Let’s start with these two data points . . .
INFLATION FEARS – As my great friend Joe Cherner pointed out to me yesterday, the 5-year Treasury Inflation Protected Securities (TIPS) are now yielding less than zero. (Click the link and scroll down.) That is, they promise to pay 2% a year interest . . . but so concerned are folks about inflation that they were yesterday willing to shell out $1,084 for each $1,000 bond.
On April 15, 2012, when the bonds mature, yesterday’s buyers will have lost a hair more on each bond – $84 – than they will have received in interest payments from it. That’s why the yield works out to less than zero.
Except that the face value of these bonds is inflation adjusted. And that’s why people are paying so much for them.
The math is a little complicated, but it all boils down to a return of ‘three-hundredths of one percent below inflation.’ And to some, being protected against ‘all but three-hundredths of one percent of inflation’ seems pretty attractive these days.
With the Fed flooding the financial system with money, and with the US dollar sinking against foreign currencies, rising inflation is likely. Not good.
CREDIT FEARS – As another great friend pointed out to me yesterday, S&P and Moody’s last week both reaffirmed their triple-A ratings of the bonds of a company called MBIA, an insurer of those ‘collateralized mortgage obligations’ that have everyone so spooked. And yet (here was my friend’s punch line), MBIA’s bonds yield 14%.
See? The rating agencies are saying, ‘Not to worry – MBIA is a top quality credit. Triple-A. Highest rating there is.’
The market, demanding 14%, is saying, ‘You have got to be kidding.’
This is important, because if MBIA is a triple-A credit, then the bonds it insures are triple-A. If MBIA is dropped down a few notches, so too many of the bonds it insures.
(How did S&P and Moody’s come to reaffirm MBIA’s triple-A rating? I have no idea. But I am reminded of Roger Lowenstein’s wonderful Sunday Times Magazine piece recently in which he describes how, to get then Fed Chairman William McChesney Martin to lower interest rates, LBJ allegedly slammed him against a wall and physically beat him.)
With home prices falling, foreclosures rising, and a recession looming, there is the fear of a vicious cycle: more foreclosures leading to further home-price declines leading to worsening consumer confidence, a deeper recession, and . . . Not good.
What are we to draw from these data points?
First, that this is an even better time than usual to live beneath your means . . . to save for a rainy day . . . to diversify . . . to keep your transaction costs low . . . to take risk seriously . . . to expect lower interest rates but higher inflation which leads to higher interest rates which leads to more business failures, deeper recession, and lower interest rates . . . in short, a roller coaster ride.
The world rarely ends, so this will ultimately be a column of good news, but first it does appear that the chickens, as they had to, are indeed coming home to roost.
We laughed at Europeans in their funny little cars as we drove ever bigger and bigger SUVs . . . but guess who’s going broke?
We looked the other way when homes and condos were rising to crazy heights and mortgage lenders were making ‘no doc’ loans and ‘liars loans’ – loans the Fed and other regulators could easily have tamped down but didn’t.
We borrowed massively to cut taxes on the rich and then to finance an ill-conceived war, taking our National Debt up from under $1 trillion (about 30% of GDP) at the start of Reagan’s first term to $10 trillion (nearly 70% of GDP) by the end of George W. Bush’s.
We allowed the gap between the rich and everyone else – and the ranks of the uninsured – to chasm. (Did you see this past Sunday’s ’60 Minutes’ piece on the group of volunteers who have begun offering free weekend health care clinics in America as they do in the jungles of the Amazon? It will leave you shaking your head in sad disbelief.)
We watched – or, rather, didn’t watch – as Wall Street paid itself gigantic bonuses for creating securities and taking risks whose magnitude we do not yet know. (But we do know that when the CEO exited a hemorrhaging Merrill Lynch, he left with $161 million in cash and benefits.)
And as long ago as 1974, we stamped our foot at the notion of increasing the gas tax by a dime a year, forever (and using that flood of revenue to lower the income tax, so we would be taxing the thing we wanted to discourage while reducing the tax on work and investment that we wanted to encourage).
Yes, this would have sent the price per gallon to $4 by 2008 . . . but it got there anyway. The difference is, had we launched this in 1974, spurred on by OPEC’s quadrupling the price of oil, our vehicles would today get 80 miles to the gallon (so the cost of driving a mile would actually be lower in real terms than it was), Detroit would lead the automotive world, our trade deficit would be far lower, our dollar stronger, our air cleaner, our families more prosperous, our military less entangled, and more.*
*I blame Detroit, specifically its top executives. I blame the oil companies and their lobbyists. I blame our political system. I blame the woman I saw on TV screaming hysterically when Clinton raised the gasoline tax 4.3 cents a gallon – it was gonna kill her, she wailed. I blame the TV reporter on that story for not immediately pointing out she was being an idiot . . . that this tax hike would cost her just $36 over the course of a year . . . and that she could easily avoid it altogether just be making sure her tires were properly inflated. I blame myself for not advocating for the dime-per-year-per-gallon tax even more strongly.
So here we are . . . and here, now, the good news . . .
Begin with this delightful perspective from the New Yorker:
. . . A few minutes later, it was Arthur Gray on the line, from the Virgin Islands. Gray, who is eighty-five and a money manager at a firm called Carret, has been in the game since 1945. Age and experience incline him to the long view. ‘As Herman Kahn pointed out, two hundred years ago almost everyone was poor,’ he said. ‘Today, somebody on welfare in our country lives better than a maharaja did two hundred years ago. The maharaja had two hundred slaves fanning him; today, you push a button and have air-conditioning. So, as Kahn said, two hundred years from now everybody will be affluent. I think it’s a wonderful world. I can’t call this thing more than a hiccup.’
We have, I think, at least four macro forces going for us.
First, of course, we are a hard-working, ingenious people. Our political and economic system is flawed, but it’s still about the best there is for adapting to changed circumstances.
Second, the dollar has sunk so low, with no end necessarily in sight, that America is on sale – 40% off! There should be increasing demand for our goods and services (good for employment) and a market for a lot of our assets. (Sell your condo to a foreign investor and then rent it back from him?) It won’t be fun seeing some of our premier companies and real estate being bought up by overseas investors. But we insisted on trading our dollars for gasoline and VCRs, and now the gasoline has been burned up and the VCRs dumped in landfills, but those dollars – I.O.U.’s – are still out there. They may be redeemed by buying stuff. As a practical matter, this may help put a floor on some real estate; may help keep our stock market from falling as far as it otherwise might.
Third, we will have a new President soon who may be able to sweep into office much as Reagan did, when things were also precarious (nearly unprecedented inflation married to nearly unprecedented unemployment, with no way out) and infuse us, and our neighbors around the world, with confidence and hope. Psychology can be self-fulfilling (all we have to fear is fear itself), and markets have as much to do with psychology as with economics. (But economics matters, too, so the next President will, I hope, make the kinds of smart decisions Bill Clinton did, not repeat the disastrous ones of the past seven years.)
Fourth, there is technology. Faithful readers may recall Ray Kurzweil’s prediction that technological progress will be 32 times as rapid over the next half century as over the last. There are all sorts of perils in this; but also the potential for a tremendous wave of prosperity that will lift billions of boats, and overwhelm (in a good way) today’s seemingly intractable economic problems.
The sun will come out tomorrow. But maybe not literally tomorrow.
Quote of the Day
Everyman is guilty of all the good he didn't do.~Voltaire
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