing things we always need, such as energy and reasonably-priced food and clothing. You can reduce investment risk further by holding shares in more than one company and in more than one type of business; you can also diversify by including foreign equities.
Which brings us to another topic: currency depreciation. The British pound has lost some of its buying power abroad, in part a response by foreign investors to our problems with debt and a weakening economy. The pound has lost ground against the US dollar (not because the US economy is strong, but because the US dollar is still - for now - the world's trading currency) and the Euro over the last couple of years, so even if prices here in the UK seem stable, you might have gained by investment in other countries, or even just holding some money in foreign currency. Of course, the key questions are, which investments, which currencies, when to get in and out?
For the adventurous, there are commodities (everything from pork bellies to agricultural land, oil and gold), emerging markets (developing economies - remember the saying, "an emerging market is one from which it may be difficult to emerge") and specialist funds/shares, such as in technology and medical research.
Further up (or off) the scale are the outright financial gambles - futures and options, derivatives etc. These things - supposedly originally designed to cover and so reduce risk - are now the instruments that threaten our security. I think the main cause of the problem is that there seems to be no notion of "insurable interest", as with life insurance. Prior to the UK's Life assurance Act of 1774, it was possible to take out insurance on a complete stranger, whereas now you can insure only against the loss you might suffer if someone dies. If modern options trading was regulated in the same way, the market would be far smaller and much more secure. Perhaps that will come, one day.
This not the place for any recommendations, but if you are lucky enough to have any investments or savings, perhaps it's a good time to review them, maybe in consultation with your financial adviser. If you don't know which horse to back, then at least you can try to bet on a wider selection, or even all of them; for unlike racecourse betting, there is (most unfortunately) no option to stay out altogether; not unless you have nothing.
UPDATE
Z. O. Greenberg looks at ideas for diversifying investments out of the dollar. This would apply similarly to those who are chary of the British pound. But beware - some say the US dollar may strengthen soon.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
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