Worldwide Investment Distortions in Stocks, Real Estate Markets

Today an investor needs to be aware of and cautious about the distorted worldwide investment climate that exists thanks to the policies since 2000 of the US Federal Reserve System and the departed chairman Alan Greenspan.

Mr Greenspan thought that the answer to all financial problems was simply to create more money. But not by actually producing more goods and providing services but by the unchecked sheer power of the money creation tools of the magical United States Federal Reserve system. Without going into all of the details in this short article the money was created out of thin air without any backing whatsoever. And not a little of it, enormous liquidity was provided under the chairman’s rein.

In fact, Greenspan was essentially giving away money for free as he and the Federal Reserve lowered rates far below the inflation rate. No wonder so many people and corprations took on a boat load and a half of debt.

The unprecedented creation of liquidity in the US financial system attempted to cover up the effects of the towering twin trade and fiscal deficits sustained by the US and to prop up and to enhance the performance of a basically weak economy that in recent years has had its’ manufacturing base severely eroded as jobs move overseas or simply vanish.

Only blatant changes made in the economic number reporting statistics, very creative accounting practices, and the enormous artificial expansion of the money supply kept the US economic numbers from looking as they truly are; which are sub par performance levels for the weakest economic recovery on record.

In the short run Mr Greenspan’s management of the US money creation machine seemed to have been successful. The real estate market worldwide exploded with “values” reaching sky high levels. Stock markets worldwide benefited from large amounts of the excess liquidity finding its way into stocks.

Home owners were able to extract huge amounts of cash from their homes by refinancing and by taking out home equity loans and then use the proceeds to purchase all manner of consumer goods, thereby boosting the economy.

With borrowed funds so readiliy available and the government encouraging people to go deeper into debt the allocation of capital was seriously mismanaged in the US. Most of the excess liquidity flowed into consumer goods, housing, and stocks instead of expanding the nations productive capacity and repairing crumbling infrastructure.

Unfortunately, the root causes of the US’s poor performance with trade and fiscal deficits were not addressed. They are still out of control and are clearly unsustainable. One not so fine day the devil will demand his due. That day is probably not so far away as a number of nations, including Russia and the Chinese have began to slowly adjust their exposure to US dollars. An unexpected financial crisis of any sort could swiftly cause a stampede out of the dollar with unfortunate consequences for investors worldwide.

The big question now is can such bubbles in values that the excess liquidity brought to world investment markets be slowly deflated or we at risk of a sudden collapse of values right across the investment spectrum? The answer to that question is not at all clear as of this date, October 27, 2006.

However, when we look at history, the outlook of returning to the mean of long term investment trends without serious incident is not good. Bubbles have never ended calmly and without pain and a great deal of stress and suffering on many investors and financial institutions.

So what should a prudent investor do? IMHO the best thing is to keep things very simple and come back to cash and gold. Converting inflated assets of all classes of investments to a ratio of cash and gold that you feel comfortable with should put one into great shape for the next ten years or so.

After all you will be selling out at or near all time highs in most markets and at least preserve the wealth that you have accumulated thanks to Alan and company at a time when the investment cycle may suddenly reverse with disastrous results for those greedy folks who decide to go for the final little bit of return.

Being in cash with at least modest holdings in gold as an insurance policy has never been as attractive as it is right now. Forget why the TV talking heads say. They are for the most part overpaid teleprompter readers and actors who will only get you into trouble if you take their always bullish advice.

Remember, that no one in the history of the world ever went broke selling out at or near market highs but plenty of folks have been totally ruined by overstaying markets and then freezing into inaction as values collapse.

Be a good investor and let the other guy get the last buck or two that’s on the table. After all, in order for you to liquidate at near all time highs there have to be folks out there who still think that values will increase further from grossly inflated levels.

Gerald Greene