Wednesday, April 10, 2013

Sundown in America?

Sundown in America?
Bert Whitehead, M.B.A., J.D.

David Stockman, President Ronald Reagan's Budget Director, authored an opinion piece published in the Sunday New York Times on March 30, 2013. His provocative conclusion is that eight decades of bipartisan Keynesian spending and Federal Reserve money-printing have left us exhausted and bankrupt. The article can be referenced here.

His article certainly outlines a doomsday scenario, buttressed with historical trends and US policy gone awry. I would refer my readers to a blog I wrote a month ago – which is now distributed by a number of online financial websites – titled “The Race to Zero Interest Rates.” This lays out a similar financial unraveling, but emphasizes the global scale of the issue. Today, more so than the past, our issues are intertwined with international reactions. The article can be found here.

Most observers agree with David Stockman about the likely outcome of debilitating inflation, but no one knows when this outcome is likely to happen. My article explains some key global factors that may continue to dampen inflation for awhile – perhaps even for 10 to 20 years.

There are an infinite number of factors that impact the global economy, which now shapes the US economy to a large extent. Also, economies don’t evolve in a straight line, but are molded by many factors interacting simultaneously.

Most imbalances are self-correcting, like supply rising to meet increasing demand. Innovations often solve problems that seem intractable, and create opportunities that could never be foreseen. With all due respect to Mr. Stockman, I don’t think anyone can create a dynamic algorithm to take into account all of these possibilities and their unlimited contingent possible combinations. No matter how concrete a belief may be, there is always a contradiction that can prove it wrong.

While it is often observed that history repeats itself, the actual course of history is sheer guesswork. Stockman’s advice is to “get out of the markets and hide out in cash.” In my opinion, this is a dangerous knee-jerk reaction to our economic situation. It reminds me of all the past prophets of doom who advocate a single asset class as the safe haven of the future, with usually gold and real estate taking center stage. They are, of course, usually offset by a similar chorus of single-minded get-rich gurus pumping investments into stocks in BRIC emerging countries, or various commodities, or even junk bonds. We must remind ourselves: for every buyer, there is a seller – and one of them is wrong!

I always prefer to view these problems from an endogenous perspective: how does this affect your family and what should you do about it? I still favor balance for our clients. You must continue to diversify yourself and take into considerations the only 3 possible economic scenarios: continued deflation, rising prosperity, and the specter of inflation.

Keep in mind that most financial approaches involve complex instruments which are actually designed for large pension funds, foundations, insurance companies, etc. The three tried and true strategies for ‘real people’ are well-known and very simple: 
  1. Always live within your means
  2. Save 10% of every dollar you earn
  3. Keep your portfolio diversified
We still recommend Treasuries as the only solid buffer against deflation. When deflation kicks in, the current value of bonds drops, but at maturity you will get your money back. The most efficient protection against inflation is a fixed rate long-term mortgage for at least 50% of the value of your house because you will fix a portion of your housing costs and pay back the obligation with cheaper dollars. And dollar-cost-averaging into the stock market, using primarily large cap index funds , assures that you will benefit from long or short spurts of prosperity.

Some financial
commentaries appeal to greed, others to fear. The prudent path is to avoid extremes and disregard exhortations to take undiversified positions within your portfolio. Diversification is your true ally and the only reasonable answer to the question “What if everyone is wrong?”

I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague of mine in Poughkeepsie, NY, and copyediting by Laura Webber.