My Two Cents - "The Survival Guide"

10/20/2006

The good news is that if you haven't started storing your wealth, it isn't too late to begin. The problem for most Americans is that there just isn't much to save as is reflected by the nation's negative savings rate. No matter how you slice it, there is going to be some economic pain. The question is do we have this pain on our terms or someone else's? Those who have safeguarded their wealth (ie purchasing power) will feel much less pain than those who haven't. The following are 5 steps that I feel will help the average American prepare for the negative affects of the next K-winter. Please bear in mind that I shy away from recommending specific investments for a reason, opting instead to focus on general strategies, the goal of which is preservation of purchasing power.

1) Get out of debt to whatever extent possible. Mortgages notwithstanding, pay off all other revolving and installment debt. Accomplish this by ceasing all unnecessary spending. Start with the highest interest debt first (usually credit cards). Yes, these are tough measures, but tough times require tough measures. This advice will fall on deaf ears to 90% of America, but I figure if you're reading this column, then you probably understand the importance of not being encumbered with debt.

2) Get your savings out of US Dollar denominated assets. For many people this is unfathomable, but do it to whatever extent you're comfortable. There are high quality financial instruments that can be purchased outside the United States which return dividend streams in foreign currencies. These investments act as a hedge against a falling dollar and in the meantime pay great dividends! Let me debunk some popular myths surrounding investment in foreign markets.

a) "It's too risky" Contrary to popular opinion, a diversified portfolio of quality foreign assets carries less risk than a diversified portfolio of US assets. The reason is a simple one. While a US portfolio may contain many different assets, they have two things in common. They're denominated in dollars and they're all in the US. A recession hits your portfolio. Being spread out across the globe hedges away a good deal of that risk.

b) "It's not patriotic to invest abroad" Keep in mind that if foreigners had this attitude and weren't willing to send us 2.5 billion dollars each day that this economy would have collapsed long ago. There is nothing unpatriotic about preserving your wealth and helping to ensure financial security for your family.

3) Secure a predetermined portion of your portfolio in gold and silver. If you're comfortable with 10%, then do 10%. There are hundreds of reputable brokers who can assist you in obtaining these metals. There are also a few certificate programs as well. Find out what you're comfortable with and go that route. Gold and silver will act as an inflation hedge since it is real money (scarcity) and cannot be printed like cash. If we get to a hyperinflationary situation, gold and silver will rise very quickly. The gains will be nominal, but your purchasing power will be protected.

4) If you feel the need to buy US Securities, stick to Old Economy stocks (Manufacturing), consumer staples companies that make necessities, food companies and the like. Pick companies that feature low P/E ratios (price/earnings) and pay dividends. These stocks will get hammered, but will be the first to recover. I stress that first and foremost, I would go with option #2, but understandably, there are some folks who just aren't comfortable having all their assets overseas. If you must buy US stocks, buy smart. Note: Right now is a horrible time to buy most US stocks. You may be able to find some bargains, but they are going to be few and far between.

5) Communicate with your family and friends and try to get them to understand the importance of taking action now. The more people you can get on board, the more people will not go down with the ship. If we do see a downright crash, people who still have purchasing power can form cooperatives.

The second question posed to me this week was 'deflation or hyperinflation?'. I am going 90-10 on the side of hyperinflation as opposed to deflation give those two choices. The government simply cannot tolerate deflation to any great degree. Remember, deflation, by definition is a contraction in the money supply. If the supply of money and credit were to contract, there simply wouldn't be enough to service the huge debt obligations. The US government would most likely end up defaulting on the national debt. In my opinion, the government would opt for hyperinflation in a second given the choice between the two.

However, the most likely scenario would be a gradual inflationary growth of the money supply (and resulting increases in general price levels). Enough to keep the national debt stagnant in real terms even though it would continue to grow in nominal terms. By inflating, the US government can slowly try to back its way out of debt. Sounds great right? Wrong. This will all be done to the detriment of savers (holders of cash money). This is why it is critical to continue to save, but to make sure that a sizable portion of those savings is protected. This is one debt you truly owe to yourselves.

Graham Mehl is a pseudonym. He is not an ‘insider’. He is required to use a pseudonym by the policies of his firm when releasing written work for public consumption. Although not an insider, he is astonishingly bright, having received an MBA with highest honors from the Wharton Business School at the University of Pennsylvania. He has also worked as an analyst for hedge funds and one G7 level central bank.

Andy Sutton is a research and freelance Economist. He received international honors for his work in economics at the graduate level and currently teaches high school business. Among his current research work is identifying the line in the sand where economies crumble due to extraneous debt through the use of economic modelling. His focus is also educating young people about the science of Economics using an evidence-based approach.