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Friday, January 9, 2009

The long term pending US disaster - Bonds

I had a discussion today with a friend (well, maybe he doesn't consider me a friend, but an entertaining crackpot) about cash, resources, stocks, bonds, real estate and other investment vehicles.

I have been repeating a theme in person, and now I'll repeat it to you. :)

I view now there is no such thing as absolute "wealth". Most people look at cash as "absolute" wealth, others defer to gold as a definition. So what is the creation/storage of "wealth"?
In simple terms in every day life:

We work and receive X pay for our efforts. At the end of the day the costs to "live" costs Y, the net left over (or borrowed if negative) is Z. X-Y=Z
Z can then be stored in cash, or some other asset. An asset could be a baseball card (assuming it appreciates or maintains value), gold, stock, or cash. When needed we exchange some of Z to answer a need (such as buy a house).

The problem is, most people DO NOT look at cash as a "risky play" like the other assets. People look at stock as "risky" now that it fell substantially. Why do I say cash (could) be a risky play? Well, what is CASH?

CASH is NOT backed by gold, a common misconception. During the the Great Depression almost all currencies left the Gold standard. "Tricky Dick" Nixon finished off any remaining ties in the USA currencies tied to gold. What backs CASH? Well nothing. Its basically in essence the "stock" of the USA. As an example, the Peso vs Cash vs Zimbabwe dollars trade among each other. Kinda like gold, silver, copper trade at different values "per ounce" for each other, or for dollars.

So what makes the USD more or less valuable than others? There are whole books written to explain it. But at it's heart is the faith by people that it is a safe storage for value.

As an example, do you believe GOLD is safe? Gold went from 1,000 an ounce down to about 750 in 2 months in 2008, now back up to 825 range. OIL? OIL went from about $140 a barrel down to $36 in a few months. Same for food, real estate, bonds, etc.

Even the US DOLLAR has had its ups and downs, some of it pretty severe recently, which is part explanation for some commodity moves.

What else represents the US Government's credit worthiness? US Bonds. When US dollars are created, they are NOT just printed, like a photo copy machine.(in Zimbabwe it is) For every USD printed, an EQUAL number of US Bonds are created. These bonds are printed by the US treasury and sold on the open market. The bonds are used to create/leverage generation of US Cash. The interest on the bonds more or less represents the credit worthiness of the US to pay back the bond and to cover some of the expected inflation during that period of time.

For example, if you where to buy a Zimbabwe bond(which doesn't exist), and I have no idea what the actual interest rate would be, but probably 1 million %, as compared to USD of 2%.

Which brings me back to the point of the USD as a play, like any other play. When you keep your life savings in "cash", you are making a play that the value of the USD will remain about the same or rise. In Zimbabwe, the moment you are paid, people run out and buy 100% of their cash for goods. Why? Because the inflation is high and faith in the Zimbabwe currency is low.

Now, I am NOT suggesting the USD will ever be like the Zimbabwe currency. But it paints a stark picture that maybe, just maybe, in the next 1 month to 3 years the US Dollar may not be as "valuable" as it is now. And that the US Bond rates will not remain at sub 2%. That at some point, as the US Government prints trillions of debt, our creditors will say enough.

They will ask for, 2.5% interest, maybe even 3%. And heaven forbid we return to 1980 of 20% interest for bonds. Do I think the US Dollar is facing immediate problems. No, not at all. Do I believe every month that goes by the US edges, ever so slightly more towards an issue? As long as the only answer in the US for "stimulus" is creating more debt and covering all insolvent companies with "free" money? Yes.

This leads me up to my article of the day, where China once again is having rumblings that they don't want to buy as much US Debt as they do now. In reality, they are the dope dealer and we are the addict. The US Dollar is addicted to debt, and China can't help itself but continue to give the US it's fix. I don't see this ending soon.

The video below, while a bit out there as a media source, does quote some disdain for the US dollar as the default currency for the world. I have blogged (or was it emailed) before how the US Dollar was the only currency to buy oil since WWII, but a year or so ago Euro's and other currencies are now trading.

This long rant, ties to a previous post, which you can read by clicking here. In addition to another post on why resources over the long haul will cost more for Americans.
This post supports for the common (not day-trader) why I still support "cheap" resource of OIL as a long term investment, and if/when gold hits under 600 an ounce as a way to "store" wealth, in a safer manner than cash for the long haul.

The question you have to ask yourself is, assuming Obama debt spends over 1 Trillion per year, and the US government spends 1 trillion per year covering the losses of financial companies each year for the next two years, do you believe the USD will be worth more, less, or the same as it does today? The answer isn't simple, since it has to be asked as compared to WHAT?
Other currencies have issues worse than the USD, some a little better. But at the end of the day, some things transcend currency valuations and are more absolute (but all are still RELATIVE, there is no absolute wealth). Buying cheap Real Estate (like an acre for $5K) , Gold (if cheaper), or Oil in 5 years in my opinion can't be worth significantly less than today, and maybe even more in USD.

And this is the point, what is the SAFEST play to store wealth for the next 5 years? Stock market? Click for my 2009 view. Real estate? Click for my 2009-2011 view. Cash? You now have an exhaustive explanation of my view.

CHEAP Oil as an investment has the added advantage of it is always needed (although demand level changes) and if there is world instability, it will spike up, not down. As always GDX is still my favorite long term play. UPDATE 2/9 - Read USO vs USL Check out USO , possibly GDX (click) , food EFT (RJA) or a broad resource fund and consult your financial adviser. Never put all your eggs in one basket, including cash/bonds.

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