Interest rates are cut to virtually zero. The Bank of England is printing money. It all adds up to the biggest bubble ever. Get out of cash, before it's too late.
These markets can make even the best and smartest investors in the world look like mugs. If it can do that to the cream of the crop, imagine what it can do to little old me? I currently look like a two-headed, one-eyed zombie, 15-legged monster from Planet Zog.
Even the great Warren Buffett might be feeling a little battered and bruised during these difficult economic times. He's seen his fair share of stock market crashes, like 1973/4 and 1987, but he has never before witnessed a freefall in business activity at such a pace.
In his annual letter to shareholders, Buffett freely admitted to his failures, including buying oil giant ConocoPhillips (NYSE: COP) when the oil price was near its peak. The mistake cost "several billion dollars."
His preferred share investments in Goldman Sachs (NYSE: GS) and General Electric (NYSE: GE) when the common shares in those companies traded at much higher values than they do today, if nothing else have been poorly timed.
The Next Great Bubble
And then there's Buffett's prediction of the next bubble, the US Treasury bond bubble of late 2008, a time when briefly, investors were effectively paying the US Treasury to hold their money. Yes – yields or short-dated US bonds were negative.
Today, the returns are not much better, with 2-year US Treasuries yielding 0.9%, and the 10-years yielding 2.8%. The yields are effectively saying there won't be any meaningful inflation over the next 10-years.
Start The Printing Presses
Here in the UK, with interest rates now at 0.5%, the Bank of England is about to resort to printing money in an attempt to stimulate the economy. They do this by buying gilts, our equivalent to US Treasuries.
On FT.com, here is how Manoj Ladwa, senior trader at ETX Capital, describes the Bank’s strategy, and the potential pitfalls…
"Otherwise known as printing money, quantitative easing will allow banks to borrow more funds from the central bank and so inject funds into the economy and restore the flow of credit.
But it will only work if banks loosen their lending criteria and a measure of business confidence returns. The policy also needs be monitored closely as increased money supply coupled with falling production could lead to demand outstripping supply and hyperinflation."
Look Out Zimbabwe…Here Comes The United Kingdom
The yield on 10-year gilts now stands at 3.4%, again suggesting inflation is not going to rear its ugly head any time soon.
Yet Manoj Ladwa above says printing money may lead to hyperinflation. He is not alone.
Writing about the government and central banking strategies, in his annual letter to shareholders, Warren Buffett said "…one likely consequence is an onslaught of inflation." Buffett’s letter was published a week ago. Nothing much has changed since.
Send More Money
He said the economy will be in shambles throughout 2009 and probably well beyond. No change there. He said that conclusion does not tell us whether the stock market will rise or fall. No change there, except this week, it has chosen to fall rather than rise. He said America's best days lie ahead. No change there.
The gilt and Treasury bubble is in full swing, aided and abetted by central banks, including our own Bank Of England.
The Bank is acutely aware of the dangers of inflation. But first and foremost, they must fight today's battle, and deal with the consequences later. As Bank of England governor Mervyn King said...
"The amount of money is not growing at all, and the economy is in a recession, so we need to increase the supply of money."
A Nice Problem To Have
Doing nothing is not an option. The Bank of England won't be doing nothing for quite some time, especially if the economy starts inflating again. Right now, that would be a nice problem to have.
The Bank no doubt stands ready to stomp on the brake pedal should inflation start accelerating. It can stop printing money. It can rapidly raise interest rates. The government can raise taxes. It doesn't sound too enticing, does it? Believe me, compared to now, it's very enticing.
It's hard to imagine this gilt bubble not bursting. Right now, with the Bank deliberately adding air to the bubble, you can see why people think it won't burst.
Bubbles Go Pop
But that's the thing with bubbles. You don't realise you're in one until it's too late. Take the internet bubble. Those people who said the web would change the world have been proven correct. But those people who bid loss-making companies with questionable business models and low barriers to entry up to the high heavens, lost a fortune when the bubble burst.
The same goes for oil. When it was trading at $147 a barrel, peak oil theorists were having a field day, and with China and other emerging economy's insatiable desire for more and more oil, it didn't feel like a bubble. But a bubble it was, and just six months later, oil was back down below.
This bubble will be no different. It will probably carry on for a little longer, as most bubbles tend to, but burst it will. As Buffett said less than a week ago…
"Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long."
Just Say No
Soon, people will start saying no to 2% savings accounts. They'll look for another place to park their money. Where will they look? Some clues are below.
More on the economy and the markets:
> Our Chief Analyst Maynard Paton is seeing great opportunity amongst the economic and stock market chaos. Check out his very latest share recommendations by taking out a free 30-day trial to The Motley Fool's Champion Shares premium stock picking service. Click here for more details, including his very latest column, Four Shares Beating The Crunch.
> Bruce Jackson does not have an interest in any of the companies mentioned in this article, including Treasuries and gilts. He does have a savings account, for what it is worth.
