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How solid is your investment? Part 2
Today we carry on where we left off last week – about the goings on in the world of investing. (By investing I do not mean my kind of investing!)
I’m talking about the financial meltdown that accompanied the sub-prime and other irresponsible kinds of lending. It seems we were fortunate in South Africa in that the regulations that control the banking industry – that they complain about – are in fact saving them from themselves. Without such regulation in America they really hurt themselves and many innocent people. (Of course not everyone lost - a handful of people made a killing, as they always do. The informed and ruthless ones.)
It seems this particular bit of theft has contaminated the entire housing market in America. Which affects just about everyone. It has led to the near collapse of Merrill Lynch, only “saved” by a quick merger with Bank of America. Lehman Brothers is dead. AIG was saved by taxpayers’ money. For stock exchanges in “developing countries” it confirms the old saying that when America sneezes, the rest of the world gets pneumonia ... it’s completely weird because the instability and the serious structural infirmities are in America, yet at the first hint of trouble investors get out of ‘emerging markets’ immediately.
And apparently it’s hard to unravel the whole story because the financial structures are so complicated that essentially nobody understands them. Why? For the same reason that anything is made complicated - to keep people in the dark. There’s an interesting book called Guns, Traders and Money by Satyajit Das that explains how these structures are created to keep clients, investors, and basically everyone in the dark. With their bewildered yet willing cooperation, of course – like residuals in car finance!
Economists say that you can’t work out who owes what to whom. Merrill Lynch, AIG and Lehman Brothers all apparently traded in these murky mortgage-backed securities. Many such firms were very much part of the “passing on of the hot potato”. Yet they got burned anyway, perhaps because when you spread the risk widely, it comes back at you from another angle.
It’s been called unfathomable. It’s said that there is another $63 trillion tied up in similar structures to the sub-prime story. These involve other forms of debt including vehicle loans and credit card loans.
We recently explored some of the issues of credit card loans – it seems to be unsustainable too. Would you invest in anything like this?
Of course not. Why not?
Which makes it everyone’s problem.
My understanding of what to do to safeguard yourself? Eradicate your debt. Never invest in anything you do not understand or have control over. Or that increases your risk to a level that, if things go wrong, could damage you.
At the bottom of the newspaper page I was reading was an advert saying that you should invest in the fastest growing market in the world – carbon credits. The ad said that it was the only market not to be affected by the recent economic troubles.
Hmm. A clue. As to what’s next. Is this the next bubble?
Let’s take a closer look.
A bubble is a rise in ‘value’ or asset prices that is out of touch with reality. It’s based on speculation – the certainty that prices will continue to rise, against all historical evidence that says eventually they must crash.
We just had a housing price bubble, not as severe in South Africa, perhaps because we have more regulations to protect people from themselves (nevertheless, a lot of people got hurt anyway).
Bubbles used to be rare. We hear of the South Sea Bubble. That was in 1720 yet people still talk about it. Bubbles cause such chaos that usually governments take action to stop them happening again. That’s what happened after the consumer-lending frenzy in the 1920s led to the bubble that led to the Great Depression which only ended when the war stimulated the economy.
Bubbles are driven by emotion.
By the belief that they will never end.
That “this time things will be different”.
That “property always goes up”.
A whole lot of myths. That greed makes people blind to. People get kind of crazy. Read a book called “American Sucker” by David Denby for a personal diary of someone who got caught up in the frenzy, didn’t want to see the truth about this (or other important issues in his life) and lost the lot.
Basically when everyone’s talking about it ... when everyone’s doing it ... it could well be a bubble.
Personal judgement gets put aside. The rules are discarded because “this time it’s really different”.
It’s built on fantasies of overnight wealth. Frustration and financial desperation. Greed. Wishful thinking. Being swayed by ‘herd thinking’. It’s been called a shared hallucination.
Shared hallucinations are massively powerful. We are very easily influenced by others.
Directed by the visions of Nonqwase, the Xhosa nation killed their cattle and then went through mass starvation.
They were a people in trouble, under a lot of pressure from the colonists. They’d lost a great deal of land, been harried and hunted from horseback through the bush of the Eastern Cape like foxes in England. They were desperate, running out of land, food, and options.
They were ripe for a shared hallucination that promised them salvation – that promised that in return for slaughtering all their cattle, their tormentors, the British, would be driven into the sea.
Cattle were their wealth. They must have known it was a massive risk. Yet many of them were desperate enough to do it anyway.
You think this has nothing to do with you?
Look at the parallels.
Modern Western people are under a lot of pressure. Massive debt pressure. Job losses to computers. Divorce. Work pressure. Traffic. Declining health.
As discussed in many past lessons, the ordinary person is being preyed upon by rapacious corporations, mainly in the form of debt. They have no defences because they are so brainwashed by the media that they don’t even know it’s happening. Yet they are aware of increasing financial pressure.
When you are under financial pressure, what do you do? You may dream of overnight wealth, winning the lottery, etc. You may also easily be seduced by promises of quick and easy money, rock-solid investments, etc.
These are the danger signs. So you can be aware.
And you should be aware. There are people who believe that bubbles are now business as usual. As it is we see that no sooner has the dust cleared from one than another is building up.
Why?
A banknote is supposed to represent a certain quantity of real gold. When the US first began to run up big deficits, and creditors wanted to be repaid, and weren’t prepared to accept depreciated dollars, Richard Nixon quickly delinked the dollar from gold so that the US didn’t lose its gold reserves. Same thing as defaulting on the loan, actually.
We’re used to it now, but the financial chaos and instability that followed were not familiar to most people then. That’s the era when inflation suddenly rose, turning pensions into small change, to the devastation of many people’s financial planning. (Still true today, by the way, just a bit better disguised).
The dollar was the international currency but it had no measure of value. What was it worth? What people were prepared to trade it for, that’s all. Which in itself is a kind of illusion. The same illusion as “market value” is when you are buying a property. Anyway, insane or not, that’s how the world went and that’s how it still is.
Interest rates went up, two global recessions followed, and after 1975, the US was never again out of debt. The new economy was dominated not by car manufacturers or steel companies, but finance, insurance and real estate. Sometimes called FIRE. All very dependent on credit and on lots of liquidity. Deregulation (removing those government restrictions put in place to save us from ourselves) increased. It had to, or this new economy was not going to get anywhere.
The old industries were very concrete. You don’t get much more concrete than a steelworks. Or an auto assembly line. The new ones were different. They’re based on credit. And inflation still rules. Which gives us the illusion of growth. We certainly have got used to the idea that things always go up.
The US’s debt today is many times the debt that first scared Nixon into defaulting by delinking the currency from gold. But nobody can call that debt in, because the system would collapse, taking everyone down with it. Like they say, if you owe the bank a small amount of money, it’s your problem. If you owe them a lot of money, it’s their problem.
So essentially you could say that the entire financial system has become a bubble.
That’s the really big picture. Now, about the bubbles that come and go, and that could affect you. Next week we will find out more about them so we know how to protect ourselves from them.
Learn How To Invest Money is an excellent resource to find out more about the Formula For Riches and why debt keep us poor.
Other Articles that can help you to find out the truth about investments:
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