Saturday, September 22, 2007

What if the doom and gloom scenarios come true?

If you're an American and you've read the newspaper, or Web sites, or heard people talking lately, chances are you're aware of the major "doom and gloom" economic themes that have surfaced over the past couple of years, and in many cases, intensified over the past few months.

I would put them into three broad categories, which are all interrelated. The first is the housing market collapse, the second is turmoil in the credit markets affecting the international financial markets, and the third is the decline of the dollar (which many say is caused by the budget deficit).

As I was driving home from Dunkin Donuts on a cool Sunday morning in New York City, I passed a bank and recalled a story I'd read the previous Friday describing an old fashioned "run on the bank" that happened in England last week. I thought to myself "What if all of these dire predictions come true?"

I don't think everything is going to collapse like everyone says it will. The US economy has survived a huge number of similar scares in the past and over time our standard of living has increased, stocks have gone up, and people who have worked hard and had some luck have been able to become successful. I consider myself one of these people. For as much as I feel like I'm priced out of the home buying market, I am fortunate enough to have worked my way through college and grad school and into a relatively high paying job as compared to average salaries thorughout the country as a whole.

However, as a thought exercise, I wondered, if someone knew now that all of these things were going to come to fruition, what could they do in advance of the coming crash?

Problem: The declining value of the US dollar.

Fallout: USD paper money is nearly worthless. As confidence in the dollar declines, it will take more dollars to buy the same amount of goods and stores will raise prices to the extent that it would take a barrel full of them to buy a loaf of bread. The government will print up even more dollars and compound the problem. Your bank accounts and 401(k)s, which are denominated in dollars, are worth nothing. Banks fail and depositors lose their life savings.

What you can do now: Put half of your savings in non-USD denominated accounts and buy gold and other assets that will not depreciate along with the dollar. One place to open up an account denominated in a foreign currency is Everbank. Research the economies of different countries, but if I was going to put money into 3 currencies right now, I would probably pick the Canadian dollar, the Australian dollar, and Japanese yen, with other candidates being the Euro and the New Zealand dollar. Put another portion of your savings into gold. I did an entire post about buying gold that you might want to take a look at.

This Motley Fool article has another suggestion- buying stock in companies whose earnings are denominated in foreign currencies in order to squeeze more gains out of the weakening dollar.

Problem: The rising price of oil.

Fallout: It becomes prohibitively expensive to use oil. You won't be able to heat your house in the winter. You won't be able to afford to drive a car.

What you can do now: Investigate moving to a more temperate climate, such as the southern part of the country, where you won't need heating oil. Start riding your bike to work to strengthen your leg muscles and increase your aerobic capacity. Buy shares in an oil company, oil futures or oil HLDRS, so that when the price of the commodity increases, the value of your holdings also increases. Explore the use of solar power (which looks expensive now, but won't when oil doubles or triples). Maybe give one of these solar showers a shot.

Problem: Falling Housing Prices

Fallout: The value of your home drops. The value of your investment property drops. You don't want to live there anymore, and nobody wants to buy it from you. You can't sell it for enough money to pay off your mortgage.

What you can do now: First of all, let me just say that if you bought a house you couldn't afford, you're dumb. If you're fortunate enough to be able to keep up the payments and just live there, then don't worry about the value of your house declining. If you're not selling or buying something, you don't care about what its value is, you care about the cost of ownership. So, ignore the news about home prices if you like living there and can make your payments.

If you have to sell for some reason, I can't really think of anything special beyond the basic real estate ideas to increase your home's curb appeal and stage it etc...

The other thing you can do now is to carefully evaluate real estate prices and mortgage options BEFORE you buy a house. Don't pay the ridiculous prices. Don't get an adjustable-rate mortgage that can reset to a rate that will be unaffordable for you. Put simply: don't buy something you can't afford.

Those are just some brief thoughts I had. Of course you can also just go the direct route of shorting the dollar, buying oil and gold, buying credit default swaps (if you have enough money- these products are more for institutional investors), and shorting the stocks of home builders and mortgage lenders. I'm sure there are a ton of other options. If you think of any good ones, or disagree with the above feel add comments on this post.

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