Even Inlfation Adjusted Savings Are Losing Value

Bernanke fiddled while the dollar burned. In many countries, holding some savings in foreign currency accounts at the local bank is the norm. Savers learned these habits thanks to the volatility of their native currency, and the banks learned to offer these foreign currency accounts through the competitive nature of attracting bank deposits. Only in the United States, where banks make their money as brokers rather than as savings and loan institutions, is the notion of savings denominated in foreign currencies looked upon aghast. That's sad, because American savers need this option more than the third worlders who are cutting and running from their dollar pegs.

Last week, the selling price of TIPs (Treasury Inflation Protected securities) fell to the point that buyers were locking in a loss, even ignoring the fictional inflation rate with which the notes adjusted. Could you imagine buying a financial instrument that literally guaranteed that you would lose money? But that's exactly what's happening today as investors rush to buy TIPs with a real negative rate of return, in hopes that over the life of the bill, their savings won't lose as much value as if they are gambled on anything else.

It's hard to come up with a scenario that could be worse for an economy than investors who are so frightened by the speculative excesses of the financial system that they are willing to accept a real negative rate of return on savings. Unfortunately, they are probably correct to do so. The Fed has demonstrated over and over again that their sole focus is to prop up Wall Street speculators, out of the very real fear that the banking system is at risk. Well, the banking system is at risk when depositors come to see saving money as an impossibility, and banking directly with the US Treasury as the only way to preserve some portion of their savings. How we got to this point is the old story of greed and more greed, and how we'll get out of it is looking more and more like the Japanese formula, but with a hitch.

The Japanese recession of the late 80's and 90's, which dragged on for more than a decade, was characterized by deflation. The Japanese consumer, facing an uncertain future and having watched their last minute entry into equities investment vanish in smoke and mirrors, sat on their savings and refused to spend money. Despite BoJ interest rates that were basically zero, the Japanese saw deflation rather than inflation, because consumers and businesses were too smart to borrow and spend this cheap money. The end result is that the savings of the Japanese housewife actually gained value, as prices fell, despite the lack of interest paid on savings. The paper Yen acted more like a gold standard, with the exception of the carry trade.

The American recession, which we've clearly been in since 2007 even if the formal definition doesn't match, can't follow the trajectory of the Japanese recession. The point of divergence isn't the relative size of the stock market bubbles, the NASDAQ in 2000 was just as bad as the Nekkei in the late 80's, and the DOW today is as bubbly as the Nekkei in it's multiple peak attempts to recover over the past 20 years. Unlike the Japanese, America enters this recession so far in debt, that riding it out on savings isn't an option for the average American.

The real question the American saver faces is whether it makes more sense to put dollars into Federal "savings" where they will slowly lose value, and to pay taxes on the insulting return, or to hoard currency in mattresses, preferably with foreign bills mixed in. The advantage of the latter approach will come into play if future government bail-outs of American consumers are means tested. In other words, I expect Americans will not only be punished for saving money through its losing value, but also through the funding of relief for their fellow Americans who may have earned more, but have spent more as well.

The Idiot's Guide To Losing Money

Just wanted to note that I've been wrong about DUG two times already, which just goes to show what you get for not reading the small print. Incredibly, I accidentally bought DUG last year when I was trying to short the DOW and simply misread the symbol (the Dow short ETF is DOG). When I finally noticed it was decoupled from the DOW, I checked and saw that it was actually a 2X short fund for oil, and swore not only would I never make another accidental purchase through ignorance, but that I would never short oil.

A couple weeks ago when oil went over $100 a barrel, I broke my word and decided to short oil with DUG after all. At first oil went up and and DUG dropped, which was fine by me since I was sure the situation would turn around. But then, oil kept going up and DUG began to rise as well. Two days ago, I was ahead almost 10% despite oil rising to an all time high, and was finally motivated to figure out why. DUG wasn't the simple 2X oil short based on the commodity price I'd assumed when I bought it, DUG is a 2X short of the DOW Oil and Gas Index. The DOW Oil and Gas Index consists not of oil but of oil and gas energy companies, refiners, etc, who have largely taking a beating as their feedstock prices rose.

Thanks to Ben Bernanke and the Wall Street Fed bailout, the I lost back that 10% yesterday on surging stock prices, but at least I know why. I'm not sure at this point whether or not I'll hold the position, I might look for a real oil short and swap the money into that instead, especially with the price of oil at $107. While it's possible oil will continue to rise, with some folks now talking about $200 (how folks love round numbers) my own suspicion is that it's a commodity bubble and will break when the currency problems get ironed out.

The Principal Of Moral Hazard

Yesterday Ben Bernanke suggested that banks and other mortgage holders need to consider "principal reduction" in order to keep the housing bubble inflated. Well, the last three words are mine, but the idea that lenders should reduce the principal that borrowers owe on loans is his. His reasoning, I believe, is that pushing rate resets on ARMs off a couple years or simply lowering the interest rate on a mortgage won't be enough to keep the housing bubble from deflating. Statistics are showing that the majority of mortgage defaults are occurring before the rates reset.

In other words, defaults are occurring for two primary reasons. First, there are speculators walking away from homes that failed to increase in value, preventing them from refinancing to pull out more equity to pay the mortgage. Second, there are unfortunate home buyers who were empowered by loose lending standards and inflated valuations from tame estimators to get in over their heads. Which leads us to the principal of moral hazard, and how it applies to the reduction of principal.

People living in a democracy, even a heavily socialized democracy like all of those of the West have become, like to think that bad behavior has it draw-backs. It's accepted by pretty much everybody that gamblers can't expect to come out ahead all the time. If you live in a state with a casino industry, and that industry began to suffer, laying off employees and paying lower taxes because the gamblers were getting tapped out, you wouldn't expect the state government to simply give the gamblers money to keep the casinos going.

But that's exactly what the government is talking about doing when they offer to subsidize or guaranty changes to mortgage terms in order to help out homeowners, by which they really mean to prevent banks from failing. The bail-out is couched in terms of helping American homeowners, but in truth, it's all about helping out the financial industry speculators. Homeowners who got conned into overpaying for houses SHOULD walk away from their mortgages, every additional dollar they spend is throwing good money after bad. And those of us who didn't speculate on housing shouldn't have to foot the bill for the gamblers, but of course, we'll have to in the end. We're already paying through losing our savings to inflation, as the Fed has lowered the interest rate to laughable levels and intends to keep going. Reduction of principal clearly creates a moral hazard for all future financial transactions.