Topic: Economics
The Quest to Save America Our problems, what's in Danger, and what can be affected.by Jeff Peters
(conservative)
Monday, September 15, 2008
Warren Buffet's methodology of choosing common stocks involves one of several principles: there will be a point in time when every company must return to a stock value such that it reflects its true intrinsic value.
In a time of managerial testing that demands all energy from all firms in Wall Street, it seems inevitable that the stock value of these companies must reflect their true intrinsic value. The problem is that some of these companies have intrinsic values close to zero - we can see that the market is weeding out these firms as we speak.
Now, every man and woman in America have put in place a new mental guard, aimed at controlling the impulses that put future incomes and comfort at risk; all probably too late. How far can this go? What is next? Who will be affected by this Irrational Exuberance once accommodated by Wall Street?
There may be a simple answer to that question. If we remember possibly the only useful tool in macroeconomics, the circular flow diagram of income and production, we remember that savings and securities investment flows into the financial system. That money then makes its way into firms that will use that flow of capital for investment and expansion. As any reasonable person would conclude, the financial system is the heart of growth in any country.
Let's garnish this network of economic systems with today's problems. Many households defaulted on sub-prime mortgages that are putting mortgage institutions in a hot seat. This develops into an issue for investment banks that traded and sold securities, backed by these junk-bond-like mortgages, to their clients. Now investment banks that heavily invested in these securities are falling apart.
The result is only a declining confidence, which places our financial system at risk. If people don't pump money into the very institutions that serve as trading centers for securities in the private and public sectors, then they will collapse. We are currently seeing Lehman Brothers and possibly Goldman Sachs on life support.
If these companies collapse, everyday Americans will lose their pension funds, mutual funds, and the various forms of security derivatives their future depends on. This collapse will then fall into the commercial banking sector.
The companies that use your money as loans to pay for all sorts of management issues may not be able to pay back - just as Lehman Brothers has filed bankruptcy. This will cause banks to lose your money, and that may create another bank-run, just like the beginning of the Great Depression.
Milton Friedman, along with several other economists, concluded that the Great Depression resulted from a lack of dispatch of liquidity from the Federal Reserve. Ben Bernanke, whom many call a student of the Great Depression, will seek to cure his inherited problem by doing just the opposite - making available to the financial community the dollars necessary to remain alive, as opposed to stable. Depending on whether Bernanke perceives our current situation as an emulation of the Great Depression or the Stagflation era of the 70's, he will decide to keep interest rates low to evade a situation like the former, but will raise interest rates to avoid the latter.
The Great Depression dealt with a banking crisis similar to the one we are dealing with today. If this situation has a closer fit to today, then interest rates will remain low. To be honest, a collapse of the financial system is much worse than Carter's stagflation. With no financial system, and no flow of capital, there will be no growth - just like in the third world.
But expect one thing to happen as a result of this liquidity expansion: inflation and thus prices will continue to rise. To avert this problem, take your savings and exchange those 20% cotton sheets of paper for commodities with stable values.
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The views expressed in this
article are those of Jeff Peters only and do not represent
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