The economic crisis continues. Leaders continue to spin the statistics in order to manipulate the perception of consumers to believe “all is well” once again. The Fed has monetized bad debt from investment banks. What does that mean? They bought debt from investment banks that was deemed “illiquid”. Now this debt is sitting on the Federal Reserve’s balance sheet. Recently, the Bank of International Settlements (BIS) wrote that the unsustainable is now unwinding. The financial sector is in dire straits. The high leverage of the last few years is being reduced. This forces asset sales of anything of value. Even productive assets are placed on the block. This drives down prices of all assets, mostly stocks and bonds.

Had the Fed failed to bail out the institutions with these Structured Investment Vehicles (SIV), they would have become insolvent… bankrupt. When Greenspan’s Fed lowered rates to 1% a few years ago, it set the stage for the dramatic growth of the mortgage bubble. Mr. Greenspan retired just in time. This de-leveraging cycle is a multi-year and complex event. The lack of governance allowed hedge funds and financial institutions to leverage up to 300 times their cash on hand. You and I could not have done that. Lenders kept us from entering this very arena where they are guilty of losing huge amounts of money. Once again, unequal weights & measures.

If the Fed wanted to do what is best for the average American, they would take the same money they handed over to the investment banks and direct those funds to America’s infrastructure: roads, bridges, power grid, public transportation(trains, subways, trolleys, etc.) The U.S. Infrastructure is getting old. It is estimated that $45 Trillion is required to fix it.

Cash is again King. Leverage is not. Gold and silver are cash. They have no liabilities attached to them. Oil is global money. Natural gas is regional currency. U.S. dollars are depreciating. That will not change soon. As the U.S. dollar loses value, gold increases in relative value. As central banks start up the printing presses, gold increases as well. Insolvency occurs when you cannot meet your obligations with cash. You can be worth $10 million on paper and become insolvent. If you have assets that cannot easily be converted to cash, you are illiquid. A friend who is a farmer has been leveraged throughout his career as farmers have been taught. THAT is the business model. Leverage has always helped this farmer make more money. However, if the financial climate demand all accounts to be reconciled, he could be “up a creek”. If the paradigm does shift, farmers will lose their farm just as it happened in the great depression. If you don’t keep enough cash (or equivalents) on hand, beware. We can’t assume that our limited history proves anything. Major shifts in the financial markets are normally seen through the rearview mirror. Remember when Steve Forbes incorrectly predicted oil retracting back to $40 or less? Remember when the invasion of Iraq was predicted to lower oil prices?

The fundamentals for gold and gold stocks are extremely bullish. Some stocks are getting battered by the illegal short strategy by some hedge funds. I suspect that the authorities will get around to cleaning up this market. What a deal: hold gold, silver, and related stocks while all your liabilities are being devalued in dollars. Acquiring gold and silver should increase your solvency as the dollar continues its decline to the .51 level on the U.S. Dollar Index.

Real estate is illiquid and losing value at the same time. In the 1980’s I saw the implications of this environment. In the Southwest U.S., banks went out of business, people lost homes, real estate lost 50% and more in some areas. The rest of the country paid little attention to the demise of this regional market, out of sight, out of mind. It was very instructive and has prepared some of us for the current environment. We saw our last house increase in value by 30%, then lose 45% in value. Ugly!

Oil prices are causing insolvency in lower income families. Over the last 10 years, families bought cars, new and used, based on cheap oil. Most lower income families can’t just go out and replace the older, gas guzzling vehicle. Remember those 7 year auto loans? Those were targeted to people who really could not afford the payments. Effectively those were sub-prime car loans. Though oil prices might go through a correction to $100-$115, triple digit prices are here to stay. In the meantime, the gas pump is extracting liquidity from all of us. Owners of oil inventory are gaining in liquidity. 85% of the production is owned by State owned oil companies. Russia is gaining in economic strength and political power. Vladimir Putin remembers what Ronald Reagan did to the Soviet Union. The Soviets were conquered by economic power, not military conflict. Putin may return the favor. World oil continues to decline. Expect higher prices.

Alternative fuels cost more than oil. Consumers will pay a premium for alternative fuel. Conversion to alternative fuels will reduce solvency. Who can afford a $15,000 wind turbine or solar array? The premium will extract critical liquidity from the average family. Rising healthcare, food prices, and other monthly necessities will cut into the discretionary income of middle America. Expect less crowds in the restaurants. Ethanol is a poor alternative due to the global food production crisis. We all want the farmers to be profitable but the big picture dictates that corn should be used for food not fuel. Switchgrass or sugar cane is a better ethanol alternative.

In the Great Depression, things went south so quick, even those with lower leveraged positions were forced into bankruptcy. It seems that once a generation has died off who experienced a severe event, the current generation makes the same mistakes and pushes us into a parallel situation. Greed knows no generational boundaries. As the Scripture reminds us, the borrower is servant to the lender.

PS After posting this, the following article showed up on Yahoo:

Comments are closed.