November 23, 2004

11:27 AM

FinancialFilter: let's temporarily assume that Stephen Roach is correct, and the US economy is going to collapse. If I have zero debt, but significant dollar-denominated assets, what's my best strategy for handling my affairs? Should I be bulking up on foreign investments, or would they just be dragged down too? Ideas? I'm not a finance wizard, so when someone says "people with debt will be destroyed" it doesn't mean much to me, since I have no debt and don't understand how things ripple throughout the economy.
posted by aramaic to (24 comments total)

I am not a business expert, but you might look into investments that are not dependant on currency, such as gold. That's why gold is high priced now; a lot of others are thinking the same thing! Investing in foreign currency is a possibility, but can often be risky, and if the US economy were to collapse, so would a lot of other countries' economies...
posted by unreason at 11:36 AM on November 23, 2004

Also, I forgot to say: I'm especially interested in "first X happens, which causes Y, which means that Z occurs" type explanations. I simply don't grasp what things mean, in real terms.

For example: so what if interest rates rise? I'm not borrowing money, and I don't plan to. Why would I care if they suddenly tripled? Inflation I mostly understand, but interest rates elude me, since I'm a non-borrower.
posted by aramaic at 11:41 AM on November 23, 2004

It must be said that, Roach is a fool; and that if the US economy goes--the true fantasy of the Left--there will be no world left.

That said, a precious metal would work.
posted by ParisParamus at 11:48 AM on November 23, 2004

I could be wrong, but I don't think it (the collapse) can go both ways. If "people in debt will be destroyed," that means that there will be some extreme inflation to the point that instead of making $1000 a week, you'll be making $10 a week. If you don't have any debt, that won't be so bad, 'cause a loaf of bread will only cost 1 cent. However if you have a $1000 mortgage, you're screwed and will go bankrupt. HOWEVER if that is the case, and $1000 is equal to 100 weeks of salary (at $10 a week...) then I would suggest investing in a savings account and saving up a bunch of money.

Again, as I understand it. In times like this example when there is hyper inflation, the rich loose a good deal of money but still come out on top, the middle class get screwed and end up poor, and the poor only get a little screwed and usually come out better than the middle class did since they didn't have any debt to begin with.

pwb.
posted by pwb503 at 11:48 AM on November 23, 2004

To answer your question about interest rates...

When interest rates drop, businesses don't want to keep money in the bank ('cause they don't make much money there...) and rather like to invest money in their business in hopes that their investment in themselves will make more money than if they left the money in the bank. Additionally, when interest rates drop, it is easier for them to borrow more money and but newer buildings, technology, whatever to help build their businesses. With that said... Lower interest rates, means more jobs, since business are buying more and building more.

When interest rates increase, businesses don't want to spend money investing on new things and feel better stashing their money in the bank where they are guaranteed to make money. If interest rates where to tripple, we'd see lots of companies taking money out of the economy and putting it in the bank. Higher interest rates, means less jobs, since businesses don't want to borrow money to build new plants, and feel better keeping money in the bank.

pwb.
posted by pwb503 at 11:53 AM on November 23, 2004

...if the US economy goes - the true fantasy of the left - there will be no world left...

The true fantasy of the right.
posted by jasper411 at 11:55 AM on November 23, 2004

Damn. I was going to ask the same question only with the caveat of $5000 in low, fixed-rate credit card debt.

Oh well, if the economy tanks, looks like back to the developing world for me!
posted by nathan_teske at 11:58 AM on November 23, 2004

if the US economy goes--the true fantasy of the Left

Yep, it's my fantasy to lose my job, my house, my car, everything I've worked hard for. Who's the fool here? Can you keep this sh*t out of AskMefi? Please?
posted by jalexei at 12:01 PM on November 23, 2004

So debt with variable-rate interest would be bad, but debt with fixed-rate interest wouldn't be such a bad idea if you expect a lot of inflation, right?
posted by lbergstr at 12:04 PM on November 23, 2004

So debt with variable-rate interest would be bad, but debt with fixed-rate interest wouldn't be such a bad idea if you expect a lot of inflation, right?

Generally yes, though it depends on the details of the variable-rate. My mortgage is fixed for seven years, then adjustable, but it can only go up a certain amount each year and is capped at a certain percentage. If things get somewhat bad, I still believe I can save enough with a lower rate between now and then to ride it out, and if things get worst-case-scenario, I'm assuming my city will be in flames (my fantasy, you may recall), so it seems silly to worry about interest rates.
posted by jalexei at 12:13 PM on November 23, 2004

Some observations:

1) Altho in absolute terms gold is at a 16-year high, allowing for inflation it's still pretty cheap.

2) While I own a little gold and silver (enough to bribe my way across the Canadian border if need be!) if you want to go that route a more productive investment in hard assets would be in companies that extract natural resources whose price will rise with inflation, e.g. gold mining, ones with proven oil reserves, etc.

3) To flesh out the answer to lbergstr's question, in times of rising inflation/interest rates, you want the interest rate on money you owe (mortgages, car loans) to be fixed (that way you get pay off the dollar you borrowed with the equivalent of 90 cents or less) but you want the owed to you (bonds,bond-funds, CDs, etc) to go up with the prevailing rate. To do that, you'll have to accept the lower rates inherent with short term debt. For example you buy a 6-month CD, knowing you're getting a lower interest rate than the guy buying a 5-year CD, but IF interest rates steeply rise, you get to roll your CD over at the new, higher rate, while the other guy gets to grind his teeth. In simple terms, the same principle applies to bonds and bond funds.
posted by mojohand at 12:48 PM on November 23, 2004

So, if I understand correctly, higher interest rates do not threaten me directly -- it's their secondary effects (such as reduced hiring) that affect me. The lag time between primary & secondary effects would depend on things I probably can't measure (like how brave/foolish my CEO is, etc).

If that's the case, then how would a sudden jump in personal bankruptcies affect the broader economy? If a sizable percentage of people with substantial debt go bankrupt within a single year, how does that ripple through the economy -- particularly in areas that aren't directly controlled by consumer spending?
posted by aramaic at 12:58 PM on November 23, 2004

I wouldn't bother trying to bribe yourself into Canada. We're each other's largest trading partner so any extreme change in the U.S. economy is going to hurt like hell here too.
posted by timeistight at 1:00 PM on November 23, 2004

This thing on the blue seemed to be an interesting what-does-this-mean-to-everyday-life analysis, whether or not you believe it.
posted by blacklite at 1:05 PM on November 23, 2004

aramaic, if you don't owe a bunch of money with a variable interest rate, yes in the short term it doesn't affect you, until you need to borrow money for a house or car or tuition, or you want sell your house that no one can afford the mortgage for.

And if there is a massive wave of personal bankruptcies, I suggest we'll all find we're much closer tied to the 'consumer' economy than we realized. In the Depression even government employees suffered layoffs and salary cuts. Yes, very different world now, but still.

timeistight, yeah, but your food riots will be polite.
posted by mojohand at 1:12 PM on November 23, 2004

Just to reiterate, getting foreign currency or relying on a non-US economy would probably be risky. If the US economy goes, so will every other economy. The same thing would be true if the EU were to have a severe downturn. The fact is, the world economy is so tightly linked that you really can't count on any one economy being safe. This was certainly the case in the Great Depression; Europe and the US were definitely affected by each others' problems. The best thing to do is to invest in conservative things, and save your money for a rainy day.
posted by unreason at 1:30 PM on November 23, 2004

In a nutshell, if dollars are losing their value (not the strict definition of inflation, but close enough), you want to hold something other than dollars.

The first rule: Do not hold long-dated fixed-rate debt.

My thoughts.
posted by trharlan at 1:39 PM on November 23, 2004

If you've got debt at a low, fixed rate, like a mortgage that you took out last year, you will not be screwed unless you lose income (which means you're screwed no matter what the economy is doing). Credit-cards are another matter, because if they can find a way to raise your rates, they will.

Typically, as interest rates rise, bonds become a more attractive investment. Why? Because a bond is a loan (to a business, a city, whatever), and because interest rates are higher general, you can make the loan at a higher rate. It's more complicated than that--you can sell a bond without ever redeeming it and still make money on the transaction. Stocks become less attractive, partly for the above reason and perhaps partly because businesses are borrowing money at a higher rate, meaning they've got less to pay out in dividends, etc. This is Econ 101 stuff.
posted by adamrice at 2:30 PM on November 23, 2004

The continual fall of the U.S. dollar has helped the Canadian dollar soar to a 12 Year High.

If you believe, as Warren Buffet does, that the growing U.S. deficit is going to continue to erode the U.S. dollar, then investments in Canada make sense. Also, if you believe that high oil prices are here for a good long while, investing in Canada-- a net exporter of oil, rather than an importer like the U.S.-- makes double sense.

I believe a good way to play both the Canadian dollar and Canadian oil is to invest in Canadian Royalty Trusts (aka "CanRoys"). These are trusts that allow unitholders to participate in the ownership of a large portfolio of crude oil and natural gas properties. These trusts generally trade on both the NYSE and the Toronto Stock Exchange. The dividend payout for a typical CanRoy is huge: usually over ten percent.

A U.S. Investor is subject to 15% Canadian withholding tax on these dividends, but you are also usually qualified to receive a foreign tax credit on your U.S. tax return that basically cancels out the withholding tax.

Also, these dividends are paid out in Canadian money, and then converted to U.S. dollars. That means every time the Canadian dollar goes up and the U.S. dollar goes down, your dividend increases and you make more money.

A Few Cautionary Words: Oil prices are high right now, as is the Canadian Dollar. Both could fall at any time. I believe the Canadian Dollar is going to continue to rise and oil prices will remain high-- but that don't make it so. As always, do your own due diligence before investing in anything.
posted by Fuzzy Monster at 2:48 PM on November 23, 2004

The best financial writing on the net, IMHO, is at:

http://www.dailyreckoning.com

These guys are all forecasting a catastrophic devaluation of the dollar, but are not too freaked about it, in fact they seem to think it's an excellent opportunity to make some cash. It's well worth reading even if you're not an economist (in fact, many i-bankers might be offended by the site, since they are forever skewering foolish fund managers and etc.) since they do a fantastic job of bridging the gap between investment strategy and the drama of daily life. I know it sounds boring, but trust me, these are some funny guys (especially the "Mogambo Guru" =)

The site authors also have a book available.
posted by idontlikewords at 3:00 PM on November 23, 2004

adamrice: Typically, as interest rates rise, bonds become a more attractive investment. Why? Because a bond is a loan (to a business, a city, whatever), and because interest rates are higher general, you can make the loan at a higher rate.

That description might seriously mislead someone. As interest rates rise, bonds lose value. Of course, if you manage to buy a bond at the peak of the rate cycle, then you've made a good investment. But if you're holding (fixed-rate long or intermediate) bonds as rates rise, you get clobbered.

1999: Exhibit A. (The fund is especially sensitive to rising rates, but 1999 was tame in comparison to the late 1970s/early 1980s)
posted by trharlan at 3:06 PM on November 23, 2004

how would a sudden jump in personal bankruptcies affect the broader economy

It would be very, very bad. The major lenders in this country (not just banks, but also Fannie Mae/Freddie Mac, who have something like $30 trillion in loans) would go into a panic and stop lending to average Joe's unless they have perfect credit and are willing to suck up huge interest rates. If the government had to bail them out... well, they could always print up a lot of money, but then you have sick levels of inflation.
posted by Civil_Disobedient at 3:19 PM on November 23, 2004

idontlinkewords: Thanks for the fantastic link! A small (wonderful) excerpt:

"Meanwhile, back in economics land, foreigners decided that they would hold their noses, bite the bullet, and buy another $5.1 billion of US debt and store it at the Fed. If you go to the Mogambo Dictionary, you will find that when I say "foreigners" in this context, I mean foreign central banks. And the reason that these foreign central banks started buying our debt again is that these selfsame foreign central banks are reeling from the pain of listening to people, powerful people, with money invested in US debt, who are screaming on the phone, everybody wanting somebody to get up off their big butts and make us Americans do something about our financial problems because they are losing money on their portfolios.

Now, if you are like me, you assume that all foreigners are backwards idiots who dress funny and stuff their portfolios with cheese and the icky parts of dead animals. In reality, it turns out, their portfolios are crammed with, along with the aforementioned cheese and animal pieces, US debt and equities. The downside is that after awhile the cheese starts to stink, the meat products go rancid, and, once their dollar holdings are exchanged/translated back into their local currency, they are finding that the whole portfolio stinks."

posted by Civil_Disobedient at 3:36 PM on November 23, 2004

tharlan--you're right. Thanks for clarifying that for me.
posted by adamrice at 7:38 AM on November 24, 2004