The last major debt liquidation in the United States occurred during the Depression of the 1930s. After the stock market crash of October 1929, the fledgling Federal Reserve cut the money supply by a third, presumably to combat inflation, thereby that exasperated the severe economic recession of the 1930s.
The Federal Reserve in 2008, under the weight of government budget deficits and wasteful government spending, is once again desperately trying to avoid or postpone a final reckoning on both our country’s public debt and the private debt of our citizens. Public debt is well known and has been hyped by many financial commentators and writers for years. It seems to have a life of its own, growing mostly from one business cycle to the next, except for a brief period of balancing the federal budget during the Clinton years. The Federal Reserve, through its current interest rate in response to the subprime debt crisis (although that relaxation could be reversed in the future to combat inflation), may succeed in inflating some of that huge federal budget deficit. The problem is that as the level of public and private debt has risen through various economic cycles without a cleanup of the system, it has become more difficult for the Federal Reserve in each economic downturn to get the economy running again. your usual money activities. Note that Alan Greenspan had to lower key interest rates to 1% after the stock market bubble burst in 2000 before the economy and stock market recovered.
Today, the Federal Reserve under Chairman Bernanke has tried to stop an economic bankruptcy contagion with the Bear Stearns bailout. This is at the cost of massive easing from the Federal Reserve, which I think may exasperate the inflation we are now experiencing going forward. We may have just entered a recession and the Federal Reserve is already giving the economy full courses of antibiotics. Allowing the business cycle to complete removes excesses and bubbles in the system: The Fed may be trying to abrogate the business cycle today while avoiding even the slightest whisper of recession.
The subprime debt crisis, caused in part by fraudulent and/or overly aggressive lending practices, has caused many people to lose their homes due to high levels of debt. Some may not have qualified for their loans in the first place. The federal government now offers assistance to credit-worthy people whose mortgage payments may increase due to the terms of their mortgages. As bad as the real estate and credit crunch may seem, there may be new responsible buyers who qualify and deserve good home loans.
On the investment front, there are some very smart investors, Warren Buffett among them, who have been diversifying their portfolio or their company’s portfolio to include non-US companies. The dollar in late 2007-2008 declined through two decades of chart support and (barring short- to medium-term bullish countertrends) may trade lower over the long term. Adding to the mix, we may find ourselves with the possibility of a triple sweep of the Democratic Party later this election year, policies enacted that may hamper the progress of the stock market in a way not seen since the late 1970s. I discussed this possibility and its consequences in this article. However, certain inflation-sensitive investments may perform well over the long term.
I own shares of the Templeton Global Bond Fund to further tap the potential of a declining dollar. Gold is also a long-term beneficiary of a declining dollar, and has even progressed higher in recent years when the dollar has been intermittently strong. Gold can also be a hedge against a debt crisis like the one we’ve seen with subprime contagion, although the recent high in March 2008 was marked by the Federal Reserve’s bailout of Bear Stearns, which has hopefully stemmed the tide of the current crisis. I have held gold for the past several years and plan to continue holding the yellow metal.
The Federal Reserve’s job is to fight inflation. As Chairman Bernanke is a student of the Great Depression of the 1930s, when the economic system failed, he seems determined to prevent a similar economic catastrophe from happening again. Thus, recently we have seen easy money policies designed to stimulate the economy and the housing market, where the damage is greatest. Preventing a debt implosion whereby the financial system collapses appears to be high on the Fed’s priority list. That the Federal Reserve has taken such steps in the face of current inflation indicates that the possibility of such a collapse has been seen as a possible reality. .
