Why Are You Sitting in Cash?

The Treasury Department and the Federal Reserve with help from Congress and the White House is making something very, very clear. They are going to devalue the American dollar through the printing of money, maintaining excessively low interest rates and out of control government spending.

If you are sitting on excess cash and that cash is in US Dollars, I feel like you have been warned. Those dollars will be worth substantially less in the future than they are now.

The Federal Reserve has communicated loud and clear they are going to keep interest rates low for an “extended time.” By keeping interest rates artificially low they are trying to recapitalize the financial system, but in the process are punishing savers who are earning little or no interest returns on their money. By keeping interest rates so low, they are actively trying to re-inflate the economy and prices, as they are worried about deflation. They are also keeping interest rates lower than other countries, thereby causing other countries currencies to increase in value.

More importantly, the Federal Reserve is doing something called “Quantitative Easing.” This made up term, means money printing. The Federal Reserve is quite simply buying the new debt that the Treasury Department is issuing. In fact, in the second quarter of this year, the Federal Reserve bought as much as half of all new Treasury Bonds issued. Think about that for a second. The government is buying half of the debt that the government issues. Does that sound absurd?

Treasury bond issuance is up 200% this year as the government posts close to a $1.5 trillion annual deficit. So, here is a dumb question. If the Federal Reserve is buying half of all new Treasury bonds, what happens when they stop? They claim they are going to stop in the first quarter of next year.

I don’t think the Federal Reserve can stop buying. The moment they stop buying interest rates will soar and bond prices will plunge, which will make our debt problem even worse. Money printing will go on for a while, and it will destroy the dollar. In a cynical way it also makes all of us feel better in the short run. We export more in the short run with a cheaper currency, our debts our lower and stocks, real estate and other real things start going up in price. And what better way to pay for all of the government debt, than to devalue that debt?

But in the long run, this is disastrous and it always ends badly. Even worse is to look at the White House and Congress. Beyond the Fed’s money printing, we have out of control spending by Congress. The projected US deficit for 2009 through 2019 is $9 Trillion. Who in the world is going to finance that debt? Where is that money going to come from?

A recent study by Peter Bernholz showed that the 12 largest hyperinflationary episodes in history all reached a tipping point when government expenditures were more than 40% of GDP. Well, the US government is over 40% this year and is projected at 40% next year.

The evidence of massive money printing is already popping up. Look at the price of precious metals, such as gold, which is soaring. Throughout history gold has been a monetary substitute and it becomes very valuable when governments become reckless with money printing and spending.

Better yet, look at the stock market or other commodities. I think we see the clearest evidence of the money the Fed is printing flowing into the markets. The stock market is quite expensive; the economy has been terrible, yet it continues to rise. I think that is why it is quite dangerous to short right now. The market may keep going up simply because there are more dollars floating around out there.

So what is my firm, Sabre Value, doing about the devaluation of the dollar?

We are not standing still while our government destroys the value of our dollars. First, we are fully invested. Stocks should do well, especially on a nominal basis as the dollar falls. Second, we have substantial positions in stocks based in Canada and Australia and benefit as those currencies rise. Third, we own a smattering of energy and resource companies that should do well as those commodities rise in dollar prices. Finally, we think that in an environment of soaring liquidity that our microcap stocks should do exceptionally well, as the liquidity flows down to them. That liquidity should have an outsized effect on smaller equities.

I highly recommend all investors search out alternatives from real estate to stocks, to solid currencies to even precious metals and protect your savings from the falling dollar.

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13 Responses to Why Are You Sitting in Cash?

  1. Alfred the Albino Numbchuck Hurler says:

    If CPI isn’t a problem then they have free reign.

  2. You’re in Australia now, that’s new. Welcome to the Down Under investing club.

    Are you still running a long-short portfolio or have you ditched the short side?

  3. Another question for you, Aaron:

    Isn’t your advice to jump from cash into stocks a little late here? It seems likely to me that the broader market is overvalued (e.g., see Smithers on this recently, citing the Q-Ratio and Shiller’s cyclically-adjusted P/E). Further, it seems likely that when it corrects, the dollar will recover (at least temporarily), as it did last time.

  4. admin says:

    I’m not recommending jumping from cash to stocks. I’m recommending getting out of US dollar cash into anything but the US dollar. That happens to include stocks.

  5. I understand what you mean, Aaron, but your position raises two questions:

    1) Do you think stocks are overvalued now?

    2) If so, when they correct, what do you think will happen to the dollar?

    Last time we had a big correction, the dollar spiked up, as there was a flight to quality. I agree with your longer-term bearishness on the dollar, but I question whether someone who still has cash ought to diversify out of dollars now, as opposed to after the inevitable stock market correction.

  6. admin says:

    I think there are many stocks that are overvalued, but that doesn’t make all stocks a bad investment.

    I also don’t think that the dollar and stocks will stay correlated and at some point they will diverge.

    And like Marc Faber when a correction does come it will be an opportunity to buy stocks not sell them.

    But my point is not to yell buy stocks, but instead to comment on what the market is telling us. And it is telling us there are a flood of dollars and this is bad if you are sitting on a lot of dollars.

  7. Aaron,

    You may be interested in my follow up post on this, including the comment I left yesterday: “A neglected asset class?”.

  8. admin says:

    I read it and completely disagree with Richard Bernstein.

  9. What about Robert Mundel (mentioned in the last comment)?

  10. admin says:

    I basically would follow Marc Faber, John Paulson and David Einhorn and other people who have actively managed money and have a great history as opposed to strategists and academic economists.

    And if the economy double dips, I can guarantee you Stimulus 2.0 will come out of congress and the Fed will only keep stimulating, probably even announcing QE2.

  11. OK. BTW, speaking of Einhorn, did you see this post about my shorting of an Einhorn holding?

  12. admin says:

    I did see it, looks like a nice trade.

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