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Feburary 2, 2009 Are We Forever Changed? It seemed as though it would never end. But, finally, 2008, a historically dismal year for economies across the globe is behind us. While the depth of despair and desperation has not reached that of the Great Depression (1929-30’s) and we are now protected by benefit and insurance programs put in place since then, the global financial catastrophe of 2008-2010 will surely be sited in history books and studied for generations to come. For most of my readership, (those not in their 80’s or 90’s), the Great Depression was always an abstract historical event. While my generation learned about it in the classroom and through movie depictions and stories told to us by our elders, by and large we were disconnected from its brutal reality. It was an historic event that felt as removed from our own times as the ‘Boston Tea Party’ or the ‘Fall of the Roman Empire.’ |
But our parents, grandparents or great grandparents, who actually lived though the Great Depression, were profoundly affected by it for the rest of their lives. Those who lost homes, fortunes, or jobs or who waited on breadlines or who lived 6 in a room were forever impacted in terms of their economic fears and resultant behavior. After speaking with so many investors over the last 12 months, and especially over the last 90 days, I am now wondering if we too may behave differently for the rest of our lives. OUR BEHAVIORAL CHANGE As I witnessed firsthand in my grandparents and parents, survivors of the Great Depression developed what became known as the “depression mentality.” Fearing that the economy could crash again at any time, they were very reluctant to take out loans or assume any economic risk. They were extremely cautious in spending, paying cash for all purchases, large and small. Financial success was measured by the size of the rolled up wad of cash in someone’s pocket. My own father finally acquiesced to owning a credit card, only after he began to experience difficulties checking into a hotel or renting an automobile. We are now seeing signs of a similar aversion to risk taking and of extreme caution seeping into the current mentality. In addition to the obvious signs of dramatic reductions in spending and charging, and some selling of stock positions, investors have been avoiding risk by buying up U.S. Treasuries securities. This continues even as the yield on 30 day Treasuries has fallen to 0% or slightly negative! At the same time, attractively priced Tax-Free Bonds and High-Quality Corporate Bonds , with yields that are at a comparative historic high, are being ignored by investors. WHAT IT MEANS TO OUR ECONOMY NOW Reduced spending and borrowing will translate to slower or no growth for our economy over the short-term. This can lead to a deflationary cycle which we will likely experience over the next year or so. Indeed, the consumer price index actually fell in the 4th quarter and I believe we may have already entered that cycle. Although deflation and falling prices are actually positive signs for some, especially for those on fixed incomes, and can stimulate increased demand for goods and services in a healthier economy, in deflationary periods, consumers tend to hoard cash and delay purchases, hoping for even lower prices down the road. In the current economy, falling prices for good and services, will likely lead to lower profits for businesses and more layoffs for workers. Thus, the cycle will continue to feed on itself until there is economic stimulation of some sort and the perception is created that the cycle is ending. WHAT HAPPENS TO OUR ECONOMY GOING FORWARD As I have written previously, I believe that some version of the new stimulus package is what is needed in our current deflationary cycle. With that said, I will admit I am taking a giant leap of faith in how our government operates. The effectiveness of the stimulus program is contingent on the Trillions of dollars being created to fund the programs, being spent wisely and carefully. The consensus of opinions regarding the allocation of the first $350 billion spent is that the government fell far short of that standard, indeed. In order to fund the bailout and stimulus plans, the U.S. Treasury is essentially rolling out the printing press, and creating cash for the country to spend. In normal times this policy would be highly inflationary and detrimental---but not now. At the moment, consumers are scared to spend, and lenders are too risk averse to lend, and we are left in the resultant defaltionay rut. THE GOOD NEWS—REFLATING THE ECONOMY The good news is that this cycle will change—it always does. Slowly consumer and investor confidence will begin to re-build. There will again be new workers entering the work force and new consumers entering the marketplace. As happened with the generations that came of age after the Great Depression, these newer capitalists may be less risk averse than those who have felt the burn of the current crisis directly. They will buy the bonds with higher yields and the goods at lower prices and reap handsome rewards for the risks they take. Of course some of us, not as deeply traumatized as others, will do the same, and before you know it things will begin to turn-up again. And when inflation begins to seep back in the system, for this unique time in our history we can all celebrate the event together. As for now, there have been some promising signs that the government will begin doing a better job of disbursing and overseeing rescue package funds. New Treasury Secretary Tim Geithner put in place rules last week that restrict lobbying related to the Troubled Asset Relief Program, or TARP. He also introduced rules to limit political influence on funding decisions, released the full terms of previous rescue deals, and met with a group of congressional appointees charged with strengthening TARP oversight. The administration has promised additional rules that would protect taxpayers' interests and make it easier for them to see how their bailout funds are being spent. WHAT TO DO NOW The prescription for managing cash and investments in a deflationary cycle is, generally, to reduce debt, buy bonds and hoard cash. The prescription for managing cash and investments as we move from a deflationary cycle to a mildly inflationary cycle is just the opposite. It is to buy stocks, real estate, commodities and inflation bonds. At what precise point in the cycle are we now and when should an investor make tactical changes? There are, of course, no easy answers to these questions…and that is why professional guidance is highly advised. These are not times for haphazard planning. Please call us to discuss your particular framework and situation so we can help you plan through this cycle and the next cycles and help you stay on track to potentially meet your long-term goals. CONCLUSION Similar to those who lived through the Great Depression our own economic attitudes and behavior have been greatly impacted by an economic catastrophe. The generations that follow will become more removed from the event and will be less risk averse than those directly affected. Arguably, I can say this ensures that in years to come, similar mistakes will be repeated and will lead to the next great catastrophe. However, for now, I expect that the next couple of generations of Americans will help us rebuild what has broken, and will provide better leadership than our current generation of business leaders have. We all will benefit from this natural chain of events and I am optimistic about the future. Some of you who were burned in the current crises will continue to hoard cash, buy insured CD’s and possibly remain on the investments sidelines for the rest of your lives…and that’s Ok …you may not be prepared for the return of inflation, and you will not have the potential for long term growth, but everyone needs to find a way to sleep at night. In fact, just like your grandparents, you will also be providing the banking system with the capital to lend to the next generation of Americans who will take on the risk of re-building the economy. For now, avoid stressing out, as much as possible. What we are experiencing is all apart of the normal cycle of events, economic or otherwise, always occurring and always repeating itself, as we go through this predictably unpredictable journey called life. Until next time, Austin A. Frye, MBA, JD, CFP® Securities and
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