Saturday, 12 July 2008

Don't Panic

Every newspaper I read this weekend had 'Don't Panic' in one of its headlines - all referring to the FTSE100 entering Bear Territory last week. Just as in my Friday piece - What if what the economists taught us was wrong? - I suspect that Don't Panic is not that good a piece of advice either. Last autumn, when Northern Rock investors queued around the block to withdraw their savings, they too were accused of panicking. But bluntly I thought they behaved entirely rationally. Indeed, if I'd had a branch account (rather than the internet-only account I had) I'd have queued up with them.

This weekend equity investors (which basically includes everyone with a pension scheme) were told not to panic. Bit late - they really should have started to panic last summer. But is it too late to panic? A reader sent me a very interesting article which quoted a Bridgewater report which estimated that the net worth of US-based assets is down about 13% since January 2007, a total loss of almost $8 trillion or about half of GDP. The conclusion drawn was that the bad news had already been factored into prices. So buying opportunity?

Well, not if you read the rest of the articles in the weekend newspapers which warn of much worse news to come with further stock market falls. If you think 20% is bad, share prices fell 70% in the recession in the 1970s. But please Don't Panic. Clearly, you'd be a mug to liquidate your equity holdings at today's low prices. After all, if they do fall by 70%, all you have to do is wait 20 years to get your money back. (Please note this is irony not financial advice)

Footnote - I got some great responses to my Friday post. I wish you'd let me publish them! One of the best asked "Do you think we'll see an "inter-generational politics of inflation" returning?"

The reader went on to postulate:-

"Grotesquely high house prices were effectively a transfer of wealth from kids, paying rip-off prices to get the proverbial "foot on the ladder", to the older generation sitting on increasingly overvalued houses and who'd had the benefit of seeing the real value of their mortgages wiped out by the inflation of the 1970s. Any youngster who bought an overvalued property towards the end of the "nice decade" (1995-2007) will be asking themselves if the middle-aged people with big mortgage-paid-off houses, who kept telling them to get a "foot on the ladder", were doing so because they wanted more money pumped into the housing market to keep their asset prices artificially inflated .

But ... what if we see a dramatic house-price collapse followed by "Stagflation 2" if the BoE decides that deflation & GDP growth etc matters more than inflation?

Today's kids buying over the next few years will then get the same real-term, one-off property subsidy their parents got more than 30 years ago in the 1970s when their mortgages got wiped out or heavily discounted in real terms. But, of course, today's pensioner parents on fixed incomes lose out badly from inflation (as their parents did in the 1970s). Still they could always sell the house... The kids will feel bad about that suffering. But then they will console themselves with the thought that they are merely meting out the same treatment to their parents' generation that the latter had meted out in turn to their own parents' generation 30 years ago."

As one of the generation which greatly benefited from both high inflation and rising house prices in the 1970s, I can see the point. Although the consequences as I mull over retirement are scary to say the least.

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