By Whitley Strieber
ED NOTE: This article received more than a million hits over the weekend of March 23-25. As of noon today on March 26, it has received another million hits.
We have asked Mr. Strieber to make some suggestions about what investement strategy to use in current condtions. His reply is at the end of the article.
We are approaching the most serious economic crisis since the great depression, and American life is going to be disrupted in ways that we cannot now imagine. The reason is that there is too much debt, and the new bankruptcy law means that, because those debts can never be discharged, the economy will never get the chance to restart itself that has brought it out of so many slumps in the past. What is worse, the ordinary American debtor is not to blame. There is only one debtor to blame. It is the federal debtor.
But why will it happen now For the same kind of reason that it did in September of 1929: something has happened that will have enormous economic consequences that nobody now foresees, because of the corrosive synergy it will have with other factors that are out of balance.
In July of 1929, the Federal Reserve raised interest rates. This led to the raising of interest rates on margin debt, which resulted, in September, in a selloff that left the US economy extremely illiquid. Combined with the failure of the Credit Anhalt Bank in Australia, the subsequent worldwide cash shortage resulted in horrific deflation due to lack of money. The consequence was the great depression.
What has happened this time is slightly different, but the consequences will be the same. It is that China has decided to stop buying US debt. This means that a huge purchaser of US treasury debt is no longer there. But that is only the beginning of the problem. Last week, when the US Federal Reserve announced that American interest rates would remain unchanged, the dollar immediately dropped to a 2-year low. This means that countries like China, loaded with US debt and thus US dollars, suffered a tremendous loss. China is seeking to protect what is actually a hopeless position by no longer buying into what is obviously a collapsing currency.
But the dollar is not just a currency, like it or not, it is THE currency. When the dollar falls, values fall. Its that simple, and its because the world has adopted the dollar as a de-facto international currency. In this case, at its peril and to its eventual regret.
The Bush Administration made the decision to take the country into heavy debt to finance the Iraq war. It was said at the time that debt doesnt matter. The moment I heard that I though, here comes the next great depression.
When a country takes on debt beyond its capacity to manage, its citizens begin to be unable to repay their loans because the national debt is driving up interest rates. This syndrome has been the curse of Latin America, and it is about to unfold here, because the Administration took on far more debt than the economy could sustain. Far more.
The result is that the dollar is falling–that is to say, the de-facto cost of money is rising. Interest rates are rising no matter what the Federal Reserve does.
At present, the American economys ability to sustain its debt is faltering. Because of regulatory insufficiency, the mortgage lending industry has been allowed to fuel a false prosperity on the backs of loans to house buyers who were not, in fact, qualified to make the purchases that they did. And they werent qualified BEFORE all this happened. The inevitable result is in the news now every day: foreclosures, foreclosures and more foreclosures. But it will get worse. The next thing that will happen is that credit card debt will begin to become unstable. For years, banks have been allowed to charge usurious interest for this debt, and it hasnt mattered because the economy was healthy. But now it does matter. We are running out of places to put American debt, which means only one thing: it is going to come back to haunt us.
As the dollar falls, the interest the US pays on its debt instruments must rise so that the debt will find a market. But what China has done has radically reduced the size of that market just when the debt has risen beyond our economy’s capacity to handle it. Now, the US Treasury must raise the interest it pays on its instruments until a much smaller marketplace is willing to absorb them.
This will force interest rates higher across the board. It will force the Fed to raise interest rates here at home to protect the dollar abroad, lest our paper become, as Argentina’s did a few years ago, too expensive for us to sell.
Chinas decision is the equivalent of the Federal Reserve raising interest rates in the summer of 1929a act with consequences that will be heard round the world, and will change all of our lives. The US media has the economic consciousness of a flea, so you won’t hear much about it, unless the Administration tries to put pressure on China to resume buying. That’s not a fix, though, it’s just a delaying tactic, and probably only a brief one, because it places the Chinese currency in jeopardy. China has done what it has done because it has no more capacity to absorb US debt. As it is, it has a trillion dollars to sell into a market that is already glutted with dollars.
In fact, China has acted because it can no longer afford to buy dollars. The decision isn’t arbitrary, as was the Federal Reserve’s in 1929, nor is it stupid, as the Fed’s was back then. It is an essential, inescapable decision. If they buy more dollars, it means that their own export industry does not, in effect, get the profits the dollars it has collected were supposed to provide. The result Factories close, workers are laid off, and the actual fragility of the Chinese Miracle is revealed. So they are not committing an arbitrary and reversible act at all, as the Fed did in 1929. They are acting out of their own economic necessity. They have no choice.
But the consequences will be the same.
UPDATE: Regarding investment strategies, conservative, big cap mutual funds showing consistent long-term success would be of first importance. Choose funds that concentrate on companies that have a broad base of sales both in and out of the US.
To hedge against the possibility that the US and its Asian suppliers such as China and Japan would bear the brunt of the type of economic decline discussed above, I would explore a specialized type of diversification into the international markets.
An excellent article about this can be found on the website of Morningstar.com. To read it, click here.
Mornigstar is widely considered to be an excellent mutual fund rating system. You can see what they have to offer here. Consumer Reports also offers high quality and objective mutual fund ratings.
As far as my own holdings are concerned, I don’t own anything mentioned in the Morningstar article cited above, although I am exploring some of the funds mentioned.
One thing I would NOT recommend is attempting, as a small investor, to trade Forex, or foreign exchange pairs. Margining in this market is extreme. Many futures brokers offer Forex trading, but for anybody except a professional Forex trader, it is a dangerous place to be. In Forex trading, you can, in a matter of minutes, lose more than your investment.
In general, daytrading is for professionals. I have daytraded S&P futures for years, with moderate success, but the amount of time necessary to trade without making losses is far in excess of the actual gains I have achieved.
So, a more conventional investiment strategy, with modifications as noted above, suits me better, personally.
If there is an economic meltdown, no investment is going to thrive in the short term. The objective is to minimize early losses, so that recovery, which it comes, will have more of an effect on your portfolio.
NOTE: This Insight, previously published on our old site, will have any links removed.