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Chris Martenson

Tuesday, April 8, 2008

Are the current levels of debt in the US placing an immoral burden on succeeding generations? Here I make the argument that they are. (Note: This is an updated version of an article I wrote in 2006.)

Here’s what we know about debt.  

Debt comes in two forms. The first is called, in banker parlance, ‘self-liquidating debt,’ and represents borrowing that will boost economic activity and therefore will stand an excellent chance of ‘paying itself back.’ The simplest example would be a case where you could borrow money at 5% but loan it out, risk free, at 7%. Here the loan will clearly ‘pay for itself.’ More typically, self-liquidating debt has a productive asset tied to it, such as a utility company, an apartment building, or a factory which generates the income to pay off the debt.

The other type is ‘non self-liquidating debt,’ which, as you have already guessed, does not ‘pay for itself’ and is used for consumption, not investment. An example would be borrowing $40,000 to buy a car that does not help you earn any more money at work. Or the construction of a shiny new town hall. Or a war of choice in the Middle East. All of these represent debt taken on today in order to purchase and consume something today, but the purchases do not then lead to new economic earnings. The money is spent, but the debt remains.

Since 2001, our national level of debt has very nearly doubled. If we take a strict view and exclude debt taken on for the purpose of speculating, say, in the housing market, almost all of this mountain of new debt has been of the non-self-liquidating variety.

And here’s the one thing we need to remember about this kind of debt: It represents future consumption taken today. Sometimes people find this statement confusing, so let me flesh this out a bit. In the case of the auto purchase given above, $40k was borrowed and the car was purchased. But later on the loan has to be paid back, with interest, and every one of those future payments are made with cash that is not then available to spend on something else. Cash that you can’t spend in the future represents consumption that you must forgo in the future. In other words, a preference for a car today acquired via debt is really just another way of saying that having the car NOW has a higher ‘value’ than having a car’s worth of purchasing power in the FUTURE. So debt is really future consumption taken today.

And, finally, remember that there are only 2 ways to make a debt go away:

1) Pay it back

2) Default on it

Unless you are the federal government in which case you can always go for the third option:

3) Print money
to pay the debt.

The federal government always favors this last option because so very few people correctly perceive the (inevitable) resulting inflation for what it really is, a hidden tax that erodes the value of all existing money, whereas everybody understands that raising taxes directly takes their money away. Inflation is everywhere and always a monetary phenomenon. Excess printing by governments always leads to inflation. Recently, many of our financial observers have been confused by the fact that the explosion in debt/credit, and therefore money, has resulted in asset, not commodity, inflation, but it is inflation nonetheless.

So what does any of this have to do with the title? What does any of this have to do with morality?

Well, if we rotate the topic slightly, we can observe that there are two other ways to view debt. On the one hand, there’s debt taken on with the intent of paying it back, and then there’s debt taken on with the intent that it will not be paid back.

To pass judgment on these two approaches, the former is moral, the latter is immoral (and usually illegal). To really understand this judgment we’ll need to take look at this in greater detail.

Certainly we can all agree that taking out a loan with the intent of never paying it back runs afoul of a variety of civil and criminal laws. But what about a situation where one generation borrows with the intent that a future generation will be the one paying off the loan? Further, what if the loans were of the non self-liquidating (consumptive) variety and zero benefit would accrue to the future generation? How would we term such borrowing?

Well, the 6,000-pound elephant in the room is that this is exactly how the US has been operating for the past 20 years or so. This is not to point a finger of blame, or to create victims and victimizers. We have all been equal, eager, and willing participants in this game. We have been robbing Peter to pay Paul. Unfortunately, Peter has not yet even been born, which means that Peter never got a chance to voice his opinion on the matter.

At any rate, we can observe the phenomenon of generational theft in the negative $65 trillion net worth of the US at the federal level, the $9.4 trillion in direct federal debt (4/2008), and the negative $1 trillion in unfunded pension obligations at the state level. Each of these represents borrowed promises that the current generation has opted to lay upon future generations. In every case it has also meant that current and past generations have been able to enjoy both high consumption and low taxes.

Need more proof? Observe the record-breaking 97% pass rate of state bond issuances in the November 2006 elections. This Bloomberg article explains, and is worth your time to read:

 

Welcome to the Golden Age of Public Finance — Nov. 8 (Bloomberg)

That’s the message voters sent to the municipal market yesterday, as they approved the majority of the record $78.6 billion in bonds placed on the ballot this year.

Of the $56.5 billion in bond issues totaling $200 million or more being considered nationwide, Bloomberg News this morning calculated that 97 percent had passed. The majority appear to be for education, the remainder, money to be used for infrastructure construction and maintenance.

The election of 2006 marks a watershed for the municipal market. Never before have voters had to consider so many bond issues. Never before had they approved so many.

What’s going on here? The easiest answer would be to blame California, where voters were asked to approve that outlandish package of $43 billion for transportation, water, and school construction, and did.

That’s the easy answer. It would be harder to prove, but it wouldn’t be overstating the case to attribute the big election to generational change.

Stay with me here. The people who approved these bond issues, most of them, I’d bet, grew up in the 1970s.

What does that have to do with it? These are people who are used to having nice things. By comparison, those who grew up in the Great Depression and the 1940s were used to making do. They were suspicious of government, and of debt.

When they entered their 30s and 40s, it was the 1970s. The approval ratio for the 1970s, the entire decade, was 49 percent. There were years when this frugal generation approved 9.5 percent (1975), 18 percent (1971) and 33 percent (1973) of the bonds put before them for consideration.

Those who grew up in the 1950s and 1960s, certainly a happier group, approved marginally more borrowing 30 years later, when they started raising their families. The average approval ratio during the 1990s was 69 percent.

Now we’re talking about people who were born in the 1970s. These are the people who enjoyed air-conditioned schools and comfortable college dorms and coffee that tastes good, and they want the same things for their children, as well as things like smooth roads that aren’t too crowded, and new sidewalks, and nice parks, and roomy stadiums. They grew up cosseted, and squeamish about things that are less than just so.

These are the people who have moved to the suburbs and the exurbs and they see no reason why they shouldn’t borrow millions and billions of dollars for things that are going to have a useful life of, oh, when it comes to bridges and highways and sewers and the like, of 50 years to forever. The approval ratio for bonds put up for the vote in the 2000s is 80 percent, according to the Bond Buyer.

So welcome to the Golden Age of Public Finance. Now that this bunch has seen how easy it is to get a whole barge load of bonds passed, look for election ballots to swell to even more unseemly sizes in the years ahead.

I think the author, above, has made a very good set of observations. Namely that the current generation has lost all compunction about borrowing long-term to finance near-term consumption.
And this has come about because Greenspan’s “easy money 4-ever policy” of 1995 through 2005 has lulled us all into thinking that easy, cheap borrowing is a permanent condition. It is not. The piper always must be paid.

But, more importantly, I have serious moral reservations about one generation saddling the next with its debts. How can this be right? At the federal level we’ve decided, as a nation, to make all sorts of promises that cannot possibly ever be kept at current levels of taxation. So either future senior citizens are going to be sorely disappointed by meager entitlement payments, or future taxpayers (my kids) are going to have to shoulder crushing employment tax burdens.

For the senior citizens, this is patently unfair, since they paid more than their fair share into these retirement programs all their working lives. Should it be their fault that our leaders decided to use those ‘excess funds’ for current spending on hapless wars, bridges to nowhere, and other exotic examples of pork barrel spending of every conceivable stripe?

On the other hand, should it be the responsibility of subsequent generations to shoulder the burden of paying for all that past consumption and for our collective decision to ‘fund’ past societal excess with future promises to pay?

In this skirmish, I must side with the future generations. I think it is incumbent on each generation to figure out how to pay for whatever levels of consumptive spending it deems fit.

I think that racking up huge debts with the intent of pushing their repayments off to future generations is morally equivalent to loan fraud. It would not surprise me in the least if future generations decide that they have no legal or moral obligations to make good on that debt.

In the meantime, we each must ask of ourselves where we stand on this issue, how we’ve benefited, and whether we have any sort of an obligation to correct the situation.

And it is up to my children to decide if they want to make good on my generation’s debts. After all, they will someday have a say in the matter. Let’s hope they are feeling generous.

An Immoral Level of Debt
PREVIEW
Tuesday, April 8, 2008

Are the current levels of debt in the US placing an immoral burden on succeeding generations? Here I make the argument that they are. (Note: This is an updated version of an article I wrote in 2006.)

Here’s what we know about debt.  

Debt comes in two forms. The first is called, in banker parlance, ‘self-liquidating debt,’ and represents borrowing that will boost economic activity and therefore will stand an excellent chance of ‘paying itself back.’ The simplest example would be a case where you could borrow money at 5% but loan it out, risk free, at 7%. Here the loan will clearly ‘pay for itself.’ More typically, self-liquidating debt has a productive asset tied to it, such as a utility company, an apartment building, or a factory which generates the income to pay off the debt.

The other type is ‘non self-liquidating debt,’ which, as you have already guessed, does not ‘pay for itself’ and is used for consumption, not investment. An example would be borrowing $40,000 to buy a car that does not help you earn any more money at work. Or the construction of a shiny new town hall. Or a war of choice in the Middle East. All of these represent debt taken on today in order to purchase and consume something today, but the purchases do not then lead to new economic earnings. The money is spent, but the debt remains.

Since 2001, our national level of debt has very nearly doubled. If we take a strict view and exclude debt taken on for the purpose of speculating, say, in the housing market, almost all of this mountain of new debt has been of the non-self-liquidating variety.

And here’s the one thing we need to remember about this kind of debt: It represents future consumption taken today. Sometimes people find this statement confusing, so let me flesh this out a bit. In the case of the auto purchase given above, $40k was borrowed and the car was purchased. But later on the loan has to be paid back, with interest, and every one of those future payments are made with cash that is not then available to spend on something else. Cash that you can’t spend in the future represents consumption that you must forgo in the future. In other words, a preference for a car today acquired via debt is really just another way of saying that having the car NOW has a higher ‘value’ than having a car’s worth of purchasing power in the FUTURE. So debt is really future consumption taken today.

And, finally, remember that there are only 2 ways to make a debt go away:

1) Pay it back

2) Default on it

Unless you are the federal government in which case you can always go for the third option:

3) Print money
to pay the debt.

The federal government always favors this last option because so very few people correctly perceive the (inevitable) resulting inflation for what it really is, a hidden tax that erodes the value of all existing money, whereas everybody understands that raising taxes directly takes their money away. Inflation is everywhere and always a monetary phenomenon. Excess printing by governments always leads to inflation. Recently, many of our financial observers have been confused by the fact that the explosion in debt/credit, and therefore money, has resulted in asset, not commodity, inflation, but it is inflation nonetheless.

So what does any of this have to do with the title? What does any of this have to do with morality?

Well, if we rotate the topic slightly, we can observe that there are two other ways to view debt. On the one hand, there’s debt taken on with the intent of paying it back, and then there’s debt taken on with the intent that it will not be paid back.

To pass judgment on these two approaches, the former is moral, the latter is immoral (and usually illegal). To really understand this judgment we’ll need to take look at this in greater detail.

Certainly we can all agree that taking out a loan with the intent of never paying it back runs afoul of a variety of civil and criminal laws. But what about a situation where one generation borrows with the intent that a future generation will be the one paying off the loan? Further, what if the loans were of the non self-liquidating (consumptive) variety and zero benefit would accrue to the future generation? How would we term such borrowing?

Well, the 6,000-pound elephant in the room is that this is exactly how the US has been operating for the past 20 years or so. This is not to point a finger of blame, or to create victims and victimizers. We have all been equal, eager, and willing participants in this game. We have been robbing Peter to pay Paul. Unfortunately, Peter has not yet even been born, which means that Peter never got a chance to voice his opinion on the matter.

At any rate, we can observe the phenomenon of generational theft in the negative $65 trillion net worth of the US at the federal level, the $9.4 trillion in direct federal debt (4/2008), and the negative $1 trillion in unfunded pension obligations at the state level. Each of these represents borrowed promises that the current generation has opted to lay upon future generations. In every case it has also meant that current and past generations have been able to enjoy both high consumption and low taxes.

Need more proof? Observe the record-breaking 97% pass rate of state bond issuances in the November 2006 elections. This Bloomberg article explains, and is worth your time to read:

 

Welcome to the Golden Age of Public Finance — Nov. 8 (Bloomberg)

That’s the message voters sent to the municipal market yesterday, as they approved the majority of the record $78.6 billion in bonds placed on the ballot this year.

Of the $56.5 billion in bond issues totaling $200 million or more being considered nationwide, Bloomberg News this morning calculated that 97 percent had passed. The majority appear to be for education, the remainder, money to be used for infrastructure construction and maintenance.

The election of 2006 marks a watershed for the municipal market. Never before have voters had to consider so many bond issues. Never before had they approved so many.

What’s going on here? The easiest answer would be to blame California, where voters were asked to approve that outlandish package of $43 billion for transportation, water, and school construction, and did.

That’s the easy answer. It would be harder to prove, but it wouldn’t be overstating the case to attribute the big election to generational change.

Stay with me here. The people who approved these bond issues, most of them, I’d bet, grew up in the 1970s.

What does that have to do with it? These are people who are used to having nice things. By comparison, those who grew up in the Great Depression and the 1940s were used to making do. They were suspicious of government, and of debt.

When they entered their 30s and 40s, it was the 1970s. The approval ratio for the 1970s, the entire decade, was 49 percent. There were years when this frugal generation approved 9.5 percent (1975), 18 percent (1971) and 33 percent (1973) of the bonds put before them for consideration.

Those who grew up in the 1950s and 1960s, certainly a happier group, approved marginally more borrowing 30 years later, when they started raising their families. The average approval ratio during the 1990s was 69 percent.

Now we’re talking about people who were born in the 1970s. These are the people who enjoyed air-conditioned schools and comfortable college dorms and coffee that tastes good, and they want the same things for their children, as well as things like smooth roads that aren’t too crowded, and new sidewalks, and nice parks, and roomy stadiums. They grew up cosseted, and squeamish about things that are less than just so.

These are the people who have moved to the suburbs and the exurbs and they see no reason why they shouldn’t borrow millions and billions of dollars for things that are going to have a useful life of, oh, when it comes to bridges and highways and sewers and the like, of 50 years to forever. The approval ratio for bonds put up for the vote in the 2000s is 80 percent, according to the Bond Buyer.

So welcome to the Golden Age of Public Finance. Now that this bunch has seen how easy it is to get a whole barge load of bonds passed, look for election ballots to swell to even more unseemly sizes in the years ahead.

I think the author, above, has made a very good set of observations. Namely that the current generation has lost all compunction about borrowing long-term to finance near-term consumption.
And this has come about because Greenspan’s “easy money 4-ever policy” of 1995 through 2005 has lulled us all into thinking that easy, cheap borrowing is a permanent condition. It is not. The piper always must be paid.

But, more importantly, I have serious moral reservations about one generation saddling the next with its debts. How can this be right? At the federal level we’ve decided, as a nation, to make all sorts of promises that cannot possibly ever be kept at current levels of taxation. So either future senior citizens are going to be sorely disappointed by meager entitlement payments, or future taxpayers (my kids) are going to have to shoulder crushing employment tax burdens.

For the senior citizens, this is patently unfair, since they paid more than their fair share into these retirement programs all their working lives. Should it be their fault that our leaders decided to use those ‘excess funds’ for current spending on hapless wars, bridges to nowhere, and other exotic examples of pork barrel spending of every conceivable stripe?

On the other hand, should it be the responsibility of subsequent generations to shoulder the burden of paying for all that past consumption and for our collective decision to ‘fund’ past societal excess with future promises to pay?

In this skirmish, I must side with the future generations. I think it is incumbent on each generation to figure out how to pay for whatever levels of consumptive spending it deems fit.

I think that racking up huge debts with the intent of pushing their repayments off to future generations is morally equivalent to loan fraud. It would not surprise me in the least if future generations decide that they have no legal or moral obligations to make good on that debt.

In the meantime, we each must ask of ourselves where we stand on this issue, how we’ve benefited, and whether we have any sort of an obligation to correct the situation.

And it is up to my children to decide if they want to make good on my generation’s debts. After all, they will someday have a say in the matter. Let’s hope they are feeling generous.

Wednesday, March 26, 2008

Be careful what you believe.

A television ad for Morgan Stanley’s brokerage service flickers across the screen, showing a retired couple walking across a beach with a dog and their grandchildren.  Smiles and ease and comfort drip off the screen.  It is a happy, shiny future that they are selling.  Separately, a letter goes out from Morgan Stanley to their private clients warning of a “50% chance of a systemic crisis."  Which do you believe? 

Executive Summary

  • Keeping a wide-angle view on this developing crisis is the only way to avoid being whipsawed, and the stakes have never been higher (at least in our lifetime).
  • The US financial markets, and probably the world’s, peered over an abyss on the night of Sunday March 16, 2008, but were rescued by very unusual and concerted official actions.
  • On the “happy, shiny” side of the equation, we have the fact that stocks mysteriously went up immediately on the open after the announcement of the collapse of Bear Stearns, and have continued up since.
  • On the “Cold, Hard Facts” side of the ledger, indicating that a particularly nasty recession is already underway, here is the recent data:
  • You can choose to believe that the worst is behind us (stocks), or you can choose to believe the facts (everything else). But be sure to choose carefully, because the penalty for being wrong here will be particularly steep.  
  • Simple preparations will go a long way toward mitigating the effects of a possible systemic financial crisis.

On Sunday, March 16th, deep in the night, the US financial system, and, by extension, the world financial system, peered over the edge of an abyss.  If the Bear Stearns rescue (by the Fed & JPM together) had not happened, it is my firm conclusion that a systemic banking crisis would have ensued.  While some commentators are now saying that “the bottom is in,” with one even going so far as saying the Dow 20,000 is now a lock, I would implore you to be careful in choosing your beliefs

Here’s why.  In my economic seminars, we spend about as much time on the economic context and data that define our current reality as we do examining beliefs and asking ourselves whether the ones we hold might be of the enhancing or limiting variety.  This is important because what we believe shapes what we see, and what we see determines our actions – and therefore our future.  Holding the wrong beliefs at critical turning points can be extremely harmful.

In the book The Mind of Wall Street by Eugene Levy, a wonderful example of both a limiting and an enhancing belief are simultaneously on display when he recounts his experience during the take-over of a struggling railroad back in the 1970’s.  He made a bundle on the deal.  Here he describes the situation:

Management executives looked to the past in their assessment of the railroad.  They saw its wretched history of bankruptcy and losses, the thousands of miles of useless track, and the years of failed attempts at regulatory reform; from this they could only conclude that Milwaukee Road was a failed railroad that could never be profitable.  We looked at the same railroad and instead saw vast assets in real estate and machinery that could be sold.

The railroad executive team held limiting beliefs about their company that prevented them from seeing the value of what they held.  Because of this, they saw the wrong things and took the wrong actions, losing a ton of money as a result.  Meanwhile, Mr. Levy had an enhancing belief that allowed him to see things about the railroad that led him to a fortune.

I want to share a believe of mine with you:  I believe the stock market is being propped up by the Fed and/or US government (PPT), who are desperately afraid of allowing the stock market to signal the true state of affairs. In some ways I can understand this; I think that the authorities who are stabilizing the markets right now are quite justifiably worried about what would happen if the stock market was “allowed” to send a correct signal to a wider audience.  Because I believe that the stock market is being propped, I do not trust that it is telegraphing useful or meaningful price signals, and so I will take very different actions than someone who holds the opposite view.  I might be wrong, or the person holding the opposite view might be wrong, but one of us is making a colossal mistake.

And here’s a second belief:  The market is bigger than the authorities, and they will ultimately fail in their attempts to prop the stock market, because they are merely masking symptoms, not treating causes. If it were possible for an elevated stock market alone to cure what ails our economy, I might think differently.  But those efforts are surely misdirected.

The consumer-retrenchment genie is already out of the bottle, and intervention will only serve to exacerbate what is already a terrifying gap between the ‘official story’ (as told by the stock market), the daily lives of ordinary people, and the cold, hard facts.

Even as a possibly illegal and certainly ill-advised rescue of Bear Stearns is being revised and revisited, and the stock market keeps climbing or at least holding steady, we find that the current spate of fundamental economic news is especially worrisome, if not downright scary.  The question before you, then, is, which will you believe?  A happy, shiny stock market, or the cold, hard facts?

The ECRI and NBER say “recession is here” 

To begin with, the highly-respected Economic Cycle Research Institute (ECRI) recently said, “Now the verdict is finally in.  We have unambiguously turned onto the recession track.”   In case that wasn’t strong enough, Lakshman Achuthan, managing director at ECRI said, "[Our indicator] is exhibiting a pronounced, pervasive and persistent decline that is unambiguously recessionary," while Martin Feldstein, who heads the equally-regarded National Bureau of Economic Research, said that contraction is already under way and that it’s likely to be severe, stating, "The risks are that it could get very bad."  The ECRI leading indicator incorporates a broad array of economic signals and has a very good track record of spotting recessions.  The stock market used to do this, but seemed to lose that ability around the time of the Fed rescue of August 2007.

Now, during your average, ordinary, garden-variety recession, which this one most certainly will not be, the average decline in the stock market is 28%.  Compared to a year ago, before all this financial uncertainty was widely recognized, the S&P 500 is only down -6.6%.  So, for whatever reason, the stock market is now deeply at odds with the ECRI, the NBER, and virtually every piece of economic data.  Somebody has it very wrong.

Housing data is "the worst since the Great Depression"

This housing bubble is bursting, and with alarming speed.  It’s hard to keep up with the data, it’s coming so fast.  Sales and housing starts have been cut in half since the peak (link supplied the quote below), and it’s important to remember that “sales” include transactions in which a bank takes possession during foreclosure, so the sales numbers are misleadingly high.  Notably, foreclosures for February 2008 were reported to be running 60% higher than last February, so we might expect bank repossessions to be a significant component of the recently reported existing home sales number.

CHICAGO (MarketWatch) — Housing is in its "deepest, most rapid downswing since the Great Depression," the chief economist for the National Association of Home Builders said Tuesday, and the downward momentum on housing prices appears to be accelerating.

The NAHB’s latest forecast calls for new-home sales to drop 22% this year, bringing sales 55% under the peak reached in late 2005. Housing starts are predicted to tumble 31% in 2008, putting starts 60% off their high of three years ago.

"More and more of the country is now involved in the contraction, where six months ago it was not as widespread," said David Seiders, the NAHB’s chief economist, on a conference call with reporters. "Housing is in a major contraction mode and will be another major, heavy weight on the economy in the first quarter."

Even worse, house prices have plunged by 10.7% over the past year, according to the highly-respected Case-Shiller index, although the US government (via the OFHEO) comes to a substantially different conclusion and reports a mere 3% decline.  As always, the US government has settled on a particular methodology that manages to paint a happier, shinier picture than does a private firm whose livelihood depends on delivering useful information.  Unsurprisingly, it’s the happier, shinier number that the Fed uses when calculating how much people’s homes are worth vs. how much they owe on them. But even with this deployment, a new benchmark has been set:

NEW YORK (AP) — Americans’ percentage of equity in their homes has fallen below 50 percent for the first time on record since 1945, the Federal Reserve said Thursday.

Homeowners’ percentage of equity slipped to a revised lower 49.6% in the second quarter of 2007, the central bank reported in its quarterly U.S. Flow of Funds Accounts, and declined further to 47.9% in the fourth quarter – the third straight quarter it was under 50%. That marks the first time homeowners’ debt on their houses exceeds their equity since the Fed started tracking the data in 1945.

The Federal Reserve is in a box

That last bit of data, above, is what has the Fed running around with its hair on fire.  Sure, we can all take comfort in the “bold, decisive action” that Bernanke took to preserve confidence in the system by pouring hundreds of billions of dollars into the banking system, but that leaves out a very important observation.  Namely, that the crisis is not based on the fact that banks have run out of liquidity; that’s a symptom.   The cause of this crisis is rooted in the fact that an entirely too-large proportion of the people who took out trillions of dollars in loans lack the means or the motive to ever pay those loans back.  It is now estimated that more than 1 in 10 homes is now ‘underwater’, meaning that more is owed on the mortgage than the house is currently worth.  Currently that’s 8,800,000 homes, a number that we can reasonably expect to grow as this negative housing-price dynamic plays itself out.

So the nature of this particular crisis, like literally every single other credit-bubble fueled crisis in history, is not going to be resolved until the bad debt is wiped out or the losses are socialized.  By this I mean that the Federal Reserve would have to print enough money (out of thin air) to buy all the bad debt, as in $1 to $2 trillion dollars worth of it.  If this happened, the Fed would become the largest property holder in America, its balance sheet would be ruined, and it is highly unlikely that the dollar would survive the attempt.  Therefore, like every other credit bubble that has burst in the past, massive amounts of bad debts will simply have to be wiped away.  And the sooner that happens, the sooner we can pick ourselves up and carry on.

But is this really possible?  Can all that debt simply be defaulted upon?

Probably not.  And the primary reason is that, like everybody else, the Fed has no idea what would happen if the $615 trillion derivative tower, with all of its unknowably complicated interlocking pieces, was suddenly exposed to a rash of defaults.  The fear that this would be an extinction-level event for the banking system, meaning the complete and permanent abandonment of fractional reserve banking as a concept (or for one or two forgetful generations, whichever comes first).

I have no particular insights into the complexity of the derivative system, but I can tell you that I have spent a great deal of time trying to understand the magnitude and location of the risks, without much success.  So I draw my conclusions from two anecdotes.  The first concerns Warren Buffet’s experience in the years after he bought General Re, a fairly ordinary re-insurance company.  The company got in some trouble and the decision was made to absorb its operations and shut it down.  But after several years (and much concerted effort), Berkshire Hathaway found itself stuck with 14,384 outstanding derivative contracts and 672 outstanding counterparties of indeterminate risk and unknowable value, leading Buffet to comment that derivatives are “financial weapons of mass destruction.”   It is important to note that the difficulties Warren Buffet’s organization experienced in assessing the risk and value of a single company’s derivative portfolio was during a period of stable market conditions.

The second anecdote concerns another company with a large derivative portfolio, Fannie Mae, which found itself in an accounting scandal and was forced by the government to restate its earnings for the years 2001 to 2004.  In December of 2006, after two full years of effort by an army of 1,500 expert accountants and $1 billion dollars expended, Fannie Mae was finally able to produce an earnings statement for 2004.  The reason for the excessive cost and time?  Derivatives.  There were simply so many and they were so complex that it took 3,000 person-years of effort to determine the earnings for one single year for one company.  Again, this was during stable market conditions, without the burden of counterparty defaults and the time pressures that fast-moving market conditions can impose.

Fast forward to today.  If it takes thousands of person-years of effort to calculate the impact of derivatives on a single company, what would happen during turbulent times, especially if defaults are cascading and multiplying throughout the system and tens of thousands of companies dotting the globe are involved?  Pandemonium and a major system-threatening crisis, that’s what.

So now you know why I view the Fed’s actions not as “bold and decisive,” but rather as “necessary and forced.”  They will need to go further and begin buying mortgage debt directly, as has already been publicly suggested.  In my opinion, the Federal Reserve (let alone the Bush administration) is institutionally ill-equipped to deal with this particular crisis.  The Fed relies on government data on inflation, house prices, etc., and therefore has a faulty instrument panel.  It is as if they are flying a plane with a stuck fuel gauge and an altimeter that is off by 5,000 feet.  At night, in mountainous terrain.  But, more importantly, the Fed is a sclerotic institution whose reliance on past example (the Great Depression and Japan come to mind) is poorly suited to a modern world that spent the past ten years creating financial products light-years distant from prior experience, while the Fed snoozed along basking in the false glory that came with financial stability and recklessly low but popular interest rates.

The worst is yet to come

Someday, this financial crisis will all be yesterday’s news, but already a lot of ink is being spilled to try and convince you that the worst is already behind us.  Don’t fall for it.  Even a cursory tour of the data will convince you that the bursting of this credit bubble is just getting started and that a particularly nasty recession has just begun.  Nothing the Fed has done, or even can do, will change the fact that trillions of dollars of losses lurk within the system.  And those losses will either have to be written off or they will have to be monetized (i.e., bought by the Fed for money printed out of thin air).  Writing them off would mean the possible destruction of the banking system (and massive political upheavals).  There is a slight chance, a hope, a faith, that we can somehow print our way out of this mess by monetizing the bad debts.  However, that is a knife-edge possibility with failure on one side and the utter destruction of our currency on the other.  While the destruction of our past mistaken pile of debt would be bad for those who took leave of their senses and participated in the credit bubble, placing your faith on our authorities to ‘fix this’ could be financially ruinous.  It is well past time to protect yourself and your financial assets.  While I personally hope for a favorable outcome, I am preparing for the most likely outcome – a currency and/or systemic banking crisis.

Okay, so what should you do?  

My role as a financial commentator and futurist is to help you understand that money systems come and money systems go, and that the US dollar-based system has been, and is being, seriously mismanaged to the point where it is at risk of imploding.  This could happen either in a deflationary impulse that could ruin the entire banking system (unlikely, in my view), or in a (hyper)inflationary collapse of the currency (most likely).  Either way, the effect will be to impoverish the many.  Please don’t be among them.

As I said, I see a risk that this could happen, not a certainty, but because the cost of a systemic banking crisis would be so catastrophic, I think we should each undertake certain preparations.  The analogy I like to use is fire insurance.  We all carry it on our primary residences, not because the likelihood of a fire is high, but because the cost of one is so catastrophic.

It is my belief that by taking a few simple steps, each of us can make significant strides toward enhancing our future prospects.  I sincerely wish everybody would do so.

Let’s review a scenario and some actions that could mitigate the impact(s).

Systemic banking crisis:  50% probability over the next year

Everyone should be prepared for the possibility of a severe systemic banking crisis. You may see a higher or lower percentage probability than I do, but you’d certainly better have something higher than 0% in mind.

What this would look like is some sort of a serious warning, possibly the surprise bankruptcy of Citibank or a blow-up at a massive hedge fund.  Within 24-48 hours, the stock market would be in pretty bad shape, the dollar would be spiraling downward, and interest rates would be shooting up, as foreigners dump Treasury bonds in a frantic bid to repatriate their money while some value still remains. To stabilize the situation, the President would come on TeeVee to declare a banking holiday and state that the banking system is in a crisis and that some time will be needed to “calm things down and work out some solutions.”  During this time, banks would be closed, and it is highly likely that credit and debit cards would not work, since the interbank clearing system would be a mess.  Rules against hoarding would immediately be put in place, and talk of rationing of certain staple goods, such as gasoline, would begin.

Before any of this happens, here are the things you should consider doing:

Tier I actions:

  • Have 3 months of living expenses at home, in cash.  The idea here is to be able to buy things even if checks and debit and credit cards are temporarily inoperative.  What you risk here is losing the miniscule interest that your checking account is currently paying.
  • Have 1.5 months of living expenses at home in gold &/or silver. This protects against the impacts of a potential dollar crisis.  The more, the merrier, but 1.5 months is the bare minimum.
  • Make sure your bank accounts are with the safest possible banks.  Use a rating service such as Veribanc (the Blue Ribbon Report is good).  Better yet, spread your accounts across several highly-rated banks.  The idea here is that these banks will have the best chance of surviving and reopening first after a crisis.  Stay away from big banks – they have the greatest exposure to the unknowable derivative risks.
  • Do a little extra buying every time you shop, until you have at least 3 months worth of food on hand.  While the likelihood of a total shutdown of the food system is remote, not having to worry about this possibility if/when a crisis hits will free up an important part of your brain for other tasks.  This means buying extra cans, jars, and packages of food (pasta, etc) that generally will keep for ~1 to 2 years.  Buy only the foods you like to eat.  Rotate the new food behind the older food.
  • Have any medicines you can’t live without?  Begin accumulating and storing them, if this is an option.  Again, this is so that you have one less thing to worry about later on.

Tier II actions – only undertake these after Tier I actions are complete:

  • Increase your gold exposure until you have 10% (minimum) to 50% of your nest-egg socked away.  Read the Buying Gold and Silver guide in the Take Action section at PeakProsperity.com for types and tips on how to go about this.
  • Perform a self-assessment to identify your strengths and weaknesses, and the opportunities and threats that you could imagine arising during a systemic crisis. 
  • Address any critical weaknesses or threats that arise in the exercise above.
  • Develop “buy-lists” that you can follow in the early phases of a crisis. Having a plan for obtaining last minute items will not take you much time to develop now, but will be a godsend if anything comes to pass.
  • Have a plan for what you’ll do.
    • Who will you trust for news?
    • What will you do first?
    • If you and your immediate family are separated by a significant distance, will you all know where to meet and who is responsible for what?
    • Could you anticipate other family members, or even friends, moving in with you (or you with them) as a possible outcome? I f so, does this change any of your other preparations?
    • Thinking these through is just good, common sense, and it is something that all mature businesses do as a matter of course.  They call it continuity and/or disaster planning. If my local co-op bank can do it, so can you.
  • Know who your support network is.  Begin cultivating local networks of people who can help you share the load and provide support.

Tier III – only after you’re done with I and II:

  • Prepare your home.
    • Water storage. What if the power went out during the crisis?
    • Make your home more self-sufficient with respect to heating and cooling
    • Store more food (for family and neighbors…be a hero!)
  • Think about your job.  Will it be more secure/needed in the event of a financial crisis, or insecure?  Build up your cash and gold/silver reserves.  Eliminate debts, especially floating rate and secured debts.
  • What skills would be especially handy during a crisis?  Do you have them?  Is there anything you ever wanted to learn that falls under this category?

Conclusion

A bit of foresight and preparation will go a long way to mitigate the personal effects of a systemic financial crisis.  What we believe shapes what we see, and what we see determines our actions – and therefore our future.  We may not be able to change the game that the Federal Reserve is playing, but we can certainly take steps to prepare ourselves for the impact. 

The Federal Reserve Plays a Dangerous Game
PREVIEW
Wednesday, March 26, 2008

Be careful what you believe.

A television ad for Morgan Stanley’s brokerage service flickers across the screen, showing a retired couple walking across a beach with a dog and their grandchildren.  Smiles and ease and comfort drip off the screen.  It is a happy, shiny future that they are selling.  Separately, a letter goes out from Morgan Stanley to their private clients warning of a “50% chance of a systemic crisis."  Which do you believe? 

Executive Summary

  • Keeping a wide-angle view on this developing crisis is the only way to avoid being whipsawed, and the stakes have never been higher (at least in our lifetime).
  • The US financial markets, and probably the world’s, peered over an abyss on the night of Sunday March 16, 2008, but were rescued by very unusual and concerted official actions.
  • On the “happy, shiny” side of the equation, we have the fact that stocks mysteriously went up immediately on the open after the announcement of the collapse of Bear Stearns, and have continued up since.
  • On the “Cold, Hard Facts” side of the ledger, indicating that a particularly nasty recession is already underway, here is the recent data:
  • You can choose to believe that the worst is behind us (stocks), or you can choose to believe the facts (everything else). But be sure to choose carefully, because the penalty for being wrong here will be particularly steep.  
  • Simple preparations will go a long way toward mitigating the effects of a possible systemic financial crisis.

On Sunday, March 16th, deep in the night, the US financial system, and, by extension, the world financial system, peered over the edge of an abyss.  If the Bear Stearns rescue (by the Fed & JPM together) had not happened, it is my firm conclusion that a systemic banking crisis would have ensued.  While some commentators are now saying that “the bottom is in,” with one even going so far as saying the Dow 20,000 is now a lock, I would implore you to be careful in choosing your beliefs

Here’s why.  In my economic seminars, we spend about as much time on the economic context and data that define our current reality as we do examining beliefs and asking ourselves whether the ones we hold might be of the enhancing or limiting variety.  This is important because what we believe shapes what we see, and what we see determines our actions – and therefore our future.  Holding the wrong beliefs at critical turning points can be extremely harmful.

In the book The Mind of Wall Street by Eugene Levy, a wonderful example of both a limiting and an enhancing belief are simultaneously on display when he recounts his experience during the take-over of a struggling railroad back in the 1970’s.  He made a bundle on the deal.  Here he describes the situation:

Management executives looked to the past in their assessment of the railroad.  They saw its wretched history of bankruptcy and losses, the thousands of miles of useless track, and the years of failed attempts at regulatory reform; from this they could only conclude that Milwaukee Road was a failed railroad that could never be profitable.  We looked at the same railroad and instead saw vast assets in real estate and machinery that could be sold.

The railroad executive team held limiting beliefs about their company that prevented them from seeing the value of what they held.  Because of this, they saw the wrong things and took the wrong actions, losing a ton of money as a result.  Meanwhile, Mr. Levy had an enhancing belief that allowed him to see things about the railroad that led him to a fortune.

I want to share a believe of mine with you:  I believe the stock market is being propped up by the Fed and/or US government (PPT), who are desperately afraid of allowing the stock market to signal the true state of affairs. In some ways I can understand this; I think that the authorities who are stabilizing the markets right now are quite justifiably worried about what would happen if the stock market was “allowed” to send a correct signal to a wider audience.  Because I believe that the stock market is being propped, I do not trust that it is telegraphing useful or meaningful price signals, and so I will take very different actions than someone who holds the opposite view.  I might be wrong, or the person holding the opposite view might be wrong, but one of us is making a colossal mistake.

And here’s a second belief:  The market is bigger than the authorities, and they will ultimately fail in their attempts to prop the stock market, because they are merely masking symptoms, not treating causes. If it were possible for an elevated stock market alone to cure what ails our economy, I might think differently.  But those efforts are surely misdirected.

The consumer-retrenchment genie is already out of the bottle, and intervention will only serve to exacerbate what is already a terrifying gap between the ‘official story’ (as told by the stock market), the daily lives of ordinary people, and the cold, hard facts.

Even as a possibly illegal and certainly ill-advised rescue of Bear Stearns is being revised and revisited, and the stock market keeps climbing or at least holding steady, we find that the current spate of fundamental economic news is especially worrisome, if not downright scary.  The question before you, then, is, which will you believe?  A happy, shiny stock market, or the cold, hard facts?

The ECRI and NBER say “recession is here” 

To begin with, the highly-respected Economic Cycle Research Institute (ECRI) recently said, “Now the verdict is finally in.  We have unambiguously turned onto the recession track.”   In case that wasn’t strong enough, Lakshman Achuthan, managing director at ECRI said, "[Our indicator] is exhibiting a pronounced, pervasive and persistent decline that is unambiguously recessionary," while Martin Feldstein, who heads the equally-regarded National Bureau of Economic Research, said that contraction is already under way and that it’s likely to be severe, stating, "The risks are that it could get very bad."  The ECRI leading indicator incorporates a broad array of economic signals and has a very good track record of spotting recessions.  The stock market used to do this, but seemed to lose that ability around the time of the Fed rescue of August 2007.

Now, during your average, ordinary, garden-variety recession, which this one most certainly will not be, the average decline in the stock market is 28%.  Compared to a year ago, before all this financial uncertainty was widely recognized, the S&P 500 is only down -6.6%.  So, for whatever reason, the stock market is now deeply at odds with the ECRI, the NBER, and virtually every piece of economic data.  Somebody has it very wrong.

Housing data is "the worst since the Great Depression"

This housing bubble is bursting, and with alarming speed.  It’s hard to keep up with the data, it’s coming so fast.  Sales and housing starts have been cut in half since the peak (link supplied the quote below), and it’s important to remember that “sales” include transactions in which a bank takes possession during foreclosure, so the sales numbers are misleadingly high.  Notably, foreclosures for February 2008 were reported to be running 60% higher than last February, so we might expect bank repossessions to be a significant component of the recently reported existing home sales number.

CHICAGO (MarketWatch) — Housing is in its "deepest, most rapid downswing since the Great Depression," the chief economist for the National Association of Home Builders said Tuesday, and the downward momentum on housing prices appears to be accelerating.

The NAHB’s latest forecast calls for new-home sales to drop 22% this year, bringing sales 55% under the peak reached in late 2005. Housing starts are predicted to tumble 31% in 2008, putting starts 60% off their high of three years ago.

"More and more of the country is now involved in the contraction, where six months ago it was not as widespread," said David Seiders, the NAHB’s chief economist, on a conference call with reporters. "Housing is in a major contraction mode and will be another major, heavy weight on the economy in the first quarter."

Even worse, house prices have plunged by 10.7% over the past year, according to the highly-respected Case-Shiller index, although the US government (via the OFHEO) comes to a substantially different conclusion and reports a mere 3% decline.  As always, the US government has settled on a particular methodology that manages to paint a happier, shinier picture than does a private firm whose livelihood depends on delivering useful information.  Unsurprisingly, it’s the happier, shinier number that the Fed uses when calculating how much people’s homes are worth vs. how much they owe on them. But even with this deployment, a new benchmark has been set:

NEW YORK (AP) — Americans’ percentage of equity in their homes has fallen below 50 percent for the first time on record since 1945, the Federal Reserve said Thursday.

Homeowners’ percentage of equity slipped to a revised lower 49.6% in the second quarter of 2007, the central bank reported in its quarterly U.S. Flow of Funds Accounts, and declined further to 47.9% in the fourth quarter – the third straight quarter it was under 50%. That marks the first time homeowners’ debt on their houses exceeds their equity since the Fed started tracking the data in 1945.

The Federal Reserve is in a box

That last bit of data, above, is what has the Fed running around with its hair on fire.  Sure, we can all take comfort in the “bold, decisive action” that Bernanke took to preserve confidence in the system by pouring hundreds of billions of dollars into the banking system, but that leaves out a very important observation.  Namely, that the crisis is not based on the fact that banks have run out of liquidity; that’s a symptom.   The cause of this crisis is rooted in the fact that an entirely too-large proportion of the people who took out trillions of dollars in loans lack the means or the motive to ever pay those loans back.  It is now estimated that more than 1 in 10 homes is now ‘underwater’, meaning that more is owed on the mortgage than the house is currently worth.  Currently that’s 8,800,000 homes, a number that we can reasonably expect to grow as this negative housing-price dynamic plays itself out.

So the nature of this particular crisis, like literally every single other credit-bubble fueled crisis in history, is not going to be resolved until the bad debt is wiped out or the losses are socialized.  By this I mean that the Federal Reserve would have to print enough money (out of thin air) to buy all the bad debt, as in $1 to $2 trillion dollars worth of it.  If this happened, the Fed would become the largest property holder in America, its balance sheet would be ruined, and it is highly unlikely that the dollar would survive the attempt.  Therefore, like every other credit bubble that has burst in the past, massive amounts of bad debts will simply have to be wiped away.  And the sooner that happens, the sooner we can pick ourselves up and carry on.

But is this really possible?  Can all that debt simply be defaulted upon?

Probably not.  And the primary reason is that, like everybody else, the Fed has no idea what would happen if the $615 trillion derivative tower, with all of its unknowably complicated interlocking pieces, was suddenly exposed to a rash of defaults.  The fear that this would be an extinction-level event for the banking system, meaning the complete and permanent abandonment of fractional reserve banking as a concept (or for one or two forgetful generations, whichever comes first).

I have no particular insights into the complexity of the derivative system, but I can tell you that I have spent a great deal of time trying to understand the magnitude and location of the risks, without much success.  So I draw my conclusions from two anecdotes.  The first concerns Warren Buffet’s experience in the years after he bought General Re, a fairly ordinary re-insurance company.  The company got in some trouble and the decision was made to absorb its operations and shut it down.  But after several years (and much concerted effort), Berkshire Hathaway found itself stuck with 14,384 outstanding derivative contracts and 672 outstanding counterparties of indeterminate risk and unknowable value, leading Buffet to comment that derivatives are “financial weapons of mass destruction.”   It is important to note that the difficulties Warren Buffet’s organization experienced in assessing the risk and value of a single company’s derivative portfolio was during a period of stable market conditions.

The second anecdote concerns another company with a large derivative portfolio, Fannie Mae, which found itself in an accounting scandal and was forced by the government to restate its earnings for the years 2001 to 2004.  In December of 2006, after two full years of effort by an army of 1,500 expert accountants and $1 billion dollars expended, Fannie Mae was finally able to produce an earnings statement for 2004.  The reason for the excessive cost and time?  Derivatives.  There were simply so many and they were so complex that it took 3,000 person-years of effort to determine the earnings for one single year for one company.  Again, this was during stable market conditions, without the burden of counterparty defaults and the time pressures that fast-moving market conditions can impose.

Fast forward to today.  If it takes thousands of person-years of effort to calculate the impact of derivatives on a single company, what would happen during turbulent times, especially if defaults are cascading and multiplying throughout the system and tens of thousands of companies dotting the globe are involved?  Pandemonium and a major system-threatening crisis, that’s what.

So now you know why I view the Fed’s actions not as “bold and decisive,” but rather as “necessary and forced.”  They will need to go further and begin buying mortgage debt directly, as has already been publicly suggested.  In my opinion, the Federal Reserve (let alone the Bush administration) is institutionally ill-equipped to deal with this particular crisis.  The Fed relies on government data on inflation, house prices, etc., and therefore has a faulty instrument panel.  It is as if they are flying a plane with a stuck fuel gauge and an altimeter that is off by 5,000 feet.  At night, in mountainous terrain.  But, more importantly, the Fed is a sclerotic institution whose reliance on past example (the Great Depression and Japan come to mind) is poorly suited to a modern world that spent the past ten years creating financial products light-years distant from prior experience, while the Fed snoozed along basking in the false glory that came with financial stability and recklessly low but popular interest rates.

The worst is yet to come

Someday, this financial crisis will all be yesterday’s news, but already a lot of ink is being spilled to try and convince you that the worst is already behind us.  Don’t fall for it.  Even a cursory tour of the data will convince you that the bursting of this credit bubble is just getting started and that a particularly nasty recession has just begun.  Nothing the Fed has done, or even can do, will change the fact that trillions of dollars of losses lurk within the system.  And those losses will either have to be written off or they will have to be monetized (i.e., bought by the Fed for money printed out of thin air).  Writing them off would mean the possible destruction of the banking system (and massive political upheavals).  There is a slight chance, a hope, a faith, that we can somehow print our way out of this mess by monetizing the bad debts.  However, that is a knife-edge possibility with failure on one side and the utter destruction of our currency on the other.  While the destruction of our past mistaken pile of debt would be bad for those who took leave of their senses and participated in the credit bubble, placing your faith on our authorities to ‘fix this’ could be financially ruinous.  It is well past time to protect yourself and your financial assets.  While I personally hope for a favorable outcome, I am preparing for the most likely outcome – a currency and/or systemic banking crisis.

Okay, so what should you do?  

My role as a financial commentator and futurist is to help you understand that money systems come and money systems go, and that the US dollar-based system has been, and is being, seriously mismanaged to the point where it is at risk of imploding.  This could happen either in a deflationary impulse that could ruin the entire banking system (unlikely, in my view), or in a (hyper)inflationary collapse of the currency (most likely).  Either way, the effect will be to impoverish the many.  Please don’t be among them.

As I said, I see a risk that this could happen, not a certainty, but because the cost of a systemic banking crisis would be so catastrophic, I think we should each undertake certain preparations.  The analogy I like to use is fire insurance.  We all carry it on our primary residences, not because the likelihood of a fire is high, but because the cost of one is so catastrophic.

It is my belief that by taking a few simple steps, each of us can make significant strides toward enhancing our future prospects.  I sincerely wish everybody would do so.

Let’s review a scenario and some actions that could mitigate the impact(s).

Systemic banking crisis:  50% probability over the next year

Everyone should be prepared for the possibility of a severe systemic banking crisis. You may see a higher or lower percentage probability than I do, but you’d certainly better have something higher than 0% in mind.

What this would look like is some sort of a serious warning, possibly the surprise bankruptcy of Citibank or a blow-up at a massive hedge fund.  Within 24-48 hours, the stock market would be in pretty bad shape, the dollar would be spiraling downward, and interest rates would be shooting up, as foreigners dump Treasury bonds in a frantic bid to repatriate their money while some value still remains. To stabilize the situation, the President would come on TeeVee to declare a banking holiday and state that the banking system is in a crisis and that some time will be needed to “calm things down and work out some solutions.”  During this time, banks would be closed, and it is highly likely that credit and debit cards would not work, since the interbank clearing system would be a mess.  Rules against hoarding would immediately be put in place, and talk of rationing of certain staple goods, such as gasoline, would begin.

Before any of this happens, here are the things you should consider doing:

Tier I actions:

  • Have 3 months of living expenses at home, in cash.  The idea here is to be able to buy things even if checks and debit and credit cards are temporarily inoperative.  What you risk here is losing the miniscule interest that your checking account is currently paying.
  • Have 1.5 months of living expenses at home in gold &/or silver. This protects against the impacts of a potential dollar crisis.  The more, the merrier, but 1.5 months is the bare minimum.
  • Make sure your bank accounts are with the safest possible banks.  Use a rating service such as Veribanc (the Blue Ribbon Report is good).  Better yet, spread your accounts across several highly-rated banks.  The idea here is that these banks will have the best chance of surviving and reopening first after a crisis.  Stay away from big banks – they have the greatest exposure to the unknowable derivative risks.
  • Do a little extra buying every time you shop, until you have at least 3 months worth of food on hand.  While the likelihood of a total shutdown of the food system is remote, not having to worry about this possibility if/when a crisis hits will free up an important part of your brain for other tasks.  This means buying extra cans, jars, and packages of food (pasta, etc) that generally will keep for ~1 to 2 years.  Buy only the foods you like to eat.  Rotate the new food behind the older food.
  • Have any medicines you can’t live without?  Begin accumulating and storing them, if this is an option.  Again, this is so that you have one less thing to worry about later on.

Tier II actions – only undertake these after Tier I actions are complete:

  • Increase your gold exposure until you have 10% (minimum) to 50% of your nest-egg socked away.  Read the Buying Gold and Silver guide in the Take Action section at PeakProsperity.com for types and tips on how to go about this.
  • Perform a self-assessment to identify your strengths and weaknesses, and the opportunities and threats that you could imagine arising during a systemic crisis. 
  • Address any critical weaknesses or threats that arise in the exercise above.
  • Develop “buy-lists” that you can follow in the early phases of a crisis. Having a plan for obtaining last minute items will not take you much time to develop now, but will be a godsend if anything comes to pass.
  • Have a plan for what you’ll do.
    • Who will you trust for news?
    • What will you do first?
    • If you and your immediate family are separated by a significant distance, will you all know where to meet and who is responsible for what?
    • Could you anticipate other family members, or even friends, moving in with you (or you with them) as a possible outcome? I f so, does this change any of your other preparations?
    • Thinking these through is just good, common sense, and it is something that all mature businesses do as a matter of course.  They call it continuity and/or disaster planning. If my local co-op bank can do it, so can you.
  • Know who your support network is.  Begin cultivating local networks of people who can help you share the load and provide support.

Tier III – only after you’re done with I and II:

  • Prepare your home.
    • Water storage. What if the power went out during the crisis?
    • Make your home more self-sufficient with respect to heating and cooling
    • Store more food (for family and neighbors…be a hero!)
  • Think about your job.  Will it be more secure/needed in the event of a financial crisis, or insecure?  Build up your cash and gold/silver reserves.  Eliminate debts, especially floating rate and secured debts.
  • What skills would be especially handy during a crisis?  Do you have them?  Is there anything you ever wanted to learn that falls under this category?

Conclusion

A bit of foresight and preparation will go a long way to mitigate the personal effects of a systemic financial crisis.  What we believe shapes what we see, and what we see determines our actions – and therefore our future.  We may not be able to change the game that the Federal Reserve is playing, but we can certainly take steps to prepare ourselves for the impact. 

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