Entries from April 2009 ↓

In praise of cash

rock

Depositors storm failing UK bank, 2008.

Much digital ink has been spilled here on the issue of money. Where’s it safe? More profoundly, what is it?

Some say gold is the only true currency, since it’s rare, cannot be created, is limited in supply and expensive to find, with a history of human covet bestowing a special worth. Others say money is whatever we call it, and state-produced paper is as good as anything else. It has value because of the economy which is measured in it while providing a way of exchanging labour for goods and services.

Still others ask what’s the difference? Why’s a piece of metal worth more than a piece of paper? And why are we debating such stuff when the things we really need – food, shelter, fuel – are the commodities of indisputable value? Why don’t we covet and hoard that stuff?

Well, actually, a lot of people are – as I have learned in spades with one of my recent ventures.

The fact is, the economy will worsen considerably before it gets better. Unemployment levels will remain sky-high years after the GDP has started to expand again. Real estate is in a long-term, multi-year decline despite the current faux market caused by the unsuspecting being led to slaughter by the uncaring. The US is still falling off a cliff, and current government spending in most countries will lead to the triple wealth-busters of higher rates, higher inflation and higher taxes.

Time, then, to re-evaluate both risk, and where to put what you’ve got. Whatever the bullion bunnies say, the metal will not become the currency of daily life. That will remain dollars. So where are they safe?

Julie writes:

In your book, “After the Crash”, you suggest spreading cash around to various banks if you exceed the CDIC limits.  But you also mention that 2 banks are in trouble (one being the CIBC).  How can one tell which banks are the safer bet?  Are credit unions a safe, viable option?  In Ontario, deposits in credit unions are insured by the provincial government.  What about keeping some savings in on-line banks like ING Direct or PC Financial?  Your comments would be greatly appreciated.

Well, Julie, CDIC insurance covers $100,000 per person per account, roughly speaking. Some provinces have stepped up and declared every dollar of every account in a credit union is protected. Sounds good, of course. But let’s remember that two days before it failed, so did Lehman Brothers.

Each of the Big Five banks has about $15 billion in savings and personal chequing accounts on deposit – money which is supposed to be 100% liquid. You walk in and you have the right to take it out. But those same banks have on average less than $2 billion in cash, which means if there were a run on a bank, nine out of ten people would be SOL.

It also means there isn’t enough money lying around Ottawa (something north of $60 billion) to pay out the difference. And this does not take into account GICs, term deposits or eligible investments in RRSPs. So, the problem is not so much a bank failing (that will not happen, at least in Canada), but rather worried people realizing the insurance is only workable in certain isolated circumstances. It will not protect a nation of bank customers. Ditto for the credit union guarantee.

As for online banks, CDIC insurance applies in the same order of magnitude. But let’s get a grip here. In the event of an emergency, like a terrorist attack, there’s a good chance the electrical grid might be a target. So, no juice, no Internet, no web-based savings account, no withdrawals, no money.

Having said this, you need to keep your money somewhere. Investing it is a good idea in securities which are stable, predictable and generate decent income (believe it or not, there are many). It’s also good to have a reserve on deposit with your neighbourhood bank, along with a credit card and a line of credit equal to that amount. So, if the bank is closed one dark morning, you can still go and buy that Hummer with the gun rack.

Finally, Julie, reread the part of the book that talks about a cash reserve and a home safe. There is a smart way to get cash out of the bank, and a dangerous way. There are things you need to know about safes, and big pitfalls to avoid.

And there’s a great measure of satisfaction knowing, should the times grow more troubled, you have money, not a rock collection.

sheeple-cover-small11

‘Garth who?’ – click here

.

What fire?

burn1

Less than three per cent. Savour it. That’s all keeping us from a depression at the moment.

When an economy contracts by 10%, deflation emerges and unemployment soars, that is about as close as you’ll get to a textbook definition of a 1930s-style meltdown. And our central bank just revealed the economy shrank by an annual rate of 7.3% in the first three months of the year. Way too close for comfort.

This, natch, was why the Bank of Canada rushed to slash interest rates to basically zero this week, and why it now warns that unless you start spending your brains out, it’ll unleash the dogs of liquidity.

This is called ‘quantitative easing’ which actually means the bank starts creating new digital dollars with which it buys up debt like corporate bonds. In the ultimate Ponzi scheme, the state bank uses new national currency which it makes out of thin air to purchase debt securities held by private investors. We, the taxpayers, get to clean it all up later. Or your kids. Whatever.

This will happen, says head banker Mark Carney, if the inflation rate – scheduled to go to almost zero by the end of the year – tips into true deflation. That will cause the floodgates to open, sending a Red River-sized torrent of cash washing over the nation.

But, I hear you asking, what will this mean in Burlington?

Good question. Over to Chad:

I know you’re a very busy man and chances are slim that you’ll get a chance to read or respond to this email.   But good, sound, unbiased real estate advice is hard to come by in these crazy times so it’s worth a shot!  The reason I am emailing you is because I was a Greater Fool….

At the top of the bubble (August of 2008), I put $20 000 cash down on a town house in to be built in the spring of 2010. (that is if the builder survives until then).   I did this all against the advice of a good friend of mine who happens to follow your blog and read your books.  I truly was a greater fool.

I am 31 and my wife and I currently own a condo/townhouse.   We paid $198 000 for it and put the minimum 5% down on it at the time of purchase.   We don’t have any credit card or LOC debt.   My wife still has 2 student loans that we are paying down (she had 5 and we’ve aggressively paid off 3 of them so far) and we’ve got one car payment.   Our combined income is in the $120 000 range.

My concern is this – I bought at the top of the market.   As housing values continue to decline,I’ll have to come up with a mortgage for $300 000 on a house that is now worth $250 000, I am going to have to come up with a hand full of cash.  I also see that even if the bank values the house at $250 000 at the time of my mortgage, if what you are saying, housing values could continue to slide and I’ll be in even more do-do in a few years.

My question is this – should I just walk away from my down payment and chalk it up to a valuable lesson?  I have no interest at this point in sinking more money into the declining real estate market.  I’m much rather live frugally in our small town house and invest in energy and healthy care equities.

I just bought and read After the Crash.   Wow…

Chad, say it ain’t so. You bought a house that isn’t built yet. You put twenty grand in real money on the table. You did this (oh, the horror) in the summer of 08. You live in a home you haven’t sold yet. The new house you bought (which doesn’t exist yet) is now worth less than the mortgage on it which you have not arranged. No bank will give you such a loan.

Not only a fool, Chad, you also managed to screw yourself over six times. Impressive. But at least you have come to the right place for advice. The blog dogs are waiting, all slobber and bravado in their pit.

Choices: (a) Walk, telling the builder the deal is off, and demand your money back. Try to be heard above the laughing. (b) Sit tight and hope the builder loses your name and address. You will never see the $20,000 again, of course. If the guy feels like suing you, he has a case. You will have to hire a litigation lawyer and file a defence. Kiss another five grand goodbye for a retainer. (c) Hire a lawyer now to represent you in negotiating a settlement. Another twenty might do it. (d) Do nothing, roll the dice, hope the guy fails. (e) Move to White Rock and take a new identity.

Yeah, Chad, not an appealing list, but given what the great banker had to say this week, this is no time to be loading up on new debt, no matter how cheap it may be. If you go ahead with the mortgage, be prepared to see payments soar with any renewal in the next few year. Steel yourself for more years of declining values, and pray a greater fool shows up to rescue you from your well-deserved misery.

But at least you came here. I forgive you. Rest your soul.