The trend of taking on too much debt has been going on for over half a century:

And you will notice that we have reached a point of too much debt in this recession.  This is actually a historical event.  Americans are on the hook for as much household debt as our annual GDP.  U.S. households currently carry $13.5 trillion in household debt.  Most of this is connected to mortgage debt.  Yet with 7 million households in foreclosure or 30+ days late, you have to ask if this debt is really even worth that much?  It actually isn’t.  One third of U.S mortgage holders are underwater on their mortgage.  So banks might be pretending that the mortgages are worth $10.2 trillion when in reality, the actual market values of the homes are closer to $8 trillion.  The only way this gets balanced out is through purging of debt through foreclosure or bankruptcies (including purging the too big to fail banks on Wall Street).  Yet banks have no incentive to mark to market any item when they can keep getting taxpayer money to fund their gambling on Wall Street.

If you break down the above household debt, it looks like this:

Home mortgages:                           $10.26 trillion

Consumer debt:                               $2.481 trillion

The consumer debt amount is incredibly problematic because this is money many Americans never had in the first place.  Think of someone making $40,000 a year with no money saved purchasing the average new car costing $25,000.  They didn’t really “purchase” it but financed the entire amount.  So for the next 5, 6, or 7 years they have committed approximately $400 per month to finance this car (we’ll use 6 years at 5%).  This is a large portion of their income:

The person just committed 16 percent of their net pay for the next few years.  This is money they never had.  Now with a stable economy, it is likely that the full loan would be paid back.  Not in a recession as deep as this one.  And during the crazy credit bubble people were able to take on incredible amounts of credit card debt with no actual verification of income.  During the boom, there were people claiming that everyone paid off their credit card off each month.  The facts showed otherwise:

We were on path to having $1 trillion in outstanding credit card debt.  That is $1 trillion that Americans spent with money they had yet to earn.  Banks were willing to lend this out because if all failed, they could call on their plutocrats to bail them out while middle class Americans were left paying bills and facing higher taxes and the prospect of inflation because of the monetization of banking debt.  This is why in recent polls and surveys Americans are increasing disenfranchised with both Republicans and Democrats alike.  Banks purchase air-time with both political parties because like the stock market, they hedge their bets in order to win even if their actions destroy the real economy.

Even though credit card debt has shrunk, people are getting deeper into debt with auto and student loans:

“WASHINGTON (MarketWatch) – U.S. consumers increased their debt in March for the second month in the past three, the Federal Reserve reported Friday. Total seasonally adjusted consumer debt rose $1.95 billion, or at about a 1.0% annual rate, in March to $2.451 trillion. The increase was unexpected. Economists surveyed by MarketWatch expected consumer credit to decline by $4.5 billion in March. On a year-on-year basis, consumer credit is down 3.4%. The increase in January was led by non-revolving debt, such as auto loans, personal loans and student loans, which rose $5.1 billion or 3.9%. Credit-card debt fell $3.2 billion, or 4.5%, to $852.6 billion. This is the record 18h straight monthly drop in credit card debt. Since the collapse of Lehman Brothers in September 2008, credit card debt is down 12.6%, while nonrevolving debt is down 0.3%.”

The student loan market has now become another subprime loan market.  Many for-profit colleges allow students to finance 90+ percent of their education through federal loans and many students come out with worthless degrees.  These for-profit schools market and advertise heavily in lower income areas where unemployment is high and promise the world if you go to their schools.  Students come out with $20,000 to $50,000 in debt and a degree that has no market value.  The schools don’t care because now the government is on the hook for the loans.  Does this sound familiar?  Do you notice how no other country has such a gigantic student loan market like the U.S.?  Now we have millions of students jumping into massive student loan debt that many will be unable to pay. Frontline on PBS estimated that nearly 40 to 50 percent of for-profit student loans end up in default (if you measure defaults accurately).  Ironically this figure is edging up to the default rates of subprime loans in the housing market.

Debt has been the engine of growth in the last decade.  The fact that credit card debt has been contracting fiercely since the recession started is good.  What isn’t good is banks used the pretense for the bailouts that they needed extra money to keep lending to Americans.  This has not happened.  In fact, banks are sitting on large chunks of that money:

Now why would banks sit on over $1 trillion in excess reserves?  Because they know what they have on their balance sheet.  And more trouble is down the road.  Why would they lend to a middle class America with less money when they can gamble on the stock market and make bigger profits in one quarter?  Debt access for middle class Americans has become restricted but debt access to Wall Street is alive and kicking.  And the amount of debt in the U.S. is stunning:

Corporate debt:                                                               $7.2 trillion

State and local governments:                                    $2.3 trillion

Federal government:                                                     $7.8 trillion

Even though it isn’t openly stated, we are trying to solve a problem of too much debt with more debt.  How is that working out for Europe?

The Euro has fallen 20% in five months even after they announced a $1 trillion bailout.  We all know that more debt is never the answer to a problem that started out with too much debt.

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Comparing this crisis to the Great Depression may not be appropriate aside from the fact that we have high unemployment and an insolvent banking system.  The U.S. Treasury and Federal Reserve have jumped in with all their ammunition to save the banking sector.  The only problem is they forgot about the average American and the economy that we live in.  As we go deeper into this crisis and already have a hint as to how policy will play out it is turning out to be very similar to the Japanese contraction and lost decade(s).  Global debt is growing at breakneck speed:

Source:  Societe Generale

By 2011 global economies will have close to $45 trillion in debt.  Is this a far stretch?  The U.S. already broke the $12 trillion mark.  In order to compare our current crisis with Japan it is important to understand the history of their boom and bust:

“(Baseline Scenario) At a high level of generalization, the causes of the bubble were similar to those we have just seen. Loose monetary policy (in late 1980s Japan, and in the U.S. this decade) and high savings levels (by Japanese households in Japan’s case, China and oil exporters in ours) created a large pool of money looking for investments to buy. Rising prices encouraged speculation in both real estate and stocks. Poor underwriting standards – due to some combination of government direction of investment and self-dealing within industrial and financial conglomerates – and an unconditional willingness to lend against real estate as collateral meant that banks made hundreds of billions of dollars’ worth of loans that were sustained solely by rising prices. When prices fell, those loans lost most of their value, crippling banks’ ability to lend to creditworthy borrowers and choking the economy. The lack of credit, combined with the negative wealth effect of collapsing asset prices, dampened economic growth, which averaged 1% per year for the 1990s.”

It is important to note that Japan has been in a multi-decade malaise.  No “V” shaped recovery but a very long “L” situation.  Japan’s government sat back initially but then decided to bail out the banks and infuse massive amounts of fiscal stimulus.  The Bank of Japan like Alan Greenspan and Ben Bernanke slashed rates to their zero bound:

The above chart shows a similar path.  The big difference of course is the minor push up in the early part of this decade but this occurred in the back drop of a booming stock market and real estate bubble.  Japan has been in the doldrums since the late 1980s.  In fact, if you look at the chart above Japan has held onto record fiscal deficits for years and we are now following a very similar path.  Our current budget deficit of $1.4 trillion is enormous:

Japan contented with a busted stock market and crashing real estate sector with bailing out an insolvent banking industry and also, pushing rates to the zero bound.  The idea of letting banks keep overvalued assets at peak prices is something many of us are now getting familiar with.  With $3 trillion in commercial real estate, much of it overvalued, it will be interesting to see how banks move on this.  If current actions are any indication, banks are merely going to delay mark-to-market and value assets at inflated prices.  This did not work for Japan.  Why?  The banking sector became a vampire leeching off the productive sectors of the economy.  They couldn’t put their assets on the market because it would render them insolvent.  In the end, it stunted growth.  Keep in mind that Japan also managed to stay somewhat prosperous because it was able to export into a booming global economy.  Demand for goods such as Toyotas, Hondas, Sonys, and other high cost goods was strong.  But these are higher end products that typically ship to wealthier economies.  How will they do in the current global contraction?

The stock market path of the Nikkei and S&P 500 seems similar:

Over 20 years and the Nikkei is no where close to the peak reached in the late 1980s.  It is possible to muddle through for a very long time.  In fact, the Nikkei has been moving sideways with a tendency to the negative for 20 years.  The current stock market rally does not reflect market fundamentals and is merely a reflection of all the liquidity injected into the system.  But like Japan, all this does is keeps an insolvent banking sector walking for a few more years while the overall economy stays in a frozen pattern:

“One of the major barriers to expansionary policy was the weakness of Japan’s banking system. The asset price collapse and economic slowdown meant that increasing proportions of their loan portfolios became non-performing. Because writing down these loans to their true market values would have caused banks to become insolvent, they kept them on their books, rolling them over (extending bad loans indefinitely) in order to avoid having to take writedowns. As a result, the banks were severely undercapitalized and largely unable to engage in new lending. It was only in 1998 or 2003 (depending on whom you ask) that the government got serious about cleaning up the banking sector, letting weak banks fail or forcing banks to accept new government capital.”

This is all sounding very familiar.  Yet talking with friends about this, many dismiss this out right and say “well in Japan, they are big savers so they can do this.”  In reality, as Japan’s population has aged the savings rate has reflected the U.S.:

Analysis expect this rate to go negative:

“(Forbes) Japan has lived beyond its means since the 1990s thanks to massive domestic savings. Households own 1,441 trillion yen ($16.3 trillion) in assets, mostly deposited in banks, which then buy JGBs. Foreigners hold about 8 percent of outstanding JGBs.

An ageing population has eroded the savings rate to about 3 percent from more than 10 percent a decade ago and household assets have declined about 8 percent from a 2007 peak, mainly because share prices plunged after the global financial crisis.

Demographics suggest the savings rate could turn negative in a few years.

‘Like the United States, we will need foreign investors at some point,’ said Koji Ochiai, senior market analyst at Mizuho Investors Securities. ‘I doubt they will be attracted to such low yields.”

And this isn’t so different from the U.S.  American household net worth has taken a major hit of $12 trillion in this crisis but it is still sizeable in terms of real estate, stocks, and savings.  And this ties in with our big group of baby boomers.  They will draw down on their savings and stocks in retirement.  That is after all what a 401k, 403b, or pension is for.  To become your income in retirement.  But many are realizing that with stocks lower and the economy uncertain, some will have to defer that American dream of retirement or at least taper it down.

The U.S. Treasury and Federal Reserve are gambling with the U.S. dollar.  They believe that they can systematically devalue the dollar and slowly allow inflation to wash away our massive amounts of debt.  Japan tried this.  It hasn’t worked.  Now, with savings dwindling and the global economy depending less on exports, they are in a deep mess.  The U.S. is in a tough spot.  What many people don’t know is that in Japan, one-third of all workers are part-time workers.  The headline stats always show a low unemployment rate but these people are counted as fully employed.  One thing we have seen spike in our current recession is the rise in part-time employment:

Source:  Calculated Risk

This is the highest percentage of part-time workers we have had on record.  And there is no sign of this trend reversing.  If Japan is any guide, this is going to be a permanent reality of our new economy.  No job security, minimal benefits, and multiple jobs throughout one lifetime.  If we stay on the current path doing everything Japan has done, why are we to expect a different outcome?  Remember the big deficit we currently have?  Where revenues don’t even come close to matching spending?  Take a look at Japan:

At a certain point, the two major carry trade currencies in the world are going to meet their maker.  No country can spend this much without higher interest rates.  The current low zero bound market is more a reflection of global fears that still remain.  But there is ample evidence to examine Japan and our similarities.  Major stock market bubbles followed by major real estate booms and bust.  And Japan has demonstrated that real estate can remain depressed for 20 years:

What Japan might have bet on was some sort of asset appreciation.  This way, at least some of the value would be regained but that didn’t come to pass.  The U.S. Treasury and Federal Reserve is betting the entire country on this and putting their entire faith in the banks.  But without jobs why are we to expect that home prices will go up?  With less people buying goods, why are we to expect commercial real estate to boom?

The American dream is being deferred.  Japan had their dream postponed for two decades and it looks like they are entering a different phase of their downturn.  With our lost decade on hand already, is it possible we have another decade of stagnant growth?  Until we start seeing job and wage growth, Japan might be an outline of our future.  The American and Japanese dreams are looking very similar.

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Now why would the U.S. Treasury and Federal Reserve want to do this to the average American?  I think some Americans actually think these bank bailout machines are actually looking out for their best interest.  They are not.  Why do you think we have over 26 million unemployed and underemployed Americans even though we have committed trillions of dollars to bailouts?  Last time I checked most of the big banks are still standing while millions of workers are not.

Let us first pull up a chart of the U.S. dollar:

The U.S. dollar index hit a peak in 1985.  If you may recall, the Federal Funds rate at the time was over 11 percent.  Can you imagine that?  Talk about popping the housing bubble.  But over 18 years the dollar lost approximately 35 percent of its value.  This occurred by a declining Fed funds rate and spending more than we produced.  Little by little we exported our future away.  What is more disturbing about the chart above is the quick destruction of the dollar in the last few years.  From 2002 to the lows reached in 2008, in a little over 5 years we gave up over 40 percent of the U.S. dollar index value.  So what took us 18 years only took us 5 years this time around.

The path is unmistakable.  The U.S. dollar is being targeted.  Why?  It is the only way we can pay our way out of the current debt.  Also, the global economy is completely dependent on the American consumer.  They need us to spend to keep going (ironically).  This is where the myth of decoupling is shattered.

So why is this bad news for you?

1 – More Expensive Imports

First, even if we had a balance of trade a weaker U.S. dollar would help our exports but we have anything but a balance.  If you haven’t noticed we import so much more than we export that in the end, the already strained American consumer is going to be paying a whole lot more for items.

We are still negative.  The only reason the chart is moving up is because Americans are spending a lot less.  Americans are accustomed to buying cheap goods that come from low wage countries.  There isn’t much that can be done in terms of competition here unless people would be happy making $5 a day.  So the argument that this is good for our exports is only a short term argument.

Since these things take time, what we are seeing right now is a draw down of inventory causing deflation.  Yet what will happen after that and assuming the Fed gets its way by slamming the dollar?  Expect to see the cost of goods shoot up.  The U.S. dollar has been falling for 30 years so it is hard to see how we reverse this pattern.

2 – Global Garage Sale of U.S. Assets

Remember the ports being sold to foreigners?  Didn’t go so well did it.  If the U.S. dollar is hit any further you can expect this to be a common occurrence.  France experienced much of this after World War II when American companies started buying up French businesses.  The French didn’t much like that but American companies went out with a powerful U.S. dollar.  The tables seemed to be turned.  Now this is going to expose many questions and you can expect this to be a politically charged issue in years to come.

3 – Do you Enjoy Traveling Outside of U.S.?

Enjoy traveling outside the U.S.?  Try going to Europe and seeing how far your dollar will go.  Try going to Japan and see how strong the dollar is.  Go to Britain and see how easy it is to get by with a few hundred dollars.  It is somewhat nostalgic to watch Mad Men and have them go to Europe and seeing how life would be with a strong dollar.  We have to watch it on TV because that isn’t the case today.

Most Americans do not travel outside the U.S. so this might not be noticed but it is important to pay attention to this.

4 – A Weak Currency Hurts Global U.S. Leverage

We’ve already seen a weaker dollar hurt our standing in the world.  Countries now openly talk about creating another reserve currency.  Treasuries are still selling but only to our major trading partners.  This won’t go on forever.  We’ve reached the zero bound.  We are literally trading on the goodness of strangers.  In the early 1980s the Fed was offering 10, 12, and even 15 percent on the funds rate so you were able to lock in Treasuries in the double digits.  That was probably a once in a lifetime buy.  Now, the Fed is at zero and really has no wiggle room.  Politically, all it can do is appease our big buyers in China and Japan.

5 – Your Dollar Denominated Savings will Dwindle

The U.S. Treasury and Federal Reserve want to systematically cut the dollar by 50 percent or so in the next 5 to 10 years.  But as we’ve seen in this crisis, in an irrational world things don’t always go as planned.  To think this process will run smoothly is naïve.  Americans are already feeling the reality of a weaker dollar.  Stagnant wages over a decade.  Many average Americans in dual income families are wondering why they are earning the same and working twice as hard.  It is because the dollars they are getting paid in our worth less and less.

We really can’t cut costs much more on goods that we import.  So in the end purchasing power will be hurt.  With the housing bubble bursting we see a quick adjustment bringing values back in line to local area incomes.  Yet at the same time, higher unemployment and stagnant wages create this race to the bottom.  Trying to play with a currency is not an easy task and the Fed has been trying to meddle with so many things for decades.  The housing bubble was largely caused by the Fed cutting rates in the early part of this decade.  It would appear the U.S. dollar has one way to go if it were up to our U.S. Treasury and Federal Reserve.

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It is interesting how little coverage the tanking dollar is receiving.  Maybe people are just happy that their stocks are running back up even though P/E ratios are extremely expensive.  Yet the correlation between the dollar going under and stocks rallying is undeniable:

Now you might ask, why at the peak of the panic did the U.S. dollar reach a 3-year high?  You have to remember that for almost a year, the notion of decoupling was making the rounds across investment communities.  This idea was based on the premise that the U.S. was going to have a silo like decline while nations around the world somehow prospered with the biggest economy going under.  This had as much merit as believing subprime loans would be a contained issue.  So in late 2008, the idea was put to rest and people started rushing to safety especially with the implosion of banks like Lehman Brothers and the virtual nationalization of Fannie Mae and Freddie Mac.  In March, investors had enough and the U.S. dollar still reigned supreme as a safe haven.

Since that time, the U.S. Treasury and Federal Reserve have done everything possible to crush the dollar rally including committing to buy $1.25 trillion in various forms of debt much of it in the form of mortgages and going with quantitative easing.  What happened after this?

The stock market took off while the U.S. dollar continued a steady decline.  And of course this would only be logical because why would foreigners want to purchase debt that is inherently following a policy of inflation by its issuer?  U.S. items have become cheaper on a global stage.  For those setting this policy, it makes a lot of sense because they are trying to inject inflation and slowly grow ourselves out of trillions in debt.  U.S. households are still mired in massive amounts of debt:

Now one thing is certain and that is American households are cutting back on debt.  Much of this is happening because of a forced austerity but many are simply choosing to spend less by choice.  And given that most of our borrowing comes from foreigners who hold enormous amounts of our debt, a declining dollar makes the amount we have to pay back that much cheaper.  Now rightfully so, foreigners really do not like this kind of arrangement so the U.S. Treasury and Federal Reserve have to walk this trillion dollar debt tightrope.  Their solution?  Juice the stock market and make saving your money as unattractive as possible for domestic consumers.  Cash for clunkers.  Massive tax rebates for buying homes.  All these are steroids for consumption and over consumption ironically is what led us into this financial crisis.

So should you worry?  You may be thinking that it would be great if you can simply inflate all your debts away.  That is assuming that the U.S. Treasury and Federal Reserve actually succeed in their objective.  Keep in mind, never in the history of our country has the Fed loaded up their books with so much questionable debt:

Source:  Zero Hedge

This is unprecedented but the gist of all this is that we can somehow engineer ourselves out of this mess with targeted inflation.  Given the size of the housing and credit bubble it is hard to see how this is even possible.  The average American household is not able to balance this out given the number of rising bankruptcies and record high foreclosures.

The more troubling sign is how our currency is being sacrificed for easy finance for the banking industry.  Many banks are now staying solvent even with bad loans on their books because they are now able to raise money in the open casino (stock market) by suspending belief with massaged mark to surreal accounting methods.
The S&P 500 is not up because of earnings.  It is up because of the systematic destruction of the U.S. dollar and massive subsidies to failed banking institutions.  We still have major issues including $3 trillion in commercial real estate yet this rally has the wind blowing on its back.  Yet this is a stock bubble engineered by the juice of the U.S. Treasury and Federal Reserve.  Those who use steroids usually have it catch up on them.

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This isn’t simply a conjecture but is based on facts.  When Ben Bernanke was quoted as throwing dollars from helicopters what he meant is he had no regard for maintaining the actual value of the USD.  What he was discussing is battling the menace that is deflation.  Bernanke is an expert regarding the Great Depression.  I’m not sure that when he took the Federal Reserve chairman position did he realize he was actually going to have to face a situation which would put his theory into practice.

What we are facing is deflation and we have not seen prices drop this fast since the Great Depression:

That is why we are already dealing with the prospect that this recession will have deep impacts like nothing we have seen since World War II.  The fact that consumer prices have been falling over the past 4 months is significant.  This is not a one month event.  We have seen incredible drops over this time:

August 2008:              -0.1

September 2008:         0.0

October 2008:             -1.0

November 2008:         -1.7

The major question is will this continue.  Most of the recent historical drops have to do with the bubble in oil bursting and automotive sales simply falling off a cliff:

*Source:  Suddendebt.blogspot.com

The above chart in automotive sales is extremely telling.  Sales have fallen off a cliff.  What has occurred is we have spent our future today.  That is, we have enough cars floating in the marketplace to satisfy years of demand.  That is something that is being missed with the auto bailouts.  One part is yes, American automakers have missed the boat in creating cars people want to buy.  Yet the bigger problem is people simply have no money to buy any additional cars unless more unhealthy credit is extended.  This is something that the U.S. Treasury and Federal Reserve would love to see happen.

Every action they have taken comes at the cost of individual financial success.  They are purposely making it useless to save money.  At least, that is the psychological warfare they are trying to do.  How so?  First, you drive interest rates so low that it is almost pointless to save:

The Federal Reserve has kept interest rates at historical lows for this entire decade.  Alan Greenspan was the first to take rates to historical lows and was only beaten by his predecessor in Ben Bernanke.  This is problematic.  One primary reasons the housing bubble took off for so many years was the fact that credit was flooded into the system.  This of course came at the expense of the U.S. Dollar:

Since 2000 the USD has fallen by nearly 20 percent.  That is significant in terms of a country’s currency.  As you will also notice in the chart above, we had a bounce from recent lows that has increased the value of the USD by roughly 10 percent.  Why the sudden jump?  The fact that the USD was up in 2008 is by no means any help by the Federal Reserve or U.S. Treasury.  The reason the USD rallied last year was the destruction of the decoupling myth.  What it turned out was other countries around the world had equally bad or even worse balance sheets than the US.  So a flock to safety occurred.  In dire times the USD still holds that throne.

Even with negative rates on treasuries, people still felt the need to store their money in the USD.  During this time Ben Bernanke manipulated the effective funds rate to go from 3.94 percent in January of 2008 to our recent zero percent.  We have never seen it this low since the Great Depression.

Keep in mind that it would be very simple for our government agencies to increase the value of the USD.  All they would need to do is to raise rates to attract more capital in the system.  Capital, not devaluing the currency.  But that is the least of their worries.  What they want is for people to spend more and more.  That is why credit and debt is flooding the system:

This is an important chart.  First, the U.S. consumer is tapped out.  They are carrying roughly $14 trillion in debt with auto loans, student loans, mortgage debt, and credit card debt.  The spike highlighted in red above is banks keeping additional funds in excess reserves.  This is money that they can lend without putting their reserve limits at risk.  Yet they are not.  Why?  Look at the blue line.  If you were a bank, would you lend to a consumer market with nearly $14 trillion in debt?  Of course not.  Yet the Federal Reserve somehow thinks this is the solution to our problems.  Give banks which were at the center of creating this mess access to more funds at the expense of taxpayers.

The Fed is already pushing the limits on its own books putting nearly $3 trillion of questionable assets on its books.  This housing bubble has its roots in 1979 and only took off starting a decade ago.

From every early indication we are getting, the Fed is determined to keep this gig going.  What this means, is hard assets like gold will probably have another positive year.  By the way, gold was another winner in 2008 even after tanking.  The reason for gold is more basic.  Where else will people store their money.  In zero percent treasuries?  Globally?  Under the mattress?  It seems like gold will be one of the few last spots.  The Fed and U.S. Treasury seem to indicate further policies that will slam the dollar.  Yet here is another problem.  Other global central banks are doing the same thing which almost negates our own actions.  The race to zero interest rate policy has started.

The U.S. Treasury and Fed which have a responsibility in protecting a stable dollar are set to destroy it.

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Since we are a few short weeks away from closing the door on 2008, we can now look at various investments for the year to see how they have performed relative to other measures.  Tried and tested measures like dollar cost averaging did very little if you had your money tied to Fannie Mae and Freddie Mac.  What use was it to have the safety of bonds if they were anchored by the albatross of Lehman Brothers?

Today, we are going to assess the damage but also look at various investment areas to see how bad the damage was for the year.

Area #1 – Real Estate 2008 

*Click for larger picture

We all know that real estate has been underperforming horribly for the past year.  Yet there is a novel perspective that is making the rounds on the internet that real estate is actually out performing the stock market.  This argument is both dangerous and deceptive.  If we look at the above data, we can see based on the Case-Shiller 20 Composite Index that real estate in these large 20 metro areas is only down 10.5% for 2008.  Not bad in comparison to the stock market.

Yet this argument fails to highlight certain areas like California where property prices have fallen 40% in one year.  In addition, one failed aspect that isn’t mentioned when this argument is spewed is that real estate has the advantage and as we are all learning the disadvantage of leverage.  Let us run an easy example.

Say you invested $10,000 in the stock market via the S & P 500.  You put all that money in on the first trading day of 2008.  At this point, you would have lost 40% of your investment due to the current market condition.  That is, your $10,000 is now only worth $6,000.  Pretty painful indeed.

Let us assume you bought a really nice home for $200,000.  We’ll go ahead and assume that you lost the 10.5% from the Case-Shiller chart for the year.  How much have you lost?  Your home is now worth $21,000 less.
Even though that 10.5% decline may seem innocuous, it really isn’t because of the power of leverage.  Most stock investors aren’t leveraged to the hilt.

Area #2 – Gold

Gold has taken a big hit this year.  Or at least that is how it would seem from all the negative headlines surrounding this commodity.  As the chart above shows, gold opened the year at $835 an ounce and is currently trading at $774 an ounce.  That is a decline of 7.3%.  The reason this declines seems more vicious is the fact that gold had hit a peak price over $1,000 an ounce back in the first quarter of the year.

Overall there has been a flight to safety and gold has benefited from this.  Even after the massive global deleveraging gold has held its own.  Many investors are wishing they can say that they are only down 7.3% for the year.  Going forward, gold may be a good play for a couple of reasons.

The Federal Reserve and U.S. Treasury are doing everything they can to destroy the dollar.  They would love nothing more than a steady inflation to occur.  The worst thing that can happen is deflation and we got a taste of that last month with the CPI.  Why does the Fed and U.S. Treasury fear deflation?  Well first, we are massively in debt.  If prices keep declining, the debt we currently have actually gets more expensive because we are paying off a debt that was valued much too high.  With inflation, we can pay back that debt little by little as the value of the debt is eroded over time.

No one really has a crystal ball but seeing the actions of the U.S. Treasury the Fed and now talks of a gigantic fiscal stimulus package in 2009, we can easily assume these 3 large players want to see steadily higher prices.

Area #3 – Necessity Stores

*Click for larger picture

What if I told you that there were retail stores that were up 14%, 31%, and 34% for the year?  Most analyst wouldn’t even know where to begin to look for these good deals because they don’t get the struggles Main Street Americans are facing.  These 3 stores; Wal-Mart, Family Dollar Stores, and 99 Cent Stores have out performed the market incredibly.  Heck, even putting your money in the mattress would have outperformed the market this year but these stocks have had excellent gains.

You need to remember that many of these stores make money on volume.  With the incredible economic calamity we are facing their customer base is growing.  Thus their volume has increased.  At a certain point, I would expect to see some more strain hitting these stores in particular Wal-Mart but so far, they are sufficiently out performing the market.  If you expect the economic conditions to be tough next year, you can expect many people that once shopped in higher end stores being forced to shop here.  It is simply an elastic decision in economics.

These stores should be positioned to have a decent year next year.  Maybe not as good as 2008 but certainly out performing the overall market and other retail outlets.

Area #4 – Foreign Currencies

If you would have plunked down your U.S. Dollar into Japanese Yen during the start of the year, you would be up 16%.  I made this call back in February of 2008 and it looks like it was spot on.  Not exactly a major gain but a nice little double digit gain.  This is what I had to say regarding the Yen at the time:

“The Yen is up 14 percent in relation to the dollar in a one-year timeframe. This has a major potential of moving upward since we are seeing an unwinding of dollar debt. The Japanese hold an inordinate amount of US debt and if the unwinding continues, expect the Yen to continue to rise.”

That logic still holds true.  Hedge funds are going to be facing massive redemptions and there is no reason to believe that we are done yet.  I would say that the unwinding may be getting closer to a bottom.  What occurred is investment funds borrowed cheap and Japan had one of the lowest rates.  Well Ben Bernanke is going to put us on par with Japan pretty soon.

Another currency I talked about was the Euro.  This is what I had to say about the Euro back in February:

“The Euro is up 15 percent in relation to the dollar in a one-year timeframe. The Euro as you may know through its central bank, has not kowtowed to the markets like the Federal Reserve who has decided to let the dollar go into a free fall. The ECB has held rates steady and also the currency has a small portion backed by gold. The dollar is simply backed by the full faith of the US government. If this faith wanders, the dollar will continue to go down.”

Well the Euro is now down by 13% for the year.  Why?  Well the ECB bent over and did the same moves our Federal Reserve did.  In addition, the Eurozone is now in a recession just as we are so their currency took a hit.  The biggest damage came from the ECB breaking down.  I would not be looking at the Euro going forward.  They have property bubbles larger than the U.S. and economies that are simply taxed to death.

Area #5 – I-Bonds

Back in July I talked about U.S Savings I-Bonds.  These are great little investments that pay a fixed rate and a rate that is based on the CPI.  The intent of I-Bonds is to track inflation.  Given the recent contraction with the CPI and prices dropping, we may see a short-term drop here but given what the Fed and U.S. Treasury are doing, at a certain point it looks like we will see further inflation.  Currently I-Bonds are paying 5.64% until April of 2009:

As I discussed in the previous article, the U.S. Treasury earlier this year reduced the maximum amount of I-bonds you can purchase to $5,000 per year.  Previously, the limit was set at $30,000.  These are good little safe investments to have in your portfolio since they will never lose money.  You certainly may see a low rate this upcoming adjustment simply because of the price destruction we are seeing via short-term deflation but given all the policies and bailouts we are seeing, it is hard to see how we won’t see inflation later in the near future.  Ben Bernanke is a major student of the Great Depression and he has stated either implicitly or explicitly that he’ll  “drop money from helicopters” before letting us see deflation.  Given his actions, I think he is serious about that.
So those are a few safe places that have done well for the year.  Of course the past isn’t indicative of the future but keep your head straight, diversify wisely, and be prudent since 2009 will prove to be a more volatile year.

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Gold is currently trading at approximately $820 USD an ounce.  This estimate has gold more than doubling over this timeframe.

Now don’t you think it would have been smarter for the U.S. Government to simply buy up $306 billion in gold bars and then sell them in 2 years for $743 billion?

“(Telegraph) Mr Fitzpatrick said Britain had made a mistake selling off half its gold at the bottom of the market between 1999 to 2002. “People have started to question the value of government debt,” he said.

Citigroup said the blast-off was likely to occur within two years, and possibly as soon as 2009. Gold was trading yesterday at $812 an ounce. It is well off its all-time peak of $1,030 in February but has held up much better than other commodities over the last few months – reverting to is historical role as a safe-haven store of value and a de facto currency.”

Hah!  People have started to question the value of government debt?  You don’t say.  I wonder why the debt is going up so quickly?  Hmmm.

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When you think of true diversification, you should think outside of these areas. True diversification means having foreign currencies, rental real estate, a full-time or part-time business, consulting, precious medals, and your career. That is true diversification. The problem that many are now seeing is that their 401(k) was invested in targeted funds that believed the above mantra and really were not diversified. It comes with the territory of investing that you will take on some risk. This isn’t to say you shouldn’t have some stocks in your portfolio but the idea that the bulk of your money should be held in stocks will get a wake up call in the subsequent years.

Here is a look to show you how the three major barometers of Wall Street are doing for the year:

A few of the places of refuge in the last few years has been precious medals. Yet recently, these have been taking a hit. Why is this happening and does this mean that the precious medals bubble has now burst? The trend for precious medals is lower but much of what is happening is large unwinding of positions. You need to remember that gold is a store of value and the belief was that unrelenting pain for the United States and its economy was on a downward trend. The brief surge in the dollar has also pushed gold down. You need to recall that much of the literature has been focusing on the global $13.8 trillion United States economy thinking that we have reached a point of decoupling. This theory is wrong and the bump in the U.S. Dollar is reflecting this.

The belief was that the Untied States would suffer an economic depression yet all other economies would thrive. Well as recent data from the Euro-zone points out and the fact that Japan’s GDP actually contracted, it may be that the United States might be in a better financial position. In fact, our housing bubble is already in full progress while other counties like Spain, Ireland, England, and Australia are only entering the morning of their collapse.

Even with the current correction in precious medals, take a look at gold versus the DOW over the past four years:

Gold is down over 20 percent in a brief time but even given this, over the past four years is up a stunning 73% while the DOW is actually up by only 11 percent. These are important factors to remember since looking at the day-to-day market activity may cause you to step back and look at the overall picture.

The minor jump in the U.S. Dollar also goes to show that when push comes to shove, given all the negative first half news about the world economies the U.S. Dollar is still seen as a major safe haven. Globally the U.S. Dollar is held by 63.3% as an exchange reserve while the Euro is held by 26.5%. No other currencies come close but given the economic condition of many European counties and their own asset bubbles yet to deflate, the tough talk from the Euro Central Bank has recently abated since it looks like they may actually follow in the footsteps of Ben Bernanke and let rates stay or move them lower. The tough talk made the Euro a Cinderella for funds as many left the U.S. Dollar but now it looks like they are stuck. What more can they do?

This isn’t to say that the U.S. Dollar doesn’t have weakness. In fact, unless our own Federal Reserve steps in and raises rates the dollar will continue to face weakness given our current economic condition and enormously large deficits which may surge past the $10 trillion mark this year. Given that our yearly GDP is $13.8 trillion we are now cutting it extremely close.

Given our current GDP, the idea of decoupling is a curious one given that the large players of the United States, the Eurozone, Japan, and Germany are all heading to recessions:

*Source: Wikipedia

To think that the world with the four largest blocs entering recessions would somehow boom is mystifying. If anything the recent unwinding in precious medals and the bump in the U.S. Dollar are simply an acknowledgment that if these large economies entered into recession the chain reaction is going to be felt by all.

I still expect the United State economy to face rough times ahead. Recent estimates put the write-downs due to the credit crisis at $500 billion with future estimates of $1 to $2 trillion when all is said and done. Given the large amount of homes in states like California with hundreds of billions in option ARM mortgages that will surely default, these numbers seem realistic.

The United States housing market is gigantic. Over $12 trillion in mortgage debt is outstanding almost the size of our GDP. Actual equity destruction from peak is now looking like $3 trillion. That is $3 trillion in housing equity that is no longer here. And given that we are only 25% to 50% through, we can expect further declines.

Precious medals have been on a long run. They will correct. This correction is simply reflecting the years and false notion that decoupling would really happen. I don’t doubt that sometime in the future this may actually occur but just look at the current GDP and you’ll realize that we are decades from any such talks. The U.S. Dollar may stabilize in the short-term but once the additional losses in the credit markets rear their heads again, it will continue on falling.

Europe, Japan, and Australia will all suffer as well and are 1 to 2 years behind the United States. When you look at their asset bubbles and massive account deficits, especially those counties in the Euro-zone the contraction will be painfully obvious.

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The first thing I want to point out is the CPI. You’ll notice that last month, the reported inflation rate was 0 percent even though oil touched about $110 a barrel and has remained at those levels for sometime. Let us first calculate the current annual inflation rate based on the above numbers:

If we add up the previous five months of data, we get 2. Since this is five months of data we’ll have to adjust this for a 12 month calendar:

(2/5)=(x/12) gives us X as being 4.8 percent

So currently the annual inflation rate is at 4.8 percent. You will also notice that we have lost jobs in the previous three months to the tune of 76,000, 76,000, and 80,000. Keep in mind that during the previous three recessions, job losses during peak times reached over 300,000 a month even during the minor recession earlier in the decade. This can be looked at a couple of ways. Much of the data from the BLS lags the actual market. That is why people were predicting a recession in the middle of 2007 even while jobs were still being added. Keep in mind the way these things are calculated they leave out much of what the majority of Americans are facing on a daily basis. For one, the CPI does not calculate mortgage payments and taxes but owners equivalent of rent which understates the current burden of housing prices on many homeowners. Also, energy is blunted in the data so the rise in fuel cost isn’t reflected either. Then, you also get complicated uses of hedonics for healthcare, food, and education which again understate the true nature of consumer inflation.

So with that said, for someone to simply preserve their wealth in the current market they will need to achieve a return of 4.8 percent after taxes. Keep in mind that interest earned in CDs, savings, or money market accounts is taxed so a par rate of return is still not keeping up. But let us take a look of a few major institutions to show you how any saver in the current market is being punished:

The first one we’ll look at is Emigrant Direct. They have offered very competitive rates on their savings accounts and currently they are offering a 2.75% rate of return. You may think this is low but as we’ll show further, this is actually competitive for savings in the current market. The next place we’ll look at is ING Direct:

The current Orange Savings Account from ING is offering a rate of 3%. You notice that their CD offers a higher rate of return but let us look at what is required of this:

In order to achieve a yield of over 3%, you will need to deposit at least $50,000 or more. This isn’t even calculating the after tax amount you’ll be getting. We are simply looking at the current rates going for safe investments. When I say safe investments, I mean accounts that are protected by the FDIC which insurers individual accounts up to $100,000. The next place is your typical brick and mortar place that is also offering an online product like Emigrant Direct and ING. Washington Mutual is offering an online savings rate of 3.25% so long as you have a checking account with them:

You’re probably starting to notice a pattern here. The savings rate for many of these places hovers from 2.75% to 3.25%. Let us look at a different kind of account with Bank of American and their Money Market Savings Account:

Here, you’ll notice that the rates up to $10,000 will only yield you .35 percent. You will need $10,000 or more to get a rate above 1.24%. Bottom line is that if you stick your money into these accounts and let it sit, your money is actually eroding simply because the rate of inflation will eat it away. And this isn’t to say anything about a dollar that is also going down as well:

During the past two years, the US Dollar Index has decline by 21.7 percent. Given that many of the items Americans consume are imported, that means your purchasing power has declined by an incredible pace. If you have any doubts about this just take a trip to Europe or anywhere in the world for that matter.

There may not be a direct correlation from the Federal Funds Rates and the actual payments you make on mortgages simply because market risk is so high at the moment. But the funds rate does have a direct impact on the above savings rate on conservative accounts. What the Fed is telling you is that if you plan on saving your money in guaranteed accounts, you will in fact be losing money. Then you may be saying, what about playing the stock market. Let us look at the performance of the three major indexes:

Looking at these three even after the recent rallies and major intervention actions by the Federal Reserve they are still down on a year to date basis by:

DOW: -4.94%

S&P 500: -6.67%

NASDAQ: -10.60%

Clearly, the market is making it more difficult for people to protect their wealth. The places that have done well are in foreign currencies and commodities. Why are these doing well? Because they are simply reflecting the true devaluation of the dollar and the real rate of inflation that most Americans are feeling. Let us look at a few currencies:

The Japanese Yen is up 9.91% for the year against the dollar. This has a lot to do with the carry trade unwinding and also the extremely low central bank rates over in Japan. If you think we have low rates here, you just need to take a look over there. But there is more to this than just easy rates. In fact, the Euro is holding up strongly as well too because the ECB has held steady with their rates:

The Euro is up 7.68% for the year against the dollar. Now given that Europe may also be facing a credit bubble as big as our own by the reflection of recent writedowns on mortgage backed debt, their currency is perceived at least by foreign exchange markets as more valuable than the dollar.

The irony is that most Americans do not even have a tiny amount of money in commodities or foreign currencies to hedge their bets. Given that we are in a recession short of the technical definition, if the Fed cuts rates again expect the yield on the already inflation lagging savings accounts to go down even further and expect foreign currencies to go up and also, commodities. In this market, it is important simply to preserve wealth as many that are now seeing their equity evaporate in their homes are realizing. Even the stimulus checks that are coming out next month are not touted as savings checks but a way for you to spend even further. If anything, take those rebate checks and put them in a savings account or foreign currency. The Fed wants you to spend and be in debt since that is the last straw of our economy. Yet this is not good for you on a personal level. No wonder why Americans now have a negative savings rate. Conventional buy and hold investing styles are going to be proven extremely wrong in 2008 and if you want any more proof, just look at these scary charts. Be wise and don’t follow the advice of the Fed.

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• Continued Housing Weakness
• Credit Market Distress
• Commodity Prices Increasing
• Dollar Declining
• Yen Unwinding
• Higher Unemployment

The reason for this forecast is the insurmountable debt that we carry as a nation. If you want to look at household credit market debt outstanding, just take a look at the below chart:

The problem with the above goes in two ways. First, with the massive deflation in housing many people are now finding that their mortgage is worth more than what they initially paid for their home. What we are now seeing is an epidemic of people simply walking away from their homes. What this does in effect, is a destruction of money which is deflationary. Think about it for a minute. Someone somewhere has on their books a home that is valued at $300,000 and a corresponding mortgage for $300,000. Now let us assume the home is now “worth” $250,000, does the mortgage adjust instantaneously? Of course not. And as we all know, many people were using home equity lines to fuel the consumer economy and this is no longer an option.

Now what does this mean for our economy? First, it means the Fed is going to probably go toward a zero interest rate policy and with each cut, you will see gold and oil surging higher. We also have seen the Japanese Yen surging this year with the currency unwinding. It only makes sense since the Japanese are one of our biggest creditors and our debt is growing more and more devalued as the year progresses.

There is a great piece over at Econobrowser by Professor Jim Hamilton:

*chart source: Econobrowser

Incredibly, nearly every major commodity class is not only rising, but surging at unbelievable rates. If the Fed continues to cut rates which seems very likely, you can expect to see foreign currencies rise and commodities explode. Invest accordingly.

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