Save your money!

Disclaimer: I have no training or expertise. Don't listen to me. This is not advice. Don't make any decisions based on what's here. Do your own homework, and I recommend you listen to NPR.

We used to joke when I was a kid. My father would come home from work. He would walk in the door. My mother would ask, "What's new?"

Without fail, he would reply, "Save your money!" That was a motto he learned from living through the Great Depression. It was a motto he lived by, and one he taught all of us to live by as well. And it has served all of us well.

The President and certain economists of late have been saying the economy will still get worse before it gets better, and we haven't seen the worst yet. What does this mean? Is that just one of those things people say for the sake of drama?

Here is what I expect from the economy; these are my further projections based on new information.

• I still expect the Dow to drop to 7000 or lower by July 2009, and not exceed 10,000 for 5 years or more. The reasons are in the following bullets. Actually, I now think this projection may have understated the problem, and things may be even worse.
  
• The GDP is very bad. This is the Gross Domestic Product -- how much our nation is producing. We are producing less.
• Jobs are being lost in record numbers from nearly all sectors of the economy. Unemployment is very high in historical terms, and it will get even higher -- much higher. That means people will not have money to spend. This is not just another cyclic recession. It is the worst it has been since the depression.
  
• Manufacturing jobs will be hard hit, more than they already are. This is because manufacturers did not quickly enough respond to lower sales, and they continued producing goods. These unsold goods are either sitting in warehouses, costing storage, or they are being sold at cut rate just to free up the cash. When sales pick up again -- however long that may take -- there is plenty of unsold inventory to be sold before manufacturers need to bring workers back. So, more spending now will not necessarily mean more jobs now. Unsold inventory and reduced profitability means less justification for higher stock prices, except for those who wish to speculate.
• A new demographic must be taken into account: The baby boom generation that created the growth of the past 60 years is mainly done buying stuff. Their kids are grown and have their own families -- but not as many, and they are smaller and have less cash available. Rather than buying more stuff, as we would hope for the sake of the economy, the baby boom generation now is ready to downsize and get rid of stuff it doesn't need, rather than acquire more. And, many -- of all generations -- are now discovering that they can get by with less stuff. Remember how your parents and grandparents may have said things like "Why, during the depression, things were tough. And we just made do without all the fancy things you have." Well, now there is a whole new generation that is learning that philosophy from their own personal experience -- a whole new generation whose motto will be "Save your money!" They will be more focused now than in recent decades on saving for the future as being more important than "shinies" today. These factors will keep buying at lower rates than in recent decades. Good for them, but not so good for the economy if we were hoping for a quick fix precipitated by lots of people going out and spending money instead of saving.
  
• People have generally lost confidence in the stock market. The new Administration and Congress may take steps to improve oversight of the markets and banks, but it will take a long time for people to trust that anything has really gotten better and safer and more fair, and that any legal authority is protecting their interests. And each scandal of how the banks squander the bailout money or how the Madoffs of the world defrauded people of billions while an incompetent government did nothing even after being tipped off, will only delay the rise of confidence necessary for average people to invest in stocks in high numbers. There is serious speculation that Madoff is only the first of many, many others who will be exposed in coming months, and when these stories hit the news, it will dampen enthusiasm for the market.
  
• The money for recovery programs in which we are now embarking does not exist in some government vault, so the government will have to get it from somewhere. The government gets money in 3 ways.
  

1. One way is taxing, but we have not been taxed to a level sufficient to cover the debt being created. There is no appetite to raise taxes, and some even hope to cut them further.
2. We borrow from other countries. When our dollar is strong and interest rates are high, we become increasingly the world's banker. However, in recent months the dollar either has not been strong, or only regained strength relative to other currencies because their own economies got impacted by the financial problems in the U.S., not because of any inherent soundness or desirability of the U.S. dollar. That is to say, for the moment, foreign investors may reason that the U.S. dollar is not as secure an investment as it used to be, and not as safe as they would like, but compared to everyone else at the moment, it is the safest. This is not much of an incentive, and there is no guarantee our relative advantage will last, especially if Asian, European, or Middle Eastern economies are able more quickly than we to get back on track -- or if any of them are perceived to have greater expertise and diligence in protecting investments. Imagine, for instance, what a boon it would be for the European community to compete with the U.S. for foreign investments by guaranteeing a level of oversight and regulation that we have not done. We angered foreign investors -- we have made them feel cheated and defrauded; it would not take much to woo them to something more secure. If we want to be the world's banker, if we want their investments to keep our economy moving, we owe it to our creditors to perform due diligence and regulate and oversee financial institutions. When banks and the economy tanked, so did the billions of dollars invested by foreigners. They read the papers too, and they can plainly see that we could have and should have prevented this mess but did not. They too will need to see a history of enforcement and due diligence before they will invest the huge sums we are going to need. It remains to be seen whether the Congress can pass and fund bills to provide serious regulation of the sort needed to raise investor confidence, and to compete with any foreign market that wants to best us. Furthermore, it is popular for certain politicians and media to promote smaller government, deregulation, and less oversight; every time their message plays in the press, it will weaken the perception that the U.S. is serious about doing what it takes to ensure foreign investments in the U.S. are safe. Our credibility will suffer if those in or running for office are perceived to be arrogant, uneducated, or inclined to act on the basis of ideology instead of facts and pragmatics.
3. The government can create more money simply by printing more. If it prints more money without a basis of value, as would be the case at the moment, the result further down the road is high inflation. Historically, some economists, in fact -- such as in the Reagan Administration -- propose that we can inflate our way out of debt. As inflation reduces the value of the dollar in terms of what it can buy, the relative value of the debt shrinks. This may help the government balance its books and it may look good on paper, but it is harmful to large parts of the population. If unemployment is low, then workers' wages would rise with inflation; good for you, perhaps, if you have a job; workers can be taxed more dollars to pay off the debt, but would notice it less because they will have more dollars (although with less buying power). But those on fixed incomes will be unable to keep up with the rising costs and will be severely impoverished if inflation is high; costs go up, and they are without any means of bringing in more income to keep up.
   

• Because taxes will not be raised and interest rates are being kept artificially low in order to free up borrowing in the U.S. banking industry, the most likely choice will be #3 -- print lots more money, which will inevitably lead to high inflation.
• When inflation occurs, the Fed will eventually need to bring it under control, lest it cause other damage to the economy. The Fed will respond by raising interest rates -- a lot. How much? In the late 1970s and early 80s, you could easily get 6% interest on daily savings at a bank and 13% on a 3 year CD. Our situation is more severe, and the resulting inflation could be very much higher, so we could easily surpass those rates.
• High interest rates will do three things:

1. High interest rates will make it harder again for people to borrow. This will work against our recovery efforts because people won't be able to buy things as easily, hence less will be manufactured, fewer people will be employed making them, fewer people will have money to spend, and the stock market will have no basis to rise.
2. High interest rates will encourage more savings in banks and credit unions instead of in stocks and mutual funds. This could be unfortunate. If the stock market is depressed, then at its lowest point would be the best time to buy stocks or mutual funds, and long term investments could easily earn 25% a year or more if the economy recovers and does well. The more money in banks instead of in stocks, the longer the market will take to recover, and the less investors stand to make. The problem, of course, as we stated earlier, is that things will get worse than they are now, so only those who like big risks and can stay in the market for the long haul, should consider the market. Moreover, while some -- perhaps many -- investors will be able to make 25% or more a year in the market by proper timing, that is not easy and it is not guaranteed. Many will also lose 25% or more -- something they might ill afford after losing 40-50% already. Many will conclude, therefore, that 10% or maybe even 15% in a bank CD that is guaranteed not to lose money is better than an investment in the stock market or mutual funds, where I can possibly lose everything. With compounding, a 10% APY doubles your principle in only 7 years; can you guarantee that in the market? On the other hand, if inflation were high, would the interest you earn even keep pace? If not, then money in the bank means still means a loss in relative terms because you can buy less with my money in the future than you can today. Only those lucky enough to pick wise investments will keep up with inflation or surpass it and thus feel wealthy; everyone else will fall ever further behind and be able to afford less and less.
   
3. If interest rates get high enough, it will further encourage the foreign investment we need. So, once the economy is moving at least a little, there will be an incentive for the Fed to raise interest rates even if it makes it somewhat harder for consumers to buy. The foreign investments may be a higher priority than consumer spending.
   

• Gas prices are artificially low at the moment because of the glut on the oil market. The glut was created when prices were high. They were high, in part, because China bought huge quantities in order to prepare for, and host, the world Olympics. Oil prices dropped when China stopped buying so much after the Olympics, and when the global economy suddenly reduced consumption. To compensate, oil producing nations are cutting back production. Oil and gas prices will start rising again in coming months. This will cause more hardship and make people again have fewer dollars available to buy other things, and this, in turn, will further add to the recession. In fact, depending upon the timing it can also lead to inflation or add substantially to the inflation mentioned earlier in this post. We could then see ourselves in the ironic situation of recession and inflation at the same time -- something some economists traditionally taught was impossible.
• Given these considerations, I do not see a reason for the Dow to go up and stay up. There is no basis in productivity or in near term sales or growth. On what basis will companies be able to pay dividends? You only buy shares in companies you expect to do well, and when you buy shares you are buying part of the company. What company do you have any confidence in to weather the storm of the next few years and survive? -- for if they don't survive, you lose your investment. Any increase in the Dow that i see in the short term, I interpret as day trading and speculation -- people trying to drive up a stock or the market at large so they can sell fast and make a quick profit. But this is not a basis for a strong market, and is not a reason for most people to invest.
  

Clearly, this is all unlike anything seen in the lifetime of most of us. Much of the "common wisdom", like "the market always goes up" and "houses always rise in value", needs to be carefully reassessed. Such things may not be true any more, or perhaps not at this point in time. This is not a time for "business as usual", nor is it a time for fear. What is needed is careful and thoughtful saving and investing. Whatever you do, save your money!

Disclaimer: I have no training or expertise. Don't listen to me. This is not advice. Don't make any decisions based on what's here. Do your own homework, and I recommend you listen to NPR.