Wednesday, December 10, 2008

So How Bad Is It, Really?


In the market equivalent of shoveling cash under the mattress, hordes of buyers were so eager on Tuesday to park money in the world's safest investment, United States government debt, that they agreed to accept a zero percent rate of return.

The news sent a sobering signal: in these troubled economic times, when people have lost vast amounts on stocks, bonds and real estate, making an investment that offers security but no gain is tantamount to coming out ahead. This extremely cautious approach reflects concerns that a global recession could deepen next year, and continue to jeopardize all types of investments.

A quick finance lesson for those of you who didn't attend B-school. Interest is essentially the cost of borrowing money (there's a lot more and that's very simplistic, but I digress). If you borrow $100 from me, that's $100 I don't have. I charge you $2 interest, because I can make at least that much in another investment.
Let's assume inflation is a factor, for a second, and inflation would eat up $1 of the $100. I still come out ahead. Presumably, you being a rational person, use the $100 to make a quick $3 or more. You come out ahead.
If I lend you the money at zero interest, it means that I lose money over time. I don't recapture that $1 that inflation has eaten up. I effectively get $99 for lending you $100. Under what scenario does this arrangement work.
When inflation is a negative, or economic growth is contracting.
So in other words, the global financial markets have factored in the entire world economy. They've taken into account China, and India and Russia. And they've decided that, for the next thirty days (which includes the last two weeks of Christmas shopping), the economy is going to go south like nobody's business. They're not worried about making money: they're worried about losing more money than they already have.
Too, some global investors are scared enough that the Treaasury auctioned off some 3-month notes for zer percent, meaning those pessimists believe things won't get better before next Spring.
Personally, I would have taken zero on 12 month notes.
It's a very weird world out there. The dollar, which had hit some recent historic lows against the euro and pound, is suddenly the place to invest, primarily because oil prices, tied to the dollar, have collapsed, making dollars more freely available on the market. You'd think this would be good news to stock markets, but you'd be wrong.
The dollar being strong and the US Treasury being able to float zero interest debt actually caused the market to drop. My guess is this is mopre pyschological than economic: I see this as the last stand of the American government. For too long, we've lived on borrowed money, buoyed only be the fact that we've been able to see the private sector, similarly buoyed, scratch out some economic growth in this decade.
Despite Bush's tax cuts, which have done nothing for the real economy and only helped speed up the shuffling of paper in the fantasy economy.
The bailouts of so many businesses in so many key economic sectors (wait till the airlines start lobbying) has Wall Street worried, and rightly so.
When does the spigot turn off? What companies will be left standing when the music stops and the chairs are full? What happens when Uncle Sam himself turns empty pockets inside out?