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Peering over the ledge

We interrupt our normally optimistic reporting to bring you this view of what could go wrong...

Crown's MoneyLife radio program yesterday was a really good discussion of a recent Wall Street Journal article titled The Doomsayers Who Got It Right (subscription required). While you can't read the actual article unless you're a WSJ subscriber, the first link above is a loose transcription of the radio program which discusses many of the details in the article.

The article catches up with the current thinking of three prominent economists/money managers who predicted much of the economic crisis. An extremely brief summary of their views follows.

Jeremy Grantham points out that the unintended consequences of the government's response to the financial crisis are unknowable. He thinks there's a long-term risk of a surge in inflation and sees a better than 50-50 chance 2009 will see the stock market decline further. He's setting aside cash in case stocks fall significantly lower, though the article doesn't say he's actually predicting that. In fact, somewhat surprisingly to me, Grantham mentions that he expects real (after inflation) returns of 9.5% from foreign stocks and 7.5% from U.S. stocks over the next seven years. Those are both pretty decent numbers.

Bob Rodriguez sees the economic slide continuing much longer than most. He says his concern isn't the next two years, "but period three through 10." He expects high inflation during that time and GDP growth of less than 2% per year, which would mean a very slow recovery.

Much of this prognosis is based on a change he sees in the U.S. consumer from spender to saver. The Crown program pointed out that the paradox here is that it's a great thing at the individual level for people to quit spending so much and start saving - exactly the right prescription for personal financial health. But 70% of our national economy is made up of consumer purchases, so if the savings rate does go from 1%, where it's been in recent years, to 7%-10%, where Bob Rodriguez sees it moving to by next year, that means the economy as a whole is going nowhere fast.

As an investing blog, it's also worth noting that Rodriguez was buying stocks in October and November for the first time in over a year, though mostly in the energy sector where prices for real assets (like oil) will likely rise as inflation catches hold.

Peter Schiff is probably the most bearish of the group, expecting massive inflation and sharply higher interest rates as foreign investors eventually refuse to buy U.S. debt. He sees the dollar dropping significantly in that scenario and foreign markets outperforming U.S. markets by a significant margin as a result. (Detractors would point out that while many of Schiff's dire predictions have panned out, his actual investment performance has been poor, as his investments have been mainly overseas stocks and commodity-based, both of which were hammered in the downturn last year.)

There's value in examining the "what if's" these bearish views present. The most important take-away from an article like this is probably not so much on the investing side (though there are elements there worth exploring, and we likely will in the months to come), but the personal finance side. If these men are right, the economy is not going to get better anytime soon. In these scenarios, it is paramount that readers do the hard thing in preparing themselves financially by spending less than they earn, paying down debt, and establishing an emergency savings reserve. Don't assume things will bounce back quickly.

I really appreciated the conclusion of MoneyLife host Chuck Bentley's take on all this, which you can find at the end of the program or transcript (linked to above). He explained that as Christians, we don't have to put a positive or optimistic "spin" on this sort of news, but we can and should have hope about the future, in spite of what may come economically because God can and will redeem even the tough things that happen to us. Read or listen to the ending of his program for his full take. It's good stuff.

As you know, SMI doesn't put a lot of faith in any expert's predictions. So we're not going to get all panicky about these predictions. But it is worth soberly considering these gloomier outlooks so as to prepare ourselves in case they are accurate. That starts with getting our personal finances in order, and then ripples into our investing decisions. Again, the investing implications of all this are a little beyond the scope of this post, but we'll likely delve a little deeper into some of this in the future.

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