Looking Beneath The Recession - Where did it come from and where are the opportunities for the future?

Investment strategies for recession, deflation, inflation and depression.

By: Skip McGrath

Conventional wisdom and the mass media blame the current recession on the housing bubble and greedy mortgage companies and Wall Street executives. They are correct in the sense that those events, and the skyrocketing price of oil, were the tipping points, but this recession was in the cards long before it actually started.  And guess what -it's our fault.  We Geezers caused it by getting old. Yes, this recession was predicted and guaranteed by millions of baby boomers reaching retirement age.

We didn't cause this intentionally, but it is part of a generational cycle that economists and academics have been predicting for years.  You see, people earn the most money and spend the most money between the ages of 42 and 55.  Once they pass 55, people become more conservative in their spending. They start saving more and spending less. And, when they retire they spend even less. Remember we are a consumer-driven economy:  When a large percentage of the population spends less money that has a direct consequence to growth.

Young people are the most expensive to society. They consume more, spend more and earn less; and they contribute less to the creation of wealth. But once you pass 55, most families' children are grown and gone.  You no longer need the larger house. Instead of spending money to feed, clothe and educate your kids -now you are mostly buying birthday and Christmas gifts and toys for your grandkids.  Multiply this by millions of people now reaching 55 every year and this represents a generational change in spending habits that removes billions of dollars (soon to be trillions as the generation ages) in consumption from the economy.  Add to this that this generation is now consuming only -only a tiny percentage are still producing goods and services.

If you want to blame someone for what we are going through now, look at the Federal Reserve under Allan Greenspan.  After the attacks on 9/11, the economy was in the tank and the Fed flooded the market with cheap money in the form of lower interest rates and printing money to increase the money supply.  This spending and stupid government policies combined with unprecedented greed by bankers and mortgage companies practically guaranteed a credit crisis.

If the Fed had slowed down monetary expansion by 2003 when the economy started to recover, we would probably have still seen a recession -but it would not be combined with a credit crisis that threatens to actually drive us into a depression.  Right now, leading economists put the odds of us falling into a true depression at 50/50. If the stimulus bill and the capital infusion into the banks works we may avoid a true depression -but it will be a close call. But almost every economist agrees that we are headed for a large bout of high inflation and high interest rates -perhaps as bad as the late 70's.

Essentially excess money combined with the generational trend of baby boomers spending less combined to create the perfect financial storm.

OK - So now that we understand how we got here -what do we do next?  There are several things we can do to not only protect what we have but to actually make money going forward. I am going to number these for ease of reading, but I don't want to imply you should do them in order or that one is more important.  In fact given your particular situation some of these may not be appropriate for you.

One more thing before I start. I am not a registered financial advisor of any kind and have no credentials in the field except years of study and experience. Remember the old saying; "Free advice is worth what you pay for it."  So make your own decisions and do your own research before making any investment decisions. But as you read these recommendations, I think you will agree that given the demographic trends we are experiencing and the excess spending and debt creation going on in Washington, that these moves make sense.

The government is fighting the recession with an unprecedented amount of stimulus. Between the 2008 TARP bailout, the Obama stimulus bill, the Omnibus budget now being debated in congress, Auto company bailouts, shoring up Fannie Mae and Freddie Mac and TARP 2, a $350 Billion set aside for further bank bailouts the government - with interest this will exceed $4 Trillion worth of spending in the near term and a total of $8 Trillion over the next six years.

That money has to come from somewhere. There are only three ways a government can get money: Taxing, Borrowing or Printing.  The government will have to do all three.

They can't raise taxes too much as that takes money out of the economy and could stall any recovery. Although there will be some tax increases -most of the money will come from borrowing and printing money.  I don't have the room here to give a lesson in economics, but trust me, when the government borrows and prints excessive amounts of money it causes inflation and the government's cost to borrow money goes up.

We are currently in a deflationary trend -prices and interests rates are falling. But this will soon reverse itself as all of the money being spent and created works its way into the marketplace.  When this happens several things will happen.

1. Silver and Gold always rise with inflation. The easiest way to invest in silver and gold is through an Exchange Traded Fund (ETF). If you don't know what an ETF is, there are two links at the end of this article that show how they work.

   The two largest ETFs that track gold and silver are GLD and SLV. Those are the symbols. Just type that symbol into your brokerage account quote function and you will see the prices. Gold may go down some more before it goes up, but it always goes up with inflation. So as soon as you see interest rates and prices starting to rise -that is the time to jump in.

2. Basic Materials and Commodities like cement, steel, copper, lumber; coal and so on are in a huge slump.  Once again, any rebound in the economy (and there will be some from the stimulus bill) will cause the price of these materials to rise.  Don't try and buy these individually -that is for speculators. Once again there is an ETF that tracks the price of these materials. The symbol is MXI.

3. The US Dollar is the world's reserve currency.  If you think our banking problems are bad in the US, they are nothing compared to Europe. Large European banks have huge exposure to the developing countries in Eastern Europe and Latin America.  Many of these countries are close to defaulting on their debt and this will cause a banking crisis in Europe that will make ours look like a walk in the park.  This trend is already starting. The dollar has already recovered 20% from the low it reached in mid 2008 and could continue to reach the highs it enjoyed in 2002. This would translate into a 40% gain. The way to play the US dollar is with the ETF symbol UUP

4. US Treasury Bonds are considered a safe investment. If you hold them long enough this is true -but the price of long-term bonds (over 10 year) can move up and down dramatically with the interest rate.  The government is about to borrow more money in the next two years than it has borrowed in the last 25 years.  As the government creates more bonds there will be fewer and fewer buyers. This will drive up the yield on the bonds.  So for example, a 20-year, $10,000 bond with a yield of 5% would earn you five percent per year if you held it to maturity.  However, the way bonds are sold is by auction. The government holds an auction every few weeks and investors bid on the bonds.

   If there are a lot of bonds being auctioned off then buyers will not bid as much. So a $10,000 face value bond may sell for only $9,500.  Since the annual yield is 5% of $10,000 ($500) and you only paid $9500 for the bond that means your return is 5.26%. If you bought a bond at $10,000 and interest rates (yield on bonds) rose, the price of the bond falls. So if you needed to sell the bond, in the above example you would lose $500.

   Remember, the higher the interest rate (yield) the lower the price of the bond and vice versa. Right now, the price of bonds is falling. So you don't want to buy bonds right now. If you are really brave and you believe this trend will continue, there is a fund that makes money when bonds go down. The symbol is TBT.  That is a very speculative play. I went into that about two months ago (early Jan 09) and the fund is up 20%.  This has helped me recoup some of the losses in my IRA from last year. But, again that is speculation -not investing.

   The safer play is to wait until bond prices drop further -and they will as inflation takes hold. Yields on these bonds could go up to as much as 15%.  This happened in previous recessions and during bouts of inflation and will certainly happen again.  When bonds are returning interest rates this high, you want to buy the bonds and you can lock in a 15% return on your investment for the next 20 years no matter what happens. And when we have inflation, the Federal Reserve always acts to cool down the inflation. When this happens, the interest rates on bonds fall and the price of the bonds increases. So you can keep the bonds and earn 15% as long as you want, or you call sell them at a nice gain when interest rates fall and the bonds go back up in price.

   You can purchase Treasury Bonds directly from the government, through your bank or there are several ETFs that can hold bonds for you. The most popular is the symbol TLT.

5. Timing is everything As you can tell from reading the above strategies, you don't want to get into these at the wrong time or you could lose money. So watch for the signals. If you start to see signs of inflation when the government reports the monthly consumer price index or the wholesale price index, then that is the time to buy basic materials or gold. If you start to hear news stories of financial trouble in emerging countries or with banks in Europe, that is the time to buy the dollar. If we experience several months of inflation or if bond prices keep falling -wait until then to buy bonds.

6. Preserve Your Capital. There is something known in economics and finance as The Black Swan.  This is an unpredictable event that is very rare.  The attacks of 9/11 were a Black Swan.  Just before 9/11 the economy was humming along and people were once again making money with their investments having recovered from the Tech stock bubble of 1990. After the attacks the stock market tanked.  It did come back but it took a few years.

   So although I believe the investment strategies outlined above are sound for people our age, I would not commit a large amount of your investment capital to them. If you are early in your retirement years (<67) then you might want to put as much as 20% to 25% into these types of investments. Older than 67 I would limit it to 10%.  The rest of your money should be in insured accounts or short-term (<3 year) treasure bills or government backed money market funds.  Yes, these funds now earn less than 1.5%, but this point in your life is not a time to roll the dice with your life savings.

If you would like to learn more about ETFs and how to use them to invest and save, here are two good links that explain how they work:

http://finance.yahoo.com/etf/education

http://us.ishares.com/education_center/index.htm

Skip McGrath
Head Geezer
Official Geezer Guide