End of the Finance Based Economy
A fundamental long-term shift in the US economy has occurred. The finance based economy is coming to a conclusion, creating two possible scenarios: stagflation or deflation. At best we are looking at stagnate wage increases and higher prices. This is the lessor of two evils. The worst is outright deflation, which is an extreme deviation from the status quo.
The cycle of easy credit and lax underwriting is no longer being provided by lending institutions. Watching the government hearings mull a $700 billion dollar bailout package sends an important message that can be interpreted as “wishing things were the way they used to be.” Providing $700 billion to the US Treasury and Federal Reserve to buy any asset they choose and hold it for an indefinate period of time is interesting. Over the last few years we have seen foreign nations create sovereign wealth funds for investment purposes to the dismay of the US Congress. Questions and concerns were raised (http://www.cfo.com/article.cfm/11113688?f=rsspage) regarding the intentions of foreign governments owning US corporate securities. Now the US government is about to create one of the largest sovereign wealth funds in the world and their investment policy statement is to purchase the most illiquid, low quality assets available from commercial and investment banking institutions in the country. What’s more is the funding will come from issuing long-term US Government bonds. Extrapolate what that means for a moment. In order to attract more money to buy the bonds higher interest rates could be demanded. Higher interest rates are paid by the government, i.e. US taxpayer. As more money is used to pay back the interest and debt, the economy might sacrafice its growth rate. This could lower the value of the US dollar. If investors begin taking less risk as the finance based economy becomes unwound, they will need more value for their hard earned money. Higher interest rates from bonds means investors will demand higher growth rates from stocks as incentive to add the risk of owning equities over bonds.
The bottom line is no one can know the outcome of the current government intervention into free markets. However, as financial advisors we are paid to interpret the outcome and advise clients to act on it. So beware of P/E compression, the price of gold, higher interest rates, and the US dollar. For questions or comments concerning these above mentioned issues, please email us as we are glad to help.
Sincerely,
Greg Gilbert
President
