We are moving closer towards a political economy every day. Every dollar borrowed, taxed, printed, and spent by government really comes from the private sector. Trillions of dollars of national resources are being allocated by politicians and bureaucrats towards things they people claim will benefit our economy. Congress just passed a $3.6 trillion budget ($1.2 trillion in deficit). Combined, the Federal Reserve and Treasury have dumped $13 trillion into the economy in the last 16 months. What we must all ask ourselves right now is whether or not we trust government with our money?
The stock market certainly seems to believe in Big Brother:
Since the absolute low in early March, the Nasdaq is up 27.8%, the S&P 500 is up 24.5%, and the Dow Industrial Average is up 22.5%. These are massive gains in an extremely short period of time. Are we finally seeing results from TARP and the American Recovery and Reinvestment Act? Is Congress doing something right, and is the market finally warming up to President Obama?
We trust government for so much these days. We have the military, police forces, regulations, laws, courts, Social Security, Medicare, Medicaid, welfare, and myriad other programs upon which we have come to depend. Soon we’ll need government to run our health care, regulate carbon emissions, tell cows how much they can fart, and give us permission to take sight-seeing trips to Antarctica! But how much do we really need of some adults to tell other adults what to do? That is, after all, what government boils down to.
Being that government officials are drawn from the same population pool as everyone else, we ought to question their omnipotence. Are they fallible just like you and I? Or does winning an election or securing a federal union job suddenly strip one of human vice?
In “Contributing Factors To The Housing Boom” I wrote that multiple layers of government caused the housing troubles currently tearing apart our economy. Without the Federal Reserve pumping up the money supply, without Congress creating Fannie Mae (FNM) and Freddie Mac (FRE) and mandating they provide junk loans to people who had no chance of repaying them, and without local and state micro-regulators dictating everything from building sizes to where and how you could build, the housing market may have simply functioned like any other market. We didn’t exactly witness cheese prices behaving “irrationally exuberantly” over the last decade!
So if we accept that the people running government are fallible, and that they even have some blame in the distorted, crashing economy in which we are all forced to eke a living, we ought to question all the assumptions they expect us to take for granted. Maybe Americans should cut back on spending and save? Maybe interest rates should float higher to represent scarcity of capital for real economic activities? Maybe adding another $10 trillion to the national debt over the course of the next decade is not a good thing?
If you think that what government is doing is good- if you trust them with your life’s savings, then go ahead and listen to your regular financial adviser. Roll your savings back into the stock market. Buy government bonds. Oh, and don’t forget to buy another SUV, a bigger house, line your walls with gold the IMF is selling, and buy yourself that marble floor you’ve always wanted! The good times will return!
Or maybe they won’t. Our government and the Federal Reserve are rolling dice with our futures. They are playing games with our currency, and they are betting that their blind spending of confiscated trillions will magically restore our economy to pre-crisis conditions. This is a tall order!
Should you suddenly become suspicious, here are a few things you can do to protect yourself:
1) Avoid non-dividend paying stocks. Seek yield in everything you do. Stocks are decent inflation hedges since companies can increase prices to compensate, but you should avoid stocks that retain 100% of earnings. Retained earnings are essentially bets that the company can earn sufficiently high returns on incremental capital expenditures. In a tough business environment this becomes less realistic.
2) Buy short-term debt instruments. Avoid long-term maturity bonds since increasing inflation will wipe out coupon payments and resale value on the secondary market. The big exception to this is if you require a fixed income for living expenses for which the current risk-adjusted yield provides. If you can lock in rates you know you can live on, by all means do so.
3) Buy real estate. During an inflationary environment you want to be a net debtor holding fixed rate liabilities. Each new dollar printed makes all the others less valuable, so you might as well use this to your advantage-repay fixed rate debt with less valuable dollars in the future. The second benefit of real estate is that rents can grow with inflation, so long as your tenants do not hold long-term leases already locked in at pre-inflation terms.
4) Treasury Inflation Protected Securities (TIP). These are Treasury securities with fixed real returns supplemented by an inflation premium. These are good so long as the government issuing them remains solvent. To diversify this risk consider the international equivalent, (WIP).
5) Commodities. When the world can no longer trust our paper money people turn to commodities as a refuge. Commodities are tangible and have real utility, unlike government paper. Gold and silver are traditionally viewed as currency replacements, agricultural goods always have value in that people must eat, and energy holds the world together. Consider (DBC), (USO), (GLD), (SLV), (GSG), and (DBA), to name a few.
If you’re really savvy and feeling bold you could short the market, hedge with VIX, or join a local militia.
Disclosure: Long GLD, Long DBA, Short SPY