Why Now Is the Time to Own Things

At the beginning of the new year, the market is probably going to continue sideways for a little bit, heading slowly higher as people start getting excited about January 20th and Obama's big stimulus plan. That's the short term picture and that's just my guess. I'll probably be right, but I wouldn't say my odds are any better than 60/40.

The long term is where I can add some real value, because the long term is so simple. To understand what is going to happen in the long term you first need to understand money, which thankfully is also very simple (although there are a lot of misconceptions out there).

Money is a medium by which we barter things. The typical way it works is we exchange our time and knowledge for a salary, then we deposit that salary in the bank, and then we spend it as we see fit through the various methods the banks provide for us (credit cards, debit cards, cash, cheques, etc). The price of goods (or investments or services) is determined by the demand (and supply) of that particular good, and the demand and supply of money. For the most part there is a ready supply of any good provided someone can make a profit selling it at that price and there seems to be a never ending demand for dollars (and to a lesser extent goods and services). Where the situation is somewhat more complicated is the supply of dollars.

For something so important, the amount of regulation in the supply of dollars is somewhat lacking. Fractional reserve banking (the system the entire world uses) allows banks to take the money you deposit with them and lend out some of it. So if you put $100 in the bank, they could lend out $90 to another customer, who would use it to pay another customer, who then deposits the $90. They could then lend $81 (of the new $90 deposit) to another customer, the end result is your $100 deposit ends up as $1,000 in the economy… provided the bank is keeping 10% in reserves.

The fundamental thesis is that there will never be a situation where all your customers will ask for their deposits at the same time, there probably wouldn't even be a situation where 20% of your customers asked for their money at the same time. As an aside, this is why no bank in the entire world can survive a 'run on the bank'. They simply do not have enough cash on hand to pay back all their depositors at the same time. The problem for the past few years has been an excess supply of dollars as a result of banks lending a lot (perhaps to people they shouldn't have been lending to). When the supply of dollars is high, it reduces the value of dollars, pushing prices up.

As a result of some unfortunate events, which I won't rehash, the banks have tightened their lending standards up again. This has resulted in a large decrease in the supply of dollars, thereby increasing the value of the dollar, pushing prices down. In my opinion, if you think about the markets (housing, equities, commodities, and goods - in that order of effect) in those terms (less dollars, therefore lower prices) the magnitude of the decline becomes easier to understand. Hank Paulson and Ben Bernanke are right, it would have been a heck of a lot worse if they didn't do the TARP and inject capital into the banks. Without that capital the supply of dollars would have shrunk even more drastically (a multiple of the $350 billion put in).

That brings us back to the long term picture. The supply of dollars shrunk (as banks shrunk their leverage ratios) and deflation became a big concern. Ben Bernanke, Hank Paulson, and anyone in government (current or future) seems to be dead set on that not happening. As a result they will be showering the market and the economy in money in 2009 and they have promised to keep doing it until deflation is no longer a concern.

The problem is they have shown that they almost always hit the gas too hard (lowering rates, etc.) and hit the brakes too hard (raising rates). They are pushing the pedal to the metal in 2009, so we may see significant overshoot in dollar supply. The banks will also lend more once prices start going up (it's stupid I know) which will also increase the money supply.

So what does that mean? Own things. The government is going to do whatever it can to increase the supply of dollars (raising prices) in an effort to avoid deflation and to inflate away some debt. That means that T-Bills (especially with negative yields) are going to be bad investments, while virtually anything else (oil, gold, stock, homes*, etc.) should generate positive returns. So wait until next week (when the window dressing, and subsequent undressing, is over) and look at areas you are most comfortable with in the long term and put that money to work before they devalue it.

*Please do not rush out and buy a house. While prices are low, houses are not necessarily good investments. They take a lot of money to maintain and property taxes, etc. will probably wipe out any short term gains. A house should be purchased with an eye to the very long term.

Comments

[Mike from a...:]

Beer or liquid gold, and solar panels........Have to go feed the Kangaroo's.......oh yeah, and i watched a bit of your famous Ron Paul.libertymaven.com/2009/.../

Jan 06 08:30 AM

[Sperry8:]

Well written article! Easy to understand, short and to the point. Thanks.

Jan 06 09:23 AM

[patio:]

" So what does that mean? Own things. The government is going to do whatever it can to increase the supply of dollars (raising prices) in an effort to avoid deflation and to inflate away some debt. "

Yes, that same oh so powerful government whose policies got us into this mess, with its omnipotent abilities and foresight will surely be able to avoid deflation.
Too late.

Jan 06 01:15 PM

[sieraromero:]

Our whole economic model is broke and needs fixing. We won't do it because we do not have the will and are rapidly approaching the date that we will not have the means to fix it. Yes, buy things! That was our response to the 9-11 attacks and how to be patriotic in the Iraq war effort and every other problem that we have had since world war 2. People---It is time to wake up!

Jan 07 10:06 AM

[silver-bullet:]

Water and solar panel


On Jan 06 08:30 AM Mike from austalia wrote:

> Beer or liquid gold, and solar panels........Have to go feed the
> Kangaroo's.......oh yeah, and i watched a bit of your famous Ron
> Paul.libertymaven.com/2009/.../

Jan 07 09:44 PM