"Only a crisis, real or perceived, produces real change. When that crisis occurs, the change depends on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable".
Milton Friedman
This last week has been the most economically historic since 1929. We have witnessed a paradigm shift not just in global banking but in western style capitalism itself. Financial darwinism appears to be dead. The New Deal has been revitalised by the Neo-Conservative Bush Administration with a $50 billion insurance for money market mutual funds. This is after guaranteeing $85 billion for AIG, nationalising Fanny Mae and Freddie Mac and creating a $700 billion line of credit in order to buy worthless mortgages off the books of near bankrupt financial institutions.
The rescue package document that has been sent today to Congress is just 2 1/2 pages long. The lack of detail means that the powers given to the Treasury Secretary will probably be sweeping and wide ranging.
It is not though, the first time that the US government has intervened with the 'free markets'. In 1932, Herbert Hoover chartered the Reconstruction Finance Corporation (RFC). But it only became an effective force a year later when Roosevelt merged it with the Federal Insurance Deposit Corporation (FDIC) as part of the New Deal. It took 25 years and World War Two before it was finally abolished.
All this from the people who believe that any regulation is bad regulation and that the government should not intervene in peoples lives.
Until this week, Keynesian theory was discredited and had been largely abandoned in western Europe and the United States until the collapse of Northern Rock. Whilst initially criticised by many in the UK, its nationalisation did pave the way for the US bail outs.
So my questions are these:
1. Who will benefit from all this governmental largesse? Will it be extended beyond Wall Street and the Federal banks to local lenders. America has 7,200 banks beyond the likes of Goldman Sachs and JP Morgan. If Lehmans was allowed to fail, why should Comerica and Nations Bank survive?
2. How will they define 'at risk'? At what height will the bar be set?
3. AIG was pricing assets up to 2.7 times higher than its counterparty, Lehman Brothers. If such a pricing disparagy is common practice, then how will the government calculate true value?
4. How transparent will the process be and who will run it?
5. Is this the end of the credit crisis?
Nobody can answer the first four of these questions with any certainty. My worry is that the markets will shrug off these massive injections of cash and concentrate on the potential negative effects such as higher inflation and a possible dollar collapse due to the printing of new money.
So who will pay for it? Initially, China and Japan via T-Bills. But ultimately it is the American tax payer who will be footing the bill when the creditor nations look for their return on yield.
This isn't over. Not by a long way. My worry is that the White House is not throwing enough good money after bad. That the $700 billion is an optimistic under estimate of a situation that is far worse than presently appears. We still have to deal with the so-called 'synthetic' CDO's such as credit default swaps that have potential writedowns of up to $1700 billion and the Alt-A mortgages that Barclays Capital warned us about last week have a potential downside of another $1,000 billion.
Let's assume that the rules of real world economic's still exist. Just printing this much money to support the financial infrastructure is in itself inflationary. It will lead to a reduction in the value of the dollar which in turn could push up the cost of oil per barrel. This will lead to higher food prices as the cost of processing and transportation increases.
I may be wrong and I hope that I am.
So how to invest money in a market such as this?
Regular Premium:
Existing clients with large capital should look to hold either cash (US$) or for an asset that has long term growth prospects such as JPMF Natural resources. This fund invests in gold, mining and oil. The commodity market is oversold, Opec has reduced output and there will be a global recovery fueled by the assets that this fund invests in.
New plans and new money from existing investments should look to take advantage of the market volatility by dollar cost averaging with emerging funds from the BRIC nations and South East Asian Tigers. These economies whilst hit hard by the downturn in western markets do not have the structural issues that beset the 'developed' world. Buying them now on a regular basis with a 3 year view will prove highly profitable.
Personal Portfolios
Simple. Hold lots of cash and some bullion. Accumulate slowly. Ignore short term movements and look for trends. Watch the oil price. Remember that it is better to be a little late than to be too early.
Look for what powers an economy rather than the economy itself. By the time that equities gets back to profitability, the commodity market will have retraced back to its all time highs.
In an earlier blog I said that the first 20 years of the last 19th and 20th centuries dictated how those era's played out. We are at the epoch of the 21st century, which has seen 9-11, Katrina, the rise of China as a world power and the fall (temporary or otherwise) of the western banking system.
It is a magnificent opportunity.
Investment is changing.
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