On 4/2/2018, I predicted that the economy was starting another recession and that stock prices would drop dramatically.  With my own savings, I took almost all of my money out of the stock market and put it (largely) in two places: short term CDs (3-6 months) and gold (the GLD ETF).  (Note that this wasn’t that bad of an investment; though gold has gone down some, the interest from CDs is on par with the change in the stock market between April and now.)  Let’s take a look at what happened.

The chart below shows the price of SPY (an ETF that tracks the S&P 500) for the past year.  The technical indicators are mixed.  If one does a trend line analysis for the past year, the result depends greatly on what data he/she uses.  In the figure below, you see three different trend lines for three different subsets of data (all data, April – October, October – Present).  Let’s try to figure out what’s going on with the stock market, why didn’t we experience a drop in April (like I predicted), and what might happen in the near future.

Firstly, why was I surprised?  Why didn’t we see the stock market crash in April?  I think that this is largely because of the continued extraordinary spending of our Federal Government and the interest rate being kept extremely low by the Federal Reserve.  The federal budget for 2019 will spend approximately $4.4 trillion [1].  We are currently $21.7 trillion in Debt [2] (and paying off the paltry sum of $363 billion per year [3]).  At the same time, corporations received a tax cut of approximately 14% [4], which has led to reduced federal revenue.

So is the blue line the overall trend?  Will we soon see additional significant increases to the stock market?  I don’t think so.  Our economy is facing some incredibly difficult hurdles to overcome.  I think that a reckoning is coming, and any actions to the contrary are only delaying it and making its effect more painful.  We just can’t seem to learn from our past mistakes.

In 2008, our public was in severe debt with sub-prime mortgages (nearly $2 trillion [5]), Alan Greenspan and the federal reserve kept interest rates way too low for way too long [6], the asset-to-debt ratio of banks was far too low, and our federal government was in severe debt.  This, of course, all led to the Great Recession.  We’re in a much worse position now.

Our banks have, once again, committed massive sub-prime lending.  This time, instead of lending money to unqualified people to buy houses, banks have lent $1.1 trillion to  companies that are already burdened with extreme debt [7,8,9].  It’s called leveraged lending.  This is worse than the sub-prime lending on homes; if a debtor defaults on a home loan, the bank recovers the home.  So although much of the value of the home was wiped out, at least the bank got the home!  With leveraged lending, there is no collateral on the loan.  When these companies default, the banks will have to completely wipe off those assets from their balance sheets.  This is similar to the tech bubble bursting in the late 1990s.

(One might ask how this happened.  In 2008, we had the opportunity to let incompetent organizations fails and transfer any assets they held to competent organizations.  Instead, our politicians stupidly bailed out the banks.  And what do incompetent organizations do after winning a political lottery?  They act incompetently. Less than a week after receiving $85 billion in a government bailout, AIG sent its executives on a vacation to a California resort [10].  The incompetence continues today.)

There are now 44.2 million americans with a total student debt of $1.5 trillion [11].  Student debt is particularly rough on the borrowers; one cannot simply bankrupt out of it.  So, whereas the sub-prime borrowers of 2004-2006 could simply leave their homes and deal with 7 years of bad credit, the student borrowers of today will be saddled with this debt until it is paid off or they die (whichever comes first).  Currently, approximately 28% of students are defaulting on their debt [12]; this rate is expected to rise to approximately 40%.  It should be noted that defaulting on the debt permits interest to accrue, so the debtor is saddled with additional debt if he/she defaults.

We are in home mortgage debt nearly the same amount that we were at its peak in 2008 [12.1].  Thankfully, banks are not issuing sub-prime loans.  Unfortunately, our government has taken up the task of doing so.  As of 2016, non-bank lenders have issued approximately half of home mortgages [12.2].  Notably, these loans are not backed at all by savings accounts (since they’re not issued by banks).  75% of these mortgages are insured by the Federal Housing Authority and the Veteran’s Affairs [12.3].  The US consumer currently has approximately $8.8 trillion of mortgage debt [12.4], about half of which is loaned to sub-prime lenders through non-banks.

The US consumer now has a record level of credit card debt: $1 trillion [13].  This debt generally has a high interest rate, so it is especially difficult on the borrower.  The current default rate on credit card debt is approximately 2% [14].

The US consumer has borrowed approximately $1.1 trillion to purchase automobiles.  And would you believe it, much of the lending has been sub-prime lending!  Approximately 30% of the total loaned has been to sub-prime borrowers [15].  Like the home loans of the Great Recession, these loans are packaged and sold to other borrowers.  The current default rate on auto loans has been increasing since 2015, and is approximately 14% (almost entirely due to sub-prime borrowers).

The federal government does, of course, have the ability to change the economy: it can spend money and lend more.  How much room does the Federal government have to smooth over a financial downturn?  Due to the actions of the past, not much.

The interest rate of the Federal Reserve is currently approximately 2.25% [16].  That’s the total amount that it can reduce interest rate in order to create borrowing and stimulate the economy.  There are, of course, consequences to reducing the interest rate.  Primarily, if the interest rate reduces, then there is less incentive for American savers to keep their savings in the bank.  With less incentive, the saver may seek other investments.  With less money in banks, there will be much less money in the economy: for every dollar that an investor takes out of the bank approximately $10 is taken out of the economy (a bank must retain approximately $1 for every $10 that it lends out).  So reducing interest rates takes a significant amount out of the economy.

Separately, the Federal Reserve has two priorities: maintain the value of the dollar and smooth over the economy.  Its main priority is to maintain the value of the dollar.  And the Federal Reserve has finally acknowledged that the US dollar is experiencing inflation (something that I realized over a year ago).  Additionally, the IRS has announced that inflation is much higher that previously acknowledged and is reducing the standard deduction to take more of our money to compensate [17].  In order to prevent stagflation (simultaneous rising of unemployment and inflation), the Federal Reserve will be forced to keep interest rates high and/or increase them in spite of a bad economy.

Another trick that our federal government can do is spend money to stimulate the economy (according to Keynesian theory).  (One question is wether or not this is actually beneficial for our economy; Keynes assumed “sticky prices” in order for his theory to be valid, and it is unclear whether this assumption will be valid in our near future.  But we will leave this question for others to ponder and operate under the very questionable premise that Keynesian theory will hold.)  Can our government spend our way out of the upcoming downturn?  No; it cannot.

The federal government is currently saddled with $21.7 trillion in actual debt.  This is an average debt of approximately $178,000 per US taxpayer.  (This is triple nearly the level of debt per person that Greece had when its government went bankrupt.)  The federal government has additional debt of approximately $115 trillion in debt in unfunded liabilities (mostly debt in Social Security and Medicare).  Furthermore, the standard currency in much of the world is the US dollar (a fiat currency).  That is, people have sent the US goods in exchange for dollars based on the understanding that those dollars would be worth something later.  This is effectively a loan made by foreigners to the United States.  If foreigners decide that they’d much rather have another fiat currency or non-fiat currency than US dollars, then that debt will also come due.  This would happen if (for example) people expect a large reduction in the value of the dollar because the US government continues to spend at the stupid rates its been spending.

With our current level of debt, the interest on our debt will soon be the largest expense of the federal government [18], and will soon be larger than 100% of our GDP.  That’s with the interest rates that come with the unreasonably high credit rating of AAA [19].  Should  the credit rating drop, the interest payments on the US debt will immediately increase.  And what would make the credit rating drop?  Increased government spending!  So, even if the government does make the decision of trying spend our way out of the next recession, much of that spending will immediately go to interest on debt (and not towards stimulating the economy).

So the Fed cannot lend our way out of this mess, and our government can’t spend its way out of this mess.  (They, of course, never could.)  Have we started to see some downturns in our economy beyond the recent drop in stock market prices?  We have.  There are 4% fewer home mortgage insurances issued this year than there were last year [20] and total mortgage applications fell approximately 5% [21].  Fannie Mae, (a housing lender bailed out by the Federal Government six years ago) just required more taxpayer bailout money [22].  Pacific Gas and Electric (the massive Utilities company) will soon receive a bailout from the California state government [23].  It looks like Italy will soon be bankrupt, and Germany’s economy (the only strong economy giving value to the Euro currency) just reduced in size [24].  Iran has selected the Euro as its international currency rather than the dollar [24.0].  Apple stock (AAPL), the super safe investment which typically only goes up, has taken a huge hit recently with their announcement that they will no longer report iPhone sales and are becoming a service company [24.1]; their iPhone sales growth was 0% this year.  Trump has imposed tariffs; and though I think that this is the only moral action to take that jives with minimum wage, it will put additional pressure on the economy [25].  Current household debt is at a record high at $13.5 trillion.  Germany has retrieved its gold out of the Federal Reserve [25.1].  Consumer confidence in the economy has taken a sharp downturn [26].  And company after company is reporting disappointing earnings.

I’m doubling down on my prediction; I think this is the start of a major downturn in our economy.  Unlike before, though, our government doesn’t have the same capability to prop up stock prices.  If it tries, I think that will delay the pain and make it worse.  It’s time to pay the piper.

Facing all of this, how should one invest?  I’ll give you my opinion.  Let me start by saying, though, that I am not a certified financial planner.  I have no official qualifications that state you should follow my advice.  And even I’m not sure I’m right.

I’ve taken almost all of my money out of the stock market.  Much of my money is now in short term CDs; I like short term CDs so that I can transfer the money from lower interest rate CDs to higher interest rate CDs as they mature.  CDs, though, don’t keep up with inflation.  To compensate for inflation, I’ve put large amounts of money in gold (I’ve purchased a small amount of the mineral, but mostly I’ve invested in GLD).  Between the two, I have some guaranteed income from CDs (in case the price of gold continues to drop for reasons I don’t understand) and I compensate for inflation.  Those are my main investments; outside of that, I have some riskier investments.  I put a significant (for me) amount of money in Tesla a year ago, and that has done amazingly well.  I sold it a few weeks ago; I’m hoping it goes down to about $280, at which point I’ll buy it back.  My gains from Tesla in cash waiting to buy back my stock.  (I’m really not sure this is a good idea.  I think Tesla will multiply by 10 or 100 in the next 20 years, and I’m afraid I’ll miss out on it.  If it stays at $350 for too long, I might just buy some back at that price and again be happy every time I see Tesla on the road.  Right now, they’re just a reminder that I still don’t own Tesla.)  I’ve also put a small amount of money into MJ, a fund that purchases marijuana stocks.  Marijuana is becoming more legal in more places with each month.  And if there’s a downturn in the economy, I think that the drug will be consumed in higher and higher amounts.  (I’d like to note that I don’t do drugs, have never smoked marijuana, and encourage everyone to stay away from drugs.  I don’t think it helps life in any way.)  I’ve purchased a small amount of NAC; a mutual fund that invests in California municipal bonds that are both federal and state tax free.  The fund has generated approximately 6% interest annually (which is like 10% before taxes).  And since the money is being loaned to a government, those governments can increase taxes and make the public pay for their stupid decisions of the past.  (Sometimes municipalities do go bankrupt, though, so this is a risky investment due to the financial incompetence of our municipal officials.)  Finally, I’ve purchased a small amount of CVS.  The purchase of Aetna by CVS  has recently been approved, and CVS will work to increase efficiency (and reduce costs) in the medical system.  For example, CVS will soon perform dialysis for all Aetna customers that require it [26.1].  I think this will increase the number of Aetna customers and increase the profits of CVS.  (But even if it doesn’t, I think it’s a good thing for the world and I’m proud to be a small part of it.)  I’m currently looking for a way to purchase Credit Default Swaps on leveraged loans; if someone knows how, please inform me.  In case I’m wrong, and the stock market continues to go up, I’ve invested in Innovator Funds [27]; these funds buffer any downfall and cap any rise.  So, if I’m wrong and the economy is actually performing well, then I will capitalize on some of that increase.  (If someone thinks this is what’s going to happen, could you please explain it to me?  I have no idea why people aren’t selling all their stocks right now.)

If you don’t have savings, have been working diligently to fund Social Security, and are living paycheck to paycheck, I’m afraid you’re in for a very bad time.  My advice is to get a job with tenure and hope you make tenure before the upcoming collapse.  In the future, you might consider a vote for Libertarians and hope for the return of the gold standard so that your savings can’t be taken away from you through inflation and bailouts.

[1]  https://www.thebalance.com/current-u-s-federal-government-spending-3305763

[2]  http://www.usdebtclock.org/

[3]  https://www.thebalance.com/u-s-federal-budget-breakdown-3305789

[4]  https://taxfoundation.org/us-corporate-income-tax-more-competitive/

[5]  https://www.forbes.com/sites/stevedenning/2011/11/22/5086/#30d1e3e9f92f

[6]  https://www.rollingstone.com/politics/politics-news/how-alan-greenspan-helped-wreck-the-economy-231162/

[7]  https://www.foxbusiness.com/economy/elizabeth-warren-leveraged-lending-is-us-economys-ticking-time-bomb

[8]  https://qz.com/1465460/the-risky-leveraged-loan-market-is-scaring-the-imf-janet-yellen-and-others/

[9]  https://www.forbes.com/sites/pedrodacosta/2018/11/15/imf-issues-stark-warning-on-leveraged-loans-speculative-excesses-approaching-a-threatening-level/#58f7512a1556

[10]  https://abcnews.go.com/Blotter/story?id=5973452&page=1

[11]  https://www.forbes.com/sites/zackfriedman/2018/06/13/student-loan-debt-statistics-2018/

[12]  https://www.brookings.edu/research/the-looming-student-loan-default-crisis-is-worse-than-we-thought/

[12.1]  https://www.marketplace.org/2018/02/13/economy/divided-decade/fed-uneven-housing-recovery-great-recession

[12.2]  https://money.cnn.com/2018/03/08/news/economy/housing-economics-nonbank-lenders-brookings/index.html

[12.3]  https://www.brookings.edu/bpea-articles/liquidity-crises-in-the-mortgage-market/

[12.4]  https://www.marketplace.org/2018/02/13/economy/divided-decade/fed-uneven-housing-recovery-great-recession

[13]  https://abcnews.go.com/Business/credit-card-debt-surpasses-trillion-us-time/story?id=53608548

[14  https://www.transunion.com/blog/consumer-credit-balance-and-delinquency-rates-2018-predictions

[15]  https://www.kansascityfed.org/en/publications/research/mb/articles/2018/auto-loan-delinquency-rates-rising

[16]  https://www.bbc.com/news/business-45657009

[17]  https://www.accountingtoday.com/news/irs-inflation-adjustments-will-diminish-tax-cuts

[18]  https://money.cnn.com/2018/03/15/news/economy/interest-on-the-debt/index.html

[19]  https://www.marketwatch.com/story/fitch-says-rising-budget-deficits-could-call-uss-credit-rating-into-question-2018-04-05

[20]  https://www.nationalmortgagenews.com/news/fewer-mortgages-were-originated-with-pmi-in-2017

[21]  https://www.cnbc.com/2018/06/26/weekly-mortgage-applications-fall-sharply-as-potentialhome-buyers-dro.html

[22]  https://money.cnn.com/2018/02/14/news/companies/fannie-mae-bailout-tax-cut/index.html?iid=EL

[23]  https://www.sfchronicle.com/california-wildfires/article/California-regulator-lays-groundwork-for-PG-E-13397247.php

[24.0]  https://www.reuters.com/article/us-iran-currency-euro/iran-switches-from-dollar-to-euro-for-official-reporting-currency-idUSKBN1HP25W

[24]  https://www.washingtonpost.com/business/brexit-italy-trade-risks-piling-up-for-europes-economy/2018/11/16/e6890a9a-e9a3-11e8-8449-1ff263609a31_story.html?noredirect=on&utm_term=.74f2515b6a38

[24.1]  https://www.businessinsider.com/apple-will-no-longer-report-iphone-sales-unit-numbers-2018-11

[25]  Navarro, P. Death by China – A Global Call To Action

[25.1]  https://www.cnbc.com/2017/02/14/germany-has-got-its-gold-back–they-must-know-something-we-dont.html

[26]  https://data.oecd.org/leadind/consumer-confidence-index-cci.htm

[26.1]  https://www.fiercebiotech.com/medtech/cvs-develops-medical-device-to-corner-home-dialysis-market

[27]  http://www.innovatoretfs.com/etf/?ticker=poct