I’ve met a few old friends recently, people I’ve not seen in a while. Knowing what I do for a living, they all asked me the same thing: "How bad is it going to get?".
I made a pariah of myself each and every time by giving it to them straight. You already know my thoughts on this, of course. It’ll be bad. A few months back people (myself included) were drawing parallels with the seventies. Now all the talk is of a new Great Depression. What next? Will this be the biggest economic event since the repeal of the Corn Laws?
Today, though, I’m going to leave this question to one side. Instead, let’s have a think about what’s going to happen after the downturn (it may seem hard to believe right now, but there will be an after the downturn).
What will the world look like?
The answer will depend on what the jury decides in what is the most important trial of our times: Man versus Capitalism. The outlook for Capitalism isn’t good...
As Ambrose Evans-Pritchard writes in today’s Telegraph:
‘At this point I have given up hoping that we will draw the right conclusions from this crisis. The universal verdict is that capitalism has run amok.’
So what will the world look like after the guilty verdict is in? Let’s get ball rolling with three predictions about what the future global economy will look like:
1. The state will play a much larger roleThis is pretty much nailed on already. Governments have already gone beyond being Lenders of Last Resort. Here in Britain, the government is buying into the banks directly.
It won’t stop there, either. Economies are shrinking and people are losing jobs. Governments will do whatever they can to minimise the damage, including giving people jobs directly. It would be political suicide not to.
2. Capital will be allocated less efficientlyFor investors, this is the biggy. The prevailing "wisdom" has it that bankers are reckless mercenaries who throw money at ludicrously risky propositions in the hope of receiving a fat bonus before the whole thing blows up in their employer’s face.
While there may be an element of truth in that, let’s not get carried away. Banks exist to make money, and, by and large, it’s in their interests to lend where the return will be highest — while keeping risk to an acceptable level, of course. But that ‘acceptable level’ is now being redefined.
We will see tighter regulation of financial institutions. We could also see governments morph into reluctant banks managers as they attempt to keep the system on its feet. If this happens, expect lending decisions to be taking for political motives rather than profit motives. That is to say, the most profitable businesses — the ones that would deliver the most economic growth — will not necessarily be the ones that are funded.
Businesses that ten years ago would have had no problem getting a loan — and, crucially, that would have used that loan to fund profitable enterprises — will find it harder to get funds. As such, they will find it harder to grow, and shareholders will suffer.
To cut a long story short — the world of the future will be a harder place to make money.
3. Protectionism will end dollar hegemonyTo be honest, there’s loads of culprits I could choose when I’m playing the Who Will Knife The Dollar game. But I’ve got this sneaking suspicion — call it a hunch — that protectionism will be the catalyst. Let me explain.
Whoever wins the US Presidential election, America is in big trouble. It will be hard to resist calls to whack up tariff barriers, and protect domestic jobs from foreign competition. A weakening dollar may help US exports a bit... but the US is in a bind.
If the dollar falls too much, foreign dollar holders (eg China and the oil-rich Gulf nations) will start dumping it. The US does well out of being the world’s reserve currency. Such a move would threaten that.
So what will the US do? It could pursue a strong dollar policy (I’m not sure how, but we’ll gloss over that here!). But that would hit exporters, and hit jobs. So, in response, some bright spark will start banging the drum for protectionism.
In desperation, the US government will reach for the lifeline. Foreigners who sell goods to Americans will suddenly find their access to the world’s biggest consumer market has been severely curtailed. Bad for them... but bad for America, too.
You see, those foreign dollar holders can see the currency’s fundamentals are weak. They’re sitting on all this money whose value is in the hands of a monetary authority (the Fed) and a government whose sole concern right now is fighting the downturn. The Fed has slashed rates, and there’s a strong chance the printing presses will soon go into overdrive.
So why are foreign dollar holders playing ball? Because, as things stand, it’s still in their interests to do so. Why would they want to antagonise a nation they do so much business with? Why would they impoverish their best customers?
But throw protectionism into the equation, and the incentives change. This is particularly true in the case of goods exporters like China. Overnight, the US market is less important to them.
Now, will this be enough to tip the balance? Will it reduce their incentive to co-operate enough so that they take their ball back and stop playing? Hard to say... but I think we’re going to find out.
One thing at a time... we need to get there first
Those are my three predictions for today. But many moons will pass through the night sky before this whole thing turns around. For now, we must do two things. We must prepare, and we must protect.
So what better time than to reiterate the Fleet Street action plan:
- Buy undervalued shares — Investors are that bit more fearful now than they were when I last wrote to you over a fortnight ago. Best-selling author Warren Buffett is now banging the value drum, and with good cause. The time to be greedy approacheth...
- Keep some of your wealth in assets other than stocks — At The Fleet Street Letter we are currently recommending two investments in particular. One is a hedge against further sterling weakness; the other is an ideal wealth preserver for long-term investors. This investments allows you to still play the markets, but, if you stay the course, it protects your downside so you won’t lose any of your initial capital
- Don’t forget cash — It’s OK to be overweight in cash. If your circumstances permit, don’t be afraid to keep your powder dry and wait for better opportunities
Until next time
Ben Traynor
Editor
Fleet Street Daily
PS I’ve prepared a special report on what I believe is the greatest threat to your wealth at this moment in history. I urge you to read it, and discover how to protect yourself in "Bankrupt Britain"
The Daily Reckoning - Reckoning Day Is Here
BY BILL BONNER
"The D-word is back," says this morning’s Financial Times. "Could deflation be the next big shock to the financial system?"
Where has the FT been? The world has never seen so much deflation. Stock markets around the world have deflated by about $10 trillion. US housing has deflated by about $5 trillion. Oil has deflated to only half its high; it closed at $64 on Friday. Gold, down $13 on Friday, has deflated about 25%. Bear Stearns deflated to nearly zero.
Even the bond market is beginning to deflate. Yields are rising, to 3.97% for the 10-year T-Note.
The Dow rose 141 points on Friday. But year-to-date, the US stock market — as measured by the S&P 500 — is down 35%. That means that US stockholders alone have suffered a loss of nearly $5 trillion. And one of our 5 houses in America has sunk so low that it is now underwater; the mortgage level is higher than the value of the house.
You can read the Daily Reckoning in full here
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