The problem with 2011: Too much debt

By Robert Smith The Daily Record Newswire Overall, 2011 has been a lousy year for investors. Year to date, not a single stock market on the planet is in the plus column. In fact, most global stock markets are in bear-market territory, having fallen more than 20 percent from their respective peaks. And despite what your "financial adviser" is telling you, it doesn't have to get better. Here's why. Even though President Barack Obama and his anti-business minions are certainly making things worse, they are not the root of our economy's problem. The real problem has been, is and continues to be too much debt -- too much debt belonging to individuals, institutions and governments. In hindsight, most of the outsized growth our economy experienced over the last 20 years was predicated on ever increasing levels of debt. The answer to every bump in the road was easier money and more of it. This Fed policy was then exacerbated by a political class that thought it expedient to use the credit markets (specifically Fannie Mae and Freddie Mac) as an extension of the welfare system. After all, isn't everyone "entitled" to own a home? Ask the Occupy Wall Street folks downtown. Inevitably though, debt becomes toxic once it reaches a certain level. Generally, this is considered 80 percent to 100 percent of gross domestic product for governments, 90 percent of GDP for companies and 85 percent of GDP for households. In many advanced economies we have reached or exceeded these levels. Beyond this, additional debt chokes off growth. This may go a long way toward explaining why Ben Bernanke's attempt to re-inflate the great credit bubble via more, cheaper money (QE2 and zero interest rates) is not succeeding. It would also explain why President Obama's deficit spending -- at unprecedented levels -- seems to be having effects exactly opposite of those desired. The only conclusion a reasonable person can come to is that the piper must finally be paid. I believe our economy and others are beginning to reflect this reality by falling back into another downturn exactly as it did in the second phase of the Great Depression. Don't kid yourself: This is a depression. It won't be brought to a quick, easy end by central bankers printing more money or chief executives borrowing and spending more money. Too many people, businesses and governments borrowed too much for too long and can't pay it back. Therefore, the ability of these same governments to forestall further economic contraction is an illusion. I would argue that Fed policy already implies this with its public commitment to a zero interest rate policy through 2013. This tells me that the central bank's policy makers are becoming more pessimistic about how long it the country will need to regain a sound economic footing. Because of this weakness, our capital markets will remain unusually vulnerable to black swan (unanticipated) events. With turbulence both here and abroad, I think the best advice is "to get real." Counter instability and inflation via real assets (property or commodities) rather than paper ones. Until very recently, gold has performed quite well. The problem of course with this and other commodities is that there is neither yield nor earnings. As mentioned in a previous column, ownership of real property can offset this deficiency. Without repeating all the negative news surrounding U.S. home prices, let me observe that when compared to much of Europe, Asia or Latin America, U.S. has remarkably cheap real estate. On a square-foot basis, Florida real estate is selling at one-third the value of property in Budapest or Prague -- and at one-tenth the value of property in London. However, because no one has yet successfully picked the bottom of the housing market, the safest way to play the U.S. real estate game is to start buying income properties in markets that are supported by strong demographic trends. This alternative to low-yielding bonds and volatile stocks can diversify portfolios. Remember: Opportunity doesn't lie only in the realm of stocks and bonds. Warren Buffett invests wherever he sees the greatest potential reward with the least risk. ---------- Robert Smith is president of Peregrine Private Capital Corp. Contact him at (503) 241-4949 or at www.peregrineprivatecapital.com. Published: Thu, Nov 3, 2011