Tuesday, March 26, 2013
Fools And Their Money Are Soon Parted
This Cyprus bailout with attendant deposit confiscation for certain depositors appears to be stirring an awakening across the slumbering masses. I am basing that observation merely upon anecdotal evidence at this early juncture. Some here in the U.S. have pointed out that zero percent interest rates for four years straight has been its own form of confiscation, by favouring borrowers over savers. I have made the same point. However, the other major risk arising from zero percent interest rates, is not just underfunded pensions, it's the fact that it has turned many savers into speculators...
The Greater Fool Theory
The lines between investing and speculating are indeed blurred, however, generally an investor intends to hold an asset for the majority of its lifetime and garner the return from the yield of the investment. The speculator by contrast buys an asset intending to sell it at a higher price as quickly as possible. Speculators therefore assume they have better information and are making the acquisition at the lower price while someone else will come along with somewhat less timely information and buy the investment at a higher price. All is well of course in this game of hot potato until someone gets stuck holding the bag when prices inevitably roll over into decline. That is why speculating is considered to be based upon the greater fool theory - the buyer is always assuming that a greater fool will come along and pay a higher price.
Herein lies the problem - Low/zero interest rates have forced many investors to become unwitting speculators. They have been systematically shepherded into higher risk investments by Fed policy and complicit investment advisors who have been drinking the Kool-Aid by the gallon. These higher risk assets are the usual suspects - stocks, junk ("high yield") bonds, Real Estate Trusts etc. However, many other asset classes have been over-inflated in this cycle as well, most notably municipal bonds which have ever-present default risk. Therefore returns garnered for these past several years have not been based on the yield from the investment, they have been based simply upon rising asset values. Again, a strategy that works until it doesn't. More to the point, if you tell me that there is no shortage of fools in this world, I would believe you, the real issue is that there is an ever-dwindling supply of fools with money. Therefore, today's cadre of unwitting speculators have no exit strategy whatsoever - they are the de facto bagholders - they have a plan to buy, but no plan to sell.
There Is No Free Lunch
The bottom line is that Bernankenstein & Company have given savers one of two Faustian choices - protect capital by taking minimal return and face a 100% certain underfunding of their pensions. Alternatively, they can roll the dice by taking more risk than they should prudently take, while assuming that asset values will continue rising indefinitely, even though that scenario has never obtained in the history of mankind. Both strategies have 100% certainty of failing, however, the second scenario has plausible deniability going for it, as in "maybe this time will be different", but of course it brings much higher downside risk.