Riding out the economic storm with Pyrrho

Pyrrho responds:

Shelley,

Excuse me for taking so long to reply. I took a long Thanksgiving break and had a huge pile of work to get through when I returned.

While it is impossible to predict what exactly is going to happen, I think you can safely operate from a few basic assumptions in your planning. What follows is is what I think to be the most likely scenario, not the most optimistic or the most pessimistic.

[1] It is difficult to determine just how deep this recession is going to be, but I do not think it will be as deep as many people are currently assuming. We may overreact out of fear for a couple of years, but then the economy will stabilize at a level based on fundamentals. I think that level is higher than many fear right now. We have a safety net and fiscal and monetary policies in place that will keep this from getting as deep as the 1930's. So our general standard of living is going to drop somewhat, but it's not the end of the world. People in certain sectors of the economy (finance, retail, etc.) are going to be hit harder than others. And the poor and less educated will bear the brunt of the hardship to come, as always. But, generally speaking, most of us should not panic. We'll have our problems, but they'll be manageable.

[2] I think the problem is going to be with jump-starting the economy once things bottom out, so plan for a long L-shaped recession. The engines of economic expansion are four: consumer spending, capital investment, exports and government spending (taxes + borrowing). Three of four are down for the count. You would think government spending will be, too, but I think that is wrong. The Fed and Treasury have some secret weapons: quantitative easing and debt monetization, among others. (Shhhh...) This will keep the recession from getting too deep but will not be enough to bring us out of our slump.

[3] The government's 'nuclear option' will not cause inflation because the economy is operating nowhere near full capacity. It will keep things going while the rest of the economy restructures and reorganizes. Government priming of the economy will also keep deflation moderate.

[4] The economy will be in the doldrums just as some long-term demographic problems take hold. In other words, the older boomers will be reaching retirement age during this period. I think we can anticipate a significant cut in retirement benefits, but they will not be entirely eliminated. Most people in their forties with kids (like thee and me) can probably look forward to working until they no longer can do so, followed by moving in with their adult kids. Not the worst fate in the world, that's for sure.

So the takeaway points: [1] there will be a significant but not catastrophic drop in our general standard of living and this will not be shared evenly across industries and income groups, [2] it will take a long time to get out of the mess we're in, and [3] you should expect modest deflation. [4] Also, plan to work until you can no longer do so and bond with your kids.

One more thing: ignore talk of gold, hyperinflation and food shortages ... at least for the next few years. You should be concerned with a cash shortage! There will be plenty of food for those who can afford it. (Though I concede the essentials will not fall in price as much as the non-essentials because demand for essentials is relatively inelastic. Essentials will likely take up a bigger percentage of your household budget.)

So, let's cobble together a very modest financial strategy for at least the next few years (subject to review at that time). This plan assumes your household income remains adequate and that [1] through [4] obtain (income steady or down somewhat, long period of economic stagnation, moderate deflationary pressures, no lavish retirement for most of us).

[i] Do not take on any more debt if you can help it. Remember: Debt becomes more burdensome over time in a deflationary scenario.

[ii] Make sure your credit rating remains good.

[iii] Save as much money as you can. Remember: Cash is king.

[iv] Put your money in more than one FDIC-insured bank. Bankrate.com has a free service called 'Safe & Sound'. (Google it.) Choose local banks with the highest ratings. I have no doubt the FDIC will make good on your deposits if your bank should fail, but it may be a while before you get your money. I'm sure you'll agree that it would be nice to have access to some money during this time. So, two banks! The FDIC now covers $250,000 per depositor, per insured bank. If you have more than $250,000, split it up between two or banks by all means. I think a rash of bank failures in the next couple of years is a near certainty so exercise care.

(What I've said here applies to credit unions, too. The NCUA operates in essentially the same way as the FDIC. Support your local credit union if it is well managed and financially sound. It's the crunchy thing to do!)

[v] If you feel like doing some investing, overpay your mortgage to cut interest costs and reduce the overall term. Stay away from the stock market until Business Week runs a cover article entitled: "Invest in Stocks? You've Got to be Crazy!" That will take a few more years at the very earliest.

[vi] Keep your health insurance, and take out disability insurance if you can afford it.

ONE OTHER THING: Fear is endemic to bad economic times. Exercise caution, but don't give into fear. I try to counter greed with temperance in good times, and fear with prudence in bad times. Take Matthew 6:20 to heart.

Remember, I'm just an anonymous combox poster so take this advice only if it makes sense to you. And I reserve the right to change my mind about all of this as early as tomorrow ;-)