Riding out the economic storm with Pyrrho

Good points. I would add, *Don't encourage your kids to go into debt for college.* I would put that in big red letters with sparkles, to get their attention. Be thinking about alternatives to big-time college spending. It's true that when kids turn 18, they can sign the loan papers, but don't co-sign for them. Whip out that spread sheet and *show* them the cost-benefit ratio of college debt vs. what they can reasonably expect to earn to pay it back. (And what it means for two big-time debtors to marry and combine their respective debts.)

There is a lot of pressure on the 16-25 year old set right now to follow the common model. But as today's New York Times article on college costs points out, the cost increases are ultimately going to be unsustainable, and probably highly damaging to people both individually and socially.

Thanks, Pyrrho, especially for the bankrate.com finder. We are "in the market" for changing banking institutions. That helped a great deal.

Alkali,

I got out of the markets in the spring of 2007, but my SEP-IRA and Roth-IRAs are still intact. Tax free saving is an important component of any plan, to be sure.

I'm extremely bearish about the markets, even though there have been and will be the inevitable 'bear market rallies'. I'll wait until market capitulation, thank you, when I can do Benjamin Graham-style value investing with greater confidence.

I've always been deeply skeptical about the 'modern portfolio theory' that has been heavily oversold by contemporary financial planners. There are historical periods in which this strategy is a big loser, and I believe we're in one of those periods.

I recommend John Mauldin's Bull's Eye Investing for a solid crtique of MPT.

"[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."

What about people who don't have kids or is it just assumed that all normal people do?

So my prediction is when the Dow marks 7000 on heavy volume, buy the S&P ultra longs.

My sentiments exactly, mon cher Roland!

Pyrrho, excellent analysis. However, it is all about finances, and the best you can do talking about the financial economy is to get us back to where we were. But where we were is not where we ought to go. THAT economy was about consumption over production; that is a recipe for poverty and bankruptcy. Consumption, we are told, is (or was) 71% of the economy. But a rational economy ought to be about 50-50 production and consumption. We need to make as much as we consume.

Countries grow rich only by making things. And this is at the root of the problem. We began to lose our manufacturing capabilities in the 80's, and since then the economy has been sustained by bubbles, first the dot-com bubble and then the housing bubble. Fixing the financial system can only restore the consumptionist and bubble economy. And frankly, I don't see where the next bubble is coming from.

We can never forget the distinction between the financial economy and the real economy, the economy of actually making things. The former should exist only to support the later. When it becomes an end in itself, you get the situations we have had. I find it odd that we bailout AIG to the tune of $165B without a word of protest or a vote from Congress, yet make the auto industry dance a jig for $34B in loans. Something is wrong here.

John,

This post had a very narrow focus: how individuals (to the extent possible) should plan to ride this thing out financially. I agree with you that this is going to be a very long ride, precisely for the reasons you've mentioned.

It took a while, but I finally got your book. The vision you present is integral to rebuilding our society in my opinion. My thinking can be divided into two stages: land the plane were in using the lousy instrumentation and controls it came with, and then build a much better plane.

You forgot to invest in canned beans, lots of canned beans.

More seriously, there isn't a lot a person can do. If a person were treated as an asset, $50,000 in annual earnings for 10 years would translate into a $500,000 an asset. Over 20 years, that is like a $750,000. (A 3% discount was used relecting relatively safe job stability.) The closest an average Joe (not Joe the Plumber) has to this kind of asset is his home and most likely that is leveraged to the hilt so it has a very small net asset value. For most average Joes, the best thing they can do during a recession (or any time) is keep their jobs. Lacking that, you are just rearranging chairs on the Titanic.

As far as the advice goes, reducing debt is always a good idea. Having a large cash reserve is always a good idea. If you are hitting FDIC limits, your concerns should not be how you are going to survive for a couple years or whatever. 401(k)s and the rest only become relevant when your returns exceed $10,000/year. For 95% of folks this means your should not be worrying about taxes reducing your investment returns from 8% to 7%. The only value 401(k)s have for most people is the company match.

S&P ultra longs

What are these?

Thanks in advance.

The dot.com bubble was a bubble, but the fact was it was built around us making 'stuff': software, hardware, new technologies...

We still do make 'stuff', and not just in the manufacturing sector. We make drugs, medical devices, biotech products, etc. We make things that require a workforce with degrees in science, engineering, and mathematics. It may be true that higher education is in bubble territory, but that is only because there are WAY too many people who think that a degree in English, humanities, and etc are going to buy them anything but massive debt. Degrees in science, engineering, and mathematics actually hold there value.

3:01 was me.

Pyrrho,

Thank you very much for your comments on my book. Write me privately and let me know who you are. I am in the middle of writing another book, and can use some advice.

I realize the focus was about protection, but sooner or later we will have to face the questions of re-building. I am uncomfortable with the team Obama has assembled. They are all stellar in their fields, to be sure, but those are the various fields of finance. I am not convinced that they understand the real problem, but I live in hope that I am wrong.

The dot.com bubble did result in "things," but they were largely manufactured overseas. We did get a lot of the software business, and that was a real net to the economy, both in terms of production and what it added to efficiency. But mostly the run-up in prices was based on speculation.

I'm with you guys on the Student loans.

I graduated about 4 years ago and I have a mountain of Debt, bout 40k which if I stick to my schedule, I will end up paying back 110. Of course I'm maxing out every month. When I balance my finances every month, every last cent remaining goes towards debt reduction. That is, of course after my savings contributions.

If you have kids turning this age, it's important to discuss with them the merits of attending a private university, a public one, or any mix of expense therein. I went to a private uni, and quickly learned that it matters very little where you get or how much you pay for your education when your pursuit is a profession (grad school?)

What's important, beyond the general quality of the active faculty is the academy's ability to impart good-habits such as discipline and critical thinking. You could spend 40k a year going to Harvard and drink your way through, or you could spend 5k a year at a prominent state school and take your education seriously. I know these are extremes, and I don't want people getting all Good Will Hunting on me, saying you can get the same ed for 1.75 in library late fees - but if you, or your kids are even the slightest bit unsure of their chosen career path - I'd opt to take the most out of a generalized education and save your specialization for when you have a better grounding on your wants and desires. I knew nothing of what I wanted to do when I was 18, other than that I was supposed to go to college. Just like all the other important things in life, you reap exactly what you sew.

I'm with you too on staying out of the stock market. That doesn't mean you should stop investing. I've got friends with secure jobs and small liabilities who are buying into their 401k's at record paces. I've got friends too who are selling off to realize losses and mitigate their effects in the short term. It all depends on your individual situation - but I think Phyrro's advice here is pretty sound.

If you really want to make some impact and marginalize your exposure - I'd look into investment grade, local, muni bonds. It's a hodgepodge market you might want to find a professional's help, but in the next year or so there could be a lot of value here as cities, schools, and utilities feel the same pressures we do. Bottom line is they would rather borrow from you than the bank, and they are willing to pay a premium for that. It's a good way to realize returns similar to a CD and have a substantial impact in your local community as well - plus you know EXACTLY what your money is funding - not what some banker wants to spend it on.

Personally, I'm leaving my stock holdings exactly where they are (I didn't get burned too badly, yet.) and diverting my monthly savings into guaranteed-income investments, such as CD's and some very select bonds to increase my position and marginalize total risk. Right now, I'm not very optimistic about market performance and if I can keep up with inflation, I'm happy to live within my means and put away a couple hundred bucks each month for when it really rains - but I'm decades from retirement.

Also, I'm pretty skeptical of MPT as well - the whole idea stinks of a pyramid scheme. Think "Dogs of the Dow". The theory is sound in principle under certain conditions, but who got rich off that one?

Pyrrho:

Not sure why my name didn't show in combox.

I understand the anti-deflationary step. But I'm not sure that it's possible to come out "better off than anyone imagines." Though if we have some major values / expectataions restructuring, that would be excellent.

"It won't work if people know what they're going to do." Hmm... now I'm stuck racking my brain through fiscal and monetary policy options that could be covert and yet effective ---

Shelley,

Are you referring to printing money?

Yes, but there's more to it. And, really, don't worry about hyperinflation. That's only a chance of that if the economy is operating near full capacity.

Do you expect that housing will hold it's value or even gain value eventually?

That's a good point. I don't think it will be a problem where you live because it didn't get too bubbly up there. I think the real estate market will bottom out in four to five years and will recover slowly.

A good rule of thumb: Find out what your house would have sold for in 1995-1998 (maybe up to 2000) and then adjust the amount for inflation using an online CPI calculator. That's probably a good baseline for worst case scenario financial planning.

John,

I know your website so I'll surf over there sometime soon and get in touch. I'm very much interested in translating distributism into a viable economic program.

T Stan: Hmm... now I'm stuck racking my brain through fiscal and monetary policy options that could be covert and yet effective ---

Let me give you a hint. Who owns most of the US public debt? That's right. The government itself!

Pyrrho,
Thanks for the advice...direct and succinct. I have a question though, you said to stay out of the stock market. I am 52 and I have (or DID have before all this...I'm afraid to look now) about 100K in an IRA and a variable annuity both invested in stocks. Should I pull out of the market and take the loss or try to wait it out? Retirement is at least 10 years away but I worry that even that length of time won't be enough to recoup my losses.
And I second the previous comment...I would love to see you have a blog!

On that U.S. Treasury Securities pie chart, why are state and local governments on there twice?

As far as retirement goes, we will still have Social Security (barring some calamity on the order of nuclear war etc). The fiscal problems of Social Security are soluable with a number of doable reforms: a higher retirement age, full taxation of high income wages, rejiggering of the COLA formula. Individuals who can work into their 70s will probably be able to retire with full benefits. However as someone else brought up it is getting difficult to hold a job that late into life and while a healthcare overhaul (if done right) would reduce some of the incentives to fire the 60 year old and hire the college grad, we will probably also end up passing very stiff laws that will make it quite difficult to terminate older workers so that they will be able to stay in the work force longer.

Also, I would ask Pyrro what his time frame is for a "long" recesson. If he means a year or two he may well be right. Much longer than that and I don't think you can make any reliable predictions: the economy is a complex system and is inherently uncertain the farther out you go. Also, we have some major technological innovations in the pipeline. Biotech, nanotech and (a bit farther down the line) new energy sources. These will have a large influence on the economy and I don't see them feeding into stagnation, though we could get a 90s tech-style bubble.

Shelley: How in the world do you find out how much your house was worth 10 years ago?

An experienced realtor whould be able to help you. There's tax appraisal records, etc. that could be checked. Really, though, I'm pretty sure you're fine.

You know what? I don't agree with your assessment. Much too...cheerful. I think it's worse than you're saying it is. In fact, everything I read, and I read a lot, says it's gonna be pretty bad.
The Chinese might loan to us, but they are not our buddies. If they smell a dollar devaluation heading their way, a threat to their huge dollar holdings, look out below. I think that we're doing a stare down with them right now.
I think that we're looking at five years of contraction, high unemployment, maybe even civil unrest.
Housing won't be coming back for many years, and when it does, it will appreciate modestly the way it used to before the stupid bubble. Housing will continue to decline for the next three years, at least.
We'll have deflation for now, as the deleveraging continues. No worries about inflation, you say? After deflation, the likely scenario is inflation, especially considering the way the FED is debasing the currency.
Obviously, I hope that your more cheerful analysis is accurate...

I don't know if 7,000 will be the bottom, but for comparison's sake, the stock market in the depression reached bottom at 1/3rd its 1929 value. But it took until 1933 to find that bottom. It would not regain its 1929 high until 1954 or, if you adjust for inflation, until 1958.

Our market high was 14,000, so 7,000 could be an optimistic estimate, if this thing gets as bad as 29.

Just a thought.

Roland,

Maybe we should all defer to the opinion of the Pythia and emulate Socrates, who was prepared to admit his own ignorance rather than pretend to know something he did not. Not a good tactic if you want to have fun on a blog, however.

"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."

A few years? Uh, Money Magazine isn't paying attention.

http://money.cnn.com/2008/12/03/retirement/money_mole.moneymag/index.htm

Pyrroho wrote: "Let me give you a hint. Who owns most of the US public debt? That's right. The government itself!"

That statement doesn't give me much confidence that I will ever see one cent from Social Security.

Thanks for all the praise and questions, folks. I wish I could do more. I'm not a financial planner, just a really lazy guy who hangs out in the comboxes. If only my kids were older and my business slower ... not that I'm really wishing for either one!

I came across an interesting article in the Boston Globe. Depression 2009: What would it look like?.

For some snarky commentary on this article see TraderMark.

Thanks, LK, but I think we should stay here and keep the CC comboxes humming. It'll help Rod put a chicken in his pot (with apologies to Dorothy/Dorotheus).

Jon the Just
It would somehow be unjust for my boss (assuming she makes over the cap, as I suspect she does) to do the same?

Maybe. Her (and your) benefits are capped. A person who makes $20,000 per year for ten years will pay $12,400 in OASDI taxes. A person who makes $100,000 per year for ten years will pay $62,000. My understanding of social security retirement benefits is that both will be entitled to the same benefit. A person making $200,000 per year for ten years will pay slightly more than the person making $100,000. Is that unjust? Maybe, but not for the reasons implied by your comment.

In your situation, likely you and she are entitled to approximately the same benefits (benefits based on lifetime wages). But she made more in wages (and paid more into social security) than you did. So why do you receive the same benefit? For her the dollar candy bar costs $4 but for you it costs $0.80? You would make this situation more just by having her pay more? Why not just ask for a raise? Or if you must use coercion it might be more honest to just steal her car. Personally, I think you should just thank her.

Experience is certainly a commodity worth sharing, but its value is up to us to determine subjectively, using a fixed scale we determine on our own terms (in the case of the Austrian school, an Aristotlean Universe in an absolute reality of limited resources)...

That's fine, Clare. Nobody is here telling you how you should see the world.

Altering the quantity [of money] by monetary policy will affect its value detrimentally, destroying the dollar's purchasing power.

Not in all cases. Right now is one such case.

We have benefited from the capital of others by peaceful trade via indentured servitude but now that era's coming to an end, we're to take their wealth by force...?

The Japanese and Chinese have been printing money and sending that printed money over here! I'm suprised more people haven't picked up on that.

I'm also suprised people think I'm being optimistic. I only think the Fed and Congress will moderate the rate of deflation. That's great news, but most people will not even notice.

We'll have to pick this up at another time in a spirit of friendship. After all, two people named after the great saints of Assisi should be setting an example for others!

Alter Franciscus

Pyrrho, When you speak of the Chinese and Japanese printing money, it makes me want to know more about their system. Do they just print and spend money into existence?

John