We need to step back, take a look at our investment life and redefine where profits will come from in the future. More than any time in our lives as Americans, paper assets are in danger of falling apart. There are reasons our best investment moves may be to liquidate most paper assets other than several dozen existing AAA-rated international corporations.
How could America’s great economy be falling apart? Is it just “politicians” again? Does history repeat itself?
History doesn’t repeat itself, but the characteristics of man, bred into all of us, pass from generation to generation. Man does not change. Laws, governments and societies change, but man’s characteristics are the problem. They are generally recognized as the seven deadly sins of pride, envy, greed, anger, lust, gluttony and laziness. Government is the ultimate power in man’s Earthly life. Government attracts people who crave power at any price. “At any price” in history has meant borrowing large sums of money to sustain their time in power, which leads to currency meltdowns from inflation. Money is always borrowed to either pay for war or pay for government welfare programs.
Currency meltdowns are not planned. They occur over a prolonged period of time as a result of government overspending. The overspending is financed by debt. The money made to supplement the government’s spending is put into the economy in the form of added currency. The additional cash in the economy causes the price of goods and services to increase. This “inflation” of prices is “OK” until the inflation accelerates and the country’s currency becomes worthless.
Our economy is on the verge of a currency collapse. Economic crisises are usually accompanied by an increase in the reach and power of government, coupled with a decrease in the resources and the freedom of individual citizens. Government uses its taxing power to literally gobble up an economy’s cash. Let’s verify this by looking at a few statistics.
Bearing those numbers in mind, look at the chart that shows 24 years of U.S. government debt increases. Take note these 24 years include 12 years of Democratic and 12 years of Republican presidencies. Both major political parties are culpable in running up the debt of this country. The real danger is the increase in debt has reached amounts in which it cannot conceivably be paid off. Alarmingly, interest payments on our debt are so great that we must borrow money simply to make the interest payments. This is a prescription for disaster. All socialist economies overwhelm themselves by borrowing money simply to sustain the government: Argentina, Spain, Greece and, before that, England, France, Spain again, Rome, Greece, etc. America is the greatest of all of those past civilizations, and we’re making the same mistakes that crushed them.
Economic statistics tend to confuse the public. They are so large that citizens get “billions and trillions” mixed up. One easy way to understand the economic crisis is to compare annual government spending and indebtedness to a family’s annual income, spending and indebtedness. We can then see just what kind of shape a family would be in had they behaved economically the same way our government behaves. You can see the average family who spent money like the government would have been bankrupt a long time ago. What the public has difficulty grasping is our own federal government is bankrupt, as these numbers bear out. Further, looking at “recent budget cuts” one can see they amount to nothing on a relative basis.
The current Dow Jones Industrial average is selling at 14,000, representing a price-earnings ratio of 14.4 times earnings, and a dividend yield of 2.5%. The average long-term price-earnings ratio and yield on the Dow Industrials is 14.5 times and 4.3%, respectively. The price-earnings ratio indicates the market is selling at a historically average price relative to corporate earnings. The Dow’s dividend yield suggests the market is overpriced by 50%. The reason the market is even at these average price-earnings levels is due to the $10.7 trillion that has been created out of nowhere and put in banks during the last 12 years. Brokers and bankers are the first borrowers of money the Fed makes. They are also the largest donors of money to political campaigns. It, therefore, behooves the government to make sure the market stays at “reasonable” levels, because investors selling stock is the primary source of political campaign money.
Although this is all interesting information, what does it have to do with the market? On one hand, we know there will be continued “stimulus” (new money the Fed creates) of around $100 billion a month, roughly what is happening now, and what has happened the last several years. We also know there have been no meaningful cuts in government spending and that the debt is so great we must borrow money simply to pay interest. This is “third world-ish” political/economic behavior and cannot be sustained. At some point, the market, even with $100 billion a month added to it, is more likely to stay stable in this range of trading or go down and trade more based upon yields, rather than go much beyond where it is presently. If the market traded based upon yields, the Dow Industrials would be 8,140 points instead of 14,000 (current yield of 2.5% on the Dow, divided by average long-term yield of 4.3%). If we do have further severe currency deterioration from inflation, only the least-indebted international companies would be safe to hold. In addition to safety, those companies should have the greatest probability of growing if the economy continues to react in the future as it has acted the last 10 years.
Investors should be wary about what type of asset can weather, and succeed, through a “day of reckoning.” Properly financed real estate is going to be the best opportunity to preserve wealth. It always has been. The world’s population continues to double every few generations, and the supply of real estate is limited. Other hard assets history has proven it wise to own, through both good times and bad times, are gold and silver. Both have been used as currency for more than 8,000 years. Although the stock market has done well the last 50 years, gold, silver and income-producing real estate have done better.
A day of reckoning wipes out paper assets. Bonds become worthless and get settled for pennies on the dollar. Stocks with high price-earnings multiples fall the fastest, and stocks that pay dividends weather the storm. Highly leveraged companies are usually bankrupt, recapitalized and sold because the original stockholder’s investment becomes worthless. Such is it with governments ultimately requiring a reconstitution of the monetary system, when government can no longer meet its obligations. Simple math indicates we’re there!
No clear path for the investor exists today. These times call for defensive investments to ensure capital is preserved. The conservative investor will own only AAA-rated stocks and hard assets that will maintain, and grow, in value with further currency deterioration such as real estate, gold and silver.
George Rauch, Longboat Key, is chief executive officer of Bradenton-based General Propeller and a former Wall Street investment banker.