Sustainable Wealth E-Book

Axel Merk

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 460

Veröffentlichungsjahr: 2009

Beschreibung

A personal finance guide for today's turbulent world Sustainable Wealth empowers you to achieve your financial goals by unleashing the shackles of debt, no matter how uncertain the future may be. Filled with in-depth insights and practical advice, this reliable resource illustrates how you can predict economic booms and busts before they happen, adapt to changing markets and plan for lasting financial stability. Over the course of his career, Axel Merk has been at the forefront of identifying major trends, a leader in the public policy debate on how to fix the economy, and guide for investors looking to navigate the global credit crisis. With this new book, Merk puts your financial decisions in a global context and shows how factors ranging from the Federal Reserve and Congress to trends in Asia and Europe influence your financial well-being. * Coaches you how to recognize major economic trends before they happen * Puts forth a plan to help you cope with expenses and save for retirement, while building a legacy of wealth, not a mountain of debt * Reveals why "staying the course" when governments or markets change the rules may be hazardous to your wealth As investors struggle to adapt to the new financial landscape, Sustainable Wealth provides straightforward answers to the tough financial questions we face-and the tools to achieve a financially sustainable lifestyle.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Foreword

Preface

Introduction

Achieving Excellence as a Financial Pilot

What Is Sustainable Wealth?

A Volatile World of Debt, Consumption, and Temptation

Unintended Consequences

The Flight You’re About to Embark On . . .

PART I - A WORLD OF TEMPTATIONS

CHAPTER 1 - The Temptation of Credit

The Relationship Between Credit and Debt

Credit as Money

The Power (and Un-Power) of Central Banks

Sizing the Debt Problem

A Crisis in Confidence

Credit Crisis Consequences

A Bond Market Bubble?

Credit as a Threat to Sustainable Wealth

Credit as Fuel for Other Temptations

Using Credit Wisely

CHAPTER 2 - The Temptation of Consumption

The Consumption Paradigm

The Cost of a Consumption Economy

Long-Term Consequences

Unwinding the Consumption Bubble

What This All Means for You

CHAPTER 3 - The Temptation of Policy Change

The Boom/Bust Cycle: Can You Fool Mother Nature?

Goldilocks Intended

Above and Beyond: The Fed Ventures Into Fiscal Policy

More Bad Medicine for Boom/Bust Cycles

Regulation and Taxes: Consistency Is the Best Policy

Long-Term Policy Consequences

Policy, Complacency, and Sustainable Wealth

CHAPTER 4 - The Temptation of Complacency

Big Hat, No Cattle

Complacency’s Counterparty—Risk

The Complacency of Business Legacy

Trust Must Be Earned Every Day

Live Free or Die

PART II - ACHIEVING SUSTAINABLE WEALTH

CHAPTER 5 - Challenging Conventional Wisdom

Recognize Your Responsibility

Should You Use an Adviser?

The Proactivity of Sustainable Wealth

Low-Probability, High-Risk Events

Adaptive Investing, Rather Than Staying the Course

The Sustainable Wealth Lifestyle

CHAPTER 6 - Saving and Spending in a Volatile World

The Sustainable Wealth Grid

Become a Scenario Planner

Sustainable Wealth: A Store of Value

The Individual Wealth Cycle Model

The Importance of Pay As You Go

Getting a Handle on Expenses

How to Spend Less Than You Earn

Make the Important Standard-of-Living Decisions

Sustainable Wealth in a Volatile World

CHAPTER 7 - Crisis Investing

Signs of Crisis

Hope Is Not a Strategy

About Insurance

There’s No Such Thing as a Safe Asset

Finding a Place to Hide: Depression Investing

How to Invest in a Bust

Toward Sustainable Wealth

CHAPTER 8 - Profiting in a Volatile World

Diversification

Scenario-Based Investing

Investing in the Future

Stock Investing: Investing for Value

Diversification with Real Estate and Land

Diversification into Alternative Investments

Profit Opportunities in an Uncertain World

When to Sell

How to Invest in a Boom

Toward a Sustainable Wealth Investing Model

CHAPTER 9 - Sustainable Investing

The Power of Compounding

Doing Investing Right

A Golden College Savings Plan

Taking Risks Without Jeopardizing Sustainable Wealth

Purpose-Driven Investing

Sustainable Investing and the Sustainable Wealth Lifestyle

CHAPTER 10 - The Pursuit of Sustainable Wealth and Happiness

The Rewards of Living Within Your Means

Sustainable Work-Life Balance

Leaving a Legacy: Sustainable Giving

Sustaining Wealth Spans Generations

Surgeon General’s Warning: Sustainable Wealth May Be Addictive

Final Thoughts

Resources

About the Author

Index

Copyright © 2010 by Axel Merk. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a qualified professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. This book reflects the opinion of the author as of the time of writing. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any investment security, nor constitute specific investment advice.

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Library of Congress Cataloging-in-Publication Data:

Merk, Axel.

Sustainable wealth : achieve financial security in a volatile world of debt and consumption / Axel Merk.

p. cm.

Includes index.

eISBN : 978-0-470-56437-0

1. Finance, Personal—United States. 2. Financial security—United

States. I. Title.

HG179.M4318 2010

332.024--dc22 2009023151

To my children: Felix, Helena, Katarina, and Lina

Foreword

SustainableWealth is a timely guide for investors, full of common sense and packed with useful information. There is financial heartbreak today. Few of us have come through the financial crisis completely intact. Many have lost their homes, their retirement savings, and their jobs.

We need to remind ourselves how we have managed to lose so much so quickly. Too many of us yielded to the temptation to consume too much and to borrow too much. Some may still have their flat panel televisions and fancy cars but no house and no garage to put them in. It did not have to happen this way. Sensible investing, creating sustainable wealth, would have protected investors even in the face of the financial crisis. And if many more had followed sustainable investment policies, the boom and subsequent bust would never have occurred.

We are, however, where we are. The same practices that would have protected investors from getting carried away during the boom can help us to prosper as the economy recovers from the bust. Consuming and investing wisely now can build sustainable wealth for the future.

The investment climate today is difficult and full of uncertainty. Merk emphasizes that the Federal Reserve’s massive credit creation and the federal government’s massive debt creation risk an unhappy future of inflation and dollar depreciation. Whether these problems will occur is not yet clear, but the risk is there. Merk explains these risks and how investors can track the likelihood that they will dominate economic outcomes in coming years.

One thing is clear. Investors who believe that the near future will be like the present may make terrible mistakes. Booms aren’t sustainable; but busts do not last forever, either. The natural state of the U.S. economy is growth, and growth will come. The entrepreneurial environment in the United States is unparalleled in the world.

Be cautious, diversify across asset classes and regions of the world, but do not bet against the ability of the U.S. economy to adjust and thrive. Axel Merk’s book will help you.

April 2009

WILLIAM POOLE Former Chief Executive, Federal Reserve Bank of St. Louis

Preface

In a world where the rules of the game seem to change every day; in a world where policymakers throw trillions at problems; in a world that may become increasingly more volatile—how do you save? How do you invest? How do you plan for retirement? And how do you sleep at night without worrying what may happen tomorrow to your investment portfolio? To your wealth?

Sustainable Wealth seeks to empower you to achieve your financial goals, no matter how uncertain the future may be. In the first part of the book, I discuss the world we live in, the dynamics that drive this world, and the ways they may affect your finances. I focus on the temptations of our society: credit, consumption, policy change, and complacency. Once you have read the first part, you will no longer be at the mercy of pundits when interpreting the news, but will be able to put your financial decisions in both a personal and a global context.

In the second part of the book, you will apply these lessons to your personal finances. I start out by challenging conventional wisdom before illustrating how to save and spend in a volatile world. Sustainable Wealth goes beyond that and shows you how to invest when either you or the economy at large is faced with a crisis; are you prepared to stick to your college savings or retirement plan?

Sustainable Wealth is about learning a lifestyle. Once you are equipped with an understanding of what drives this world and know how to position yourself in times of turmoil, you are in good shape to reap the benefits of sustainable investing, sustainable wealth, and—as pointed out in the final chapter—the pursuit of happiness.

Sustainable Wealth is not a get-rich-quick guide; call it a “get-rich-slowly” guide, if you will. If you like to see the forest rather than be overwhelmed by the trees, Sustainable Wealth is for you. Once you look through the turmoil of the day, focus on your priorities, and take one step at a time, you have everything you need to get to where you want to be. When you have finished reading, Sustainable Wealth should become second nature to you. Indeed, if you get the feeling that many of the values discussed are values your grand-mother abided by, that’s no coincidence; it’s because achieving financial security isn’t rocket science. You can do it, but you need the courage to tackle your challenges and untangle a confusing and confused world.

Join me and become a wealth sustainer. It’s an adventure like no other you’ve pursued. You and your loved ones are worth it.

INTRODUCTION

Financial stocks led a broad move down in the market on the heelsof Geithner’s unveiling of the Treasury’s bank-rescue plan andSenate passage of the stimulus measure. The Dow Jones IndustrialAverage dropped by roughly 350 points, or 4.2%, reaching its worstlevels of the day in mid-afternoon trading. Bank of America andCitigroup experienced double-digit percentage losses.

—The Wall Street Journal market alert, February 10, 2009

I bet that if you had heard this on the radio today, it would have raised your heart rate, however briefly. Thoughts would probably flash through your mind about your money, your financial security, your long-term financial future. Uncomfortable thoughts. What should I do next? Should I do anything at all?

“Fly the airplane!” is what pilots are trained to do in times of crisis. You may remember “Miracle on the Hudson” pilot Chesley Sullenberger, who saved the lives of 154 people when he made an emergency landing on the Hudson River in New York City when both engines lost thrust after hitting a flock of geese. Decades of training helped him prepare to make this appear as a safe landing.

What does flying an airplane have to do with financial headlines? A lot, actually. In today’s financial world, the smooth air has virtually disappeared. As we exit the first decade of the 21st century, financial turbulence is everywhere. When turbulence hits, investor preparation should start months, if not years, earlier than the day the markets plunge. And when an unexpected crisis hits out of the blue, keeping one’s priorities straight is key.

“Staying the course,” as many in the financial community preach, is not the answer—neither is a hyperactive re-juggling of investments. Sustainable wealth is about earning, keeping, growing your nest egg; it’s about reaching your goals and being able to leave a legacy. Building and achieving sustainable wealth is a steady lifestyle that will test your endurance from time to time; it is not a trade. I am speaking as a professional investor and active private pilot.

Whether or not you fly airplanes, you’re looking for smooth air, too—that is, financial smooth air. How do you find smooth air, altitude, and airspeed for your finances? For your wealth? How do you ensure your retirement, your kids’ college tuition, your flexibility to start a business, quit a job, or enjoy the fruits of your labor as you please? How do you leave a legacy of financial security and wealth—rather than debt—to your loved ones, when Wall Street is bouncing your economic Cessna?

That’s what this book is about. It’s about achieving sustainable wealth—that is, financial well-being in a turbulent, debt-ridden, temptation-ridden world so that you can sleep well at night.

Achieving Excellence as a Financial Pilot

A good pilot responds calmly yet effectively to any change in flying conditions. A better pilot anticipates them and adjusts in advance. In that spirit, I’m going to brag a little, and tell you that I predicted the 1999-2000 tech bubble and the 2008-2009 credit crisis early.

Now, my point isn’t really to brag. It’s to tell you that if you keep a close eye on the conditions and airspace ahead of you, you can predict the turbulence, too. You can avoid it or adjust to it, and as a result, you, too, can achieve sustainable wealth.

Why is it important to achieve and maintain sustainable wealth? Well, you’re the manager, leader, chaperone, director, steward—as well as the pilot—of your own finances. You are—and I’ll say this over and over—in charge of your own financial destiny; you are the pilot in command; the buck stops with you. You make a lot of financial decisions—what to buy, what to save, what to invest, what you leave as a legacy to your loved ones. Financial decisions are not made all the time, nor every day; in some cases, they are made only once a year. By all means, you may enlist the help of a trusted financial adviser, but you must be involved; you cannot outsource your financial well-being and hope for the best. Hope won’t prepare you for the rough realities of inflation, taxes, bubbles, and crises; only understanding the world in which we live and preparing for your needs will hold you in good stead.

Very few individuals or professional money managers saw the credit crisis coming. While some predicted a slowdown and others predicted a correction, few foresaw a 40 percent drop in stock prices in 2008, the loss of almost half of the dollar’s value against the euro from 2000 to the spring of 2008, the collapse in real estate prices, a threefold swing in oil prices, a freeze of the credit markets, and an unquantifiable drop in the mood and outlook of almost every living and breathing soul with any sort of investible worth. The more you had invested, the more you lost.

So what went wrong?

Somewhere along the way, we lost touch with the reality that we invest and put capital at risk because we see opportunity and value. Here’s the problem: People took an overly myopic, hubristic view of each egg in their nest. In other words, once investors owned something, they tended to believe it would appreciate in value even if that belief was not rational. Pundits proclaimed a Goldilocks economy, and we all enjoyed the ride. In a bull market, we tend to feel very smart. Investors assumed the big picture was okay, that real estate prices would go on forever, that inflation would stay steady, that the money made by lending into the real estate and corporate markets was “good” money and would produce the desired economic results, and that everyone would continue to buy U.S. debt to make this all happen.

Few people challenged the conventional wisdom. However, the big picture was not okay, and few looked closely enough to realize that. It’s sort of like an astronomer trying to explain the universe by looking only at the stars or planets, while ignoring gravitational and other forces governing their movements. They do get a good look at the star or planet, but they can’t explain the universe or predict that a comet may hit the earth sometime in the future. Note, however, you neither need to be an astronomer nor a rocket scientist to make sense of this world.

What do I mean? Bringing this discussion back to Earth, I mean that people lost sight of the larger forces that make economies run. They lost sight of the system. More precisely, they failed to take into account larger forces such as credit, interest rates, consumption, trade, and government policy, as well as even more abstract forces like perceptions and complacencies that shape boom/bust cycles and, more generally, how the economic planets align.

That’s where Sustainable Wealth: Achieve Financial Security in a Volatile World of Debt and Consumption comes in.

What Is Sustainable Wealth?

First, let’s talk about wealth for a moment. You’ve probably seen a definition similar to the following: Wealth is what you own, less what you owe. It’s what you have, less your debts. It’s your net worth. It is cash or other assets that you can use, as you please, now or later.

And that “later” part is important. Many people have high incomes and can afford a lot, so they spend a lot. But are they prepared for the next unexpected expense? College education? Health crisis? The next chance to buy some shares, or some real estate, or a car, cheap? Are they prepared for retirement? In a surprising number of cases—no. They haven’t built wealth—that is, the untapped potential to purchase what they want, when they want it. Conversely, there are those with modest incomes who seem to be able to afford all they need, have no or little or no debt, and have ample savings to retire on.

However, many Americans have gone the other way. If you own a house with a large mortgage, you don’t actually own the house; the bank does. You have debt, not wealth. In fact, with real estate prices down and high mortgages, many people have negative net worth. And it’s not just Americans as individuals. Indeed, one of my biggest concerns is that the finances of the country are on the road to financial peril; we’ll get into that, too. However, I don’t just lament the ills of society. This book aims to provide a path to build sustainable wealth in the world we live in.

Sustainable Wealth is hardly the first book on this subject of wealth; it is a favorite topic for book authors and publishers. The bookshelves are lined with titles about building wealth, either by earning more income, spending more wisely, or investing successfully, or some combination of all of the above. They offer relatively simple formulas—build a budget, manage your debt, invest your 401(k), find the best stocks or real estate or funds or, lately, fixed income investments to buy.

Pick up one of these books and you’ll come across great ideas from time to time. But those ideas tend to work only until the next economic crisis is upon us. We’ve seen it before—in the late 1990s, we saw book after book about day trading and buying technology stocks—then came the dot.com bust. Then, in 2005-2006, out came the books about “flipping” houses—then came the real estate bust. Not surprisingly, today’s real estate shelf is filling with titles about buying foreclosures and profiting from the credit crisis.

So what’s missing? Two things, really. First, most of these books take aim at quick fixes—how to get ahead and make more money now. Sustainable Wealth is about lifestyle choices, how to have more wealth 10, 20, or 30 years down the road. Second, these books live in the micro world; they deal with specific asset classes, or “planets”—stocks, real estate assets; and how to blend these assets into a portfolio. Little to nothing is made of the global economic “universe” in which these investments exist. Who cares if an investment earns 5 percent if the economic universe is poised to bring a 6 percent inflation rate that will sap the value from your investment, not to mention the taxes one has to pay on the “gains”?

So, then, what is sustainable wealth? I didn’t invent the term; it is attributed to Elizabeth M. Parker, who defined sustainable wealth as “meeting the individual’s personal, social, and environmental needs without compromising the ability of future generations to meet their own needs.” The “meeting needs” part is clear and straightforward, and is in fact the subject addressed in most other books on the financial bookshelf.

What’s often overlooked is the second part of the definition, the “without compromising” part. This is very interesting, for it implies that sustainable wealth is not only about us being able to meet our own future needs, but those of our loved ones and of future generations as a whole. In short, I believe we can do better than parting this world with a reverse mortgage, leaving zero equity in a home.

My purpose is not just to coin a term; instead it’s to give you a recipe for creating, maintaining, and sustaining your financial well-being and, ultimately, your peace of mind. Any recipe that does this should endure even in a difficult economic environment.

Sustainable wealth is about understanding how the greater economic universe works, how it will affect your finances, and how to manage those finances to provide a sustained, comfortable future. It is about managing your financial “planets” within the known forces of the economic universe—the little picture inside the big picture. This “space” is where few personal finance books have gone before.

Ultimately, too many have become slaves of their finances rather than masters of them. There’s a saying that those who understand interest earn it; those who don’t pay it. I will show you that with good common sense and some insights into what makes the world tick the way it does, you, too, can achieve sustainable wealth.

Many individuals have gone down the wrong path, sacrificing too much of the future for the present or disregarding their future altogether. But there’s a greater issue here, one you’ve probably already heard about: As a nation we’re mortgaging our future, one printed dollar at a time, to give ourselves a comfortable present. That’s a problem, because it compromises all our abilities to provide for our own future needs. So here’s an important part of sustainable wealth management: As economic forces and remedies combine to compromise our futures, we need to learn to play “economic defense” to achieve peace of mind in the long term. In times of crisis, we must be particularly prudent with our finances, not be lured into spending with refund checks. The best long term “economic stimulus” is one that fosters long term savings and investment—politicians would rather have you spend now to allow them to win the election that’s around the corner.

With the sustainable wealth concept in mind, let’s look at some of the reasons why the present is proving to be a particularly challenging time to achieve it.

A Volatile World of Debt, Consumption, and Temptation

As we near the end of the first decade of the 21st century, deficits have soared, unemployment has reached levels unseen in almost 30 years, wage growth is elusive, energy prices have led to the first real inflation scare in decades, and real estate prices have plummeted, leading to a credit crisis of proportions not seen since the Great Depression. Worse still, the Federal Reserve and other policymakers scramble to patch up a broken system rather than instill confidence. We cannot rely on the government to fix our personal finances; we must find ways to achieve sustainable wealth independent of what the next government decision may be.

Yet calls for government help are omnipresent; citizens are willing to give up just about anything for another bailout. These calls for help are rooted in deep fear about the uncertainty ahead, about the volatility of the markets that has shattered their investment portfolios, about the volatility of policy decisions that at times makes the government appear rudderless.

A key to understanding the world is to understand what volatility is and how it impacts investors. In a capitalist world, we strive to maximize our profits. We have all heard that as we seek higher returns, the risks also increase. It requires a serious bear market, however, for investors to take the risk part seriously. In essence, volatility is nothing but a metric for expressing risk. As such, volatility is not to be feared, but it must be an integral part of an investor’s expectations.

Think of volatility as your pulse: When you go jogging, your pulse will be elevated, but you welcome the cardiovascular exercise as it strengthens your heart. Athletes have a lower resting pulse rate than sedentary people. However, an out of shape person who ran a marathon would jeopardize his or her life. One can experience an irregular heartbeat for a variety of reasons. Just as with your personal health, it is imperative that you recognize the warning signs of unreasonable risks and thus volatility early. When you experience an irregular heartbeat, stop the exercise immediately and call for help.

But whereas an elevated pulse is something that’s easily recognized—anyone can see their portfolio swinging widely during turbulent times; more dangerous and more difficult to detect early is the unhealthy drop in blood pressure that may be the precursor to a heat stroke. Translated to the markets: The absence of volatility, a perception that the world is risk free, may be the single best warning system for predicting a bubble. The difference between a bull market and a bubble is that a bull market maintains a healthy dose of risk. In contrast, the tech bubble was marked by first tech stocks, then all stocks moving up more or less in tandem; in the ramp up to the credit crisis stocks, bonds, commodities, real estate again all rose together—in a healthy market, in contrast, money typically flows from one asset class to another, or from one sector in the market to another.

Why So Much Volatility Today?

Volatility—as a measure and as an economic experience—has clearly been on the increase lately. Why? To find answers, one must look at the recent boom/bubble/bust cycles—and the response to those cycles. Short answer: Volatility is bound to return to any market as bubbles burst. That’s the point when those affected cry for help. What many fail to acknowledge is that the boom sows the seeds for the trouble down the road; the bust is a healthy cleansing of the system. The real trouble starts when individuals remain in denial as the bubble bursts or when policymakers try to stand in the way of market forces. With the best of intentions, unintended consequences tend to make the cure worse than the disease. As we saw in 2008-2009, the temptation to “fix” the housing bust and its impact on the financial industry is simply too great. The problems and their aligned policy temptations have led to unprecedented volatility, which has made it more difficult for us as individuals to achieve financial peace of mind.

To be sure, some of that volatility is a natural outcome of the increased speed of business, enabled by technology, which allows billions of dollars to change direction in a second with the stroke of a keyboard. That volatility is systemic and will not go away. But some of that volatility is brought on by the strong medicines handed down from Washington, D.C., the Federal Reserve, and other places. In this book we’ll explain those sources of volatility and what you need to understand about them.

Unintended Consequences

We will go beyond this and discuss the implications of policymakers’ attempts to tame this volatility. When one administers strong medicine or tries to change the forces of the universe, inevitably there are unintended consequences that can stand in the way of sustainable wealth, especially if the consequences are not well understood. I will highlight the unintended consequences of good intentions gone wrong throughout the book and help you learn to recognize them. Let me introduce some of them here:

• We have become serfs to debt. Our debt, both as individuals and as a nation, has grown out of control. Like a strong medicine, debt is okay, even good when used properly. But too much debt is expensive, it reduces our flexibility, and of course, it has to be paid off someday. Increasing debt brings uncertainty that undermines our economic strength, just as too much medicine can kill the patient.

• We are pushing the problem farther and farther into the future. The bow wave out in front is getting bigger. Again as individuals and as a nation, our debt loads are growing and our key industries are getting weaker. Debt is okay if you have a way to pay it back someday, but we have reached the point where we have to grow our economy at any cost just to service the debt. I liken the present situation to that of a hamster on an ever faster moving wheel—unless the wheel slows at some point we may simply not be able to keep up. Our kids and grandkids will have to pay the price—a clear violation of the sustainable wealth concept.

• We are destroying the middle class. Transitioning to a credit driven society over the past two decades was great for those who knew how to deal with credit. But an ever larger number who didn’t know how to handle debt fall through the cracks, as they were also much less “shock-resistant” to job losses and other financial surprises. Low interest rates, while designed to give a broader number of people access to credit, actually increased the wealth gap. Worse, as printing money and inflation may be the answer to many of the government’s fiscal problems, savers and those financially less sophisticated will suffer the most. Policies, despite their best intentions, risk destroying the social fabric of the country; in the process, resentful voters may increasingly vote populist politicians into office.

• We threaten the essential premise of capitalism. Capitalism is a universe that uses natural forces to properly allocate capital to the places where it achieves the best return, creating the greatest benefit both for the individual owners of capital and the society at large. We’ve been messing with that a lot lately—throwing dollars at overpriced real estate, keeping bad banks and businesses afloat, taking equity stakes in this and that, guaranteeing low-quality investments and loans. The government is playing God in place of the natural forces of the universe; if that keeps happening at the present frenetic pace, the government will eventually own everything and run everything! That’s socialism, not capitalism.

The Flight You’re About to Embark On . . .

The purpose of Sustainable Wealth is to help you make the lifestyle choices necessary to sleep well at night with your financial and investment decisions. This book is about understanding the major trends in a volatile world of debt and consumption that affect your personal finances. At first, the right choices in life may appear to be some of the hardest; but once you focus on what is important to you and understand the dynamics of the world we live in, you will have the confidence to succeed. You won’t find hot stock tips to brag about at cocktail parties, but you will earn the respect and admiration of your friends once they realize you are on a sustainable path.

You must be willing to be alert, to learn, and to take action. I predicted both the tech bubble and the credit crisis, but the best prediction doesn’t help if you fly into the thunderstorm anyway—that is, if you don’t change your behavior. For instance, I fared okay during the tech bubble, but decided to be more assertive “the next time” a major crisis would hit. In anticipation of the credit crisis, I not only changed the way I invested, but re-engineered my business, the way I save for my kids’ college education, and the way I save for retirement. I started the process as early as 2003, years before the crisis fully developed and blew out in the open. You, too, can learn how to predict major crises by reading this book.

In the first part of the book, I will discuss today’s economic universe by explaining current problems and what has and hasn’t worked to address them. Through those explanations you’ll gain a better understanding of how all the “moving parts” work together, and you’ll learn to recognize the unintended consequences that get in the way of sustainable wealth. You’ll learn how it affects you and your finances.

The global economy is explained as a series of “temptations.” These temptations—credit, consumption, policy change, and complacency—are areas that both investors and governments can “fall” for, leading to adverse consequences—including a temptation to fall for more of that temptation later on. When we take on too much consumer debt, we’re taking a bite from the apple of credit temptation. These temptations are described in Part I.

In Part II, I explain how to achieve financial peace of mind and security by guarding against these temptations, and how to insulate yourself from the temptations of others. I cover the basic principles of personal finance and investing, with an emphasis on being in the right place to survive a financial crisis and to ensure long-term—not just temporary—prosperity. If you follow my advice, you’ll be calm rather than tense and worried the next time a global or personal financial calamity hits, and you’ll have the resources and flexibility to do what you want to do in life. Like a pilot, you’ll be able to plan ahead when bad weather approaches, diverting as needed or landing to take cover—it is okay to let an opportunity pass if the risks involved are unclear or outweigh the potential benefits. Like a marathon runner, you may endure some pain along the way, but long-term preparation and conditioning will get you to the finish line with a true sense of accomplishment and an eye forward to the next race.

When it comes to your finances, you are in control—prepare and be ready. Sustainable Wealth will tell you how to do that.

PART I

A WORLD OF TEMPTATIONS

In ancient Biblical lore, the world of temptation started with the bite of the apple—and as the familiar story goes, nothing has been the same since. As you’ll see in the next four chapters, we as economic individuals and a society have sunk into a dangerous world of economic and policy temptations. Federal budget deficits in the trillions are but one result.

Arguably, these temptations—the temptations of credit, consumption, policy change and complacency—have not only created and perpetuated bad financial habits, but have led to still greater temptations. The temptation of credit has led to a temptation of consumption, which has in turn led us into financial difficulties as individuals and as a nation. To deal with those issues, we’ve succumbed to the temptation of policy and policy change. Policy change fosters yet another dangerous temptation of complacency—complacency toward risk and the seriousness of our economic problems—and shakes the very foundation of the free market system responsible for our prosperity from the beginning. The cycle may become more vicious, and unintended consequences along the way may create still more economic turmoil.

We’ve bitten into several bad apples, all of which create volatility, all of which will make it more difficult to create and sustain wealth in the future. Understanding and dealing with these temptations to create a secure financial future is the central challenge of sustainable wealth.

Part I, A World of Temptations, puts the four temptations and their consequences on your radar. After reading Part I of this book, you will have a much better understanding of the dynamics driving the economy and, ultimately, your finances.

CHAPTER 1

The Temptation of Credit

A pig bought on credit is forever grunting.

—Spanish proverb

Over the past 20 years, the United States has increasingly become a credit-driven society with a credit-driven economy. As recently as 1990, while some consumers ran up their credit cards and many had a mortgage to finance their home, leasing a car or obtaining a loan to buy a car was only starting to become popular. Nowadays, we buy everything on credit, including a mattress or exercise machine; to buy a car, we are lured with zero percent, six-year loans.

Is that a good thing or a bad thing? In the 4th century B.C., Aristotle wrote in his book Politics, “the most hated sort [to make money], and with the greatest reason, is usury, which makes a gain out of money itself, and not from the natural use of it. For money was intended to be used in exchange, but not to increase at interest.” Christianity, Judaism, and Islam have all tried in vain to prevent the spread of credit. Christians were banned from charging interest through much of history; in the 12th century, Christians were banned from receiving sacraments or a Christian burial if they charged interest. Jews were also banned from charging interest, but the restriction only extended to fellow Jews; as they were also banned from owning land, Jews became merchants and the first bankers, giving loans to Christians. Muslims, to date, are not allowed to charge interest; as a result, Islamic loans are typically structured as profit-sharing agreements. The traditional dislike for credit also extended to ancient China, where usury was prohibited. It wasn’t until the Industrial Revolution that interest-bearing loans to facilitate trade became common and accepted practice.

As a result of credit, the economy as a whole gets money to spend now in addition to money it already has. The same goes for your own personal “economy”—credit represents more money to spend in addition to the money you already have. At both levels, it represents an expansion of purchasing power. That has good consequences, but too much of a good thing can mean big problems. Too much money in circulation reduces the value of each unit of that money—that’s inflation. And when more money is created by credit than can be paid back with current incomes, that leads to (or should lead to) reduction in spending and an economic contraction.

During the credit crisis, or credit “bubble,” we saw some of both problems. The access to easy and cheap credit, which has become the standard dose of medicine for economic slowdowns, created—more accurately, amplified—a rise in asset prices. During the early part of 2008, we saw levels of inflation in commodities and asset prices that had not been seen for 30 years. As prices rose, lenders began to see less risk in their lending, and so lent more easily to more borrowers who might not have otherwise qualified. As with most bubbles, everything reversed almost at once, leaving those borrowers who had too much debt and not enough income unable to make their payments. The boom became a bust as more debt went sour, and that cycle fed upon itself. The modern Federal Reserve (or “Fed”) uses consumer price inflation expectations as its sole measure on whether to pop a bubble or not; the Fed stood by idle during the boom, because the asset inflation did not translate into an expectation of higher consumer prices. This focus has its shortfalls, as it allowed an unprecedented bubble to build; in the next chapter, on consumer temptations, I will discuss in more detail what held back consumer inflation.

Other forces in the universe were also out of alignment, including consumer spending, asset prices, and risk appraisal. The fact that the United States had already become the largest debtor nation in the world, and the fact that consumer debt was already at record levels helped to accelerate an increase in insolvency and an accompanying deterioration in confidence, hence the downturn in the economy.

In short, credit is a strong economic force; it has tremendous power to expand or contract an economy—the 2008-2009 experience could hardly serve as a better example. Just as credit amplifies U.S. and global economies, it also amplifies your own personal economy. Used wisely, it’s a good thing. But if you fall to the temptation of credit and spend too much, it can throw your own economic universe out of balance and lead to far greater problems later.

The Relationship Between Credit and Debt

Credit, in its purest sense, represents a potential, an ability, to borrow money to pay for something. A credit card is simply a device for doing that—by buying something on a credit card, you’re exercising a promise to pay that amount later. “Later” can be any time; you can pay off the balance at the end of the subsequent billing cycle, with no interest, or you can let the balance roll into the future, incurring interest charges along the way. The “later” may become “never” in case of bankruptcy or death.

Essentially, when credit is used, it becomes debt; credit is a future opportunity, whereas debt becomes a present reality. Credit can be a good thing, for it enables you to buy more goods at a time in the future. But when too much credit is used, it becomes too much debt. The buildup of onerous amounts of debt can naturally get you into economic trouble.

On a global or national scale, credit is simply the ability to borrow—or print—more money for governments to spend directly (fiscal stimulus) or to put into the banking system so banks can spend it (monetary stimulus). Just as for consumers, credit used and spent or placed into the economy becomes debt.

Good Credit, Bad Debt

Imagine, for a moment, a world without credit.

Now, as a consumer, you might be able to get by. You earn money doing whatever you do, and you take that money and buy food and clothing and other basic necessities of life. You rent shelter, so the amount you have to pay is current to the amount used or consumed. Before the days where everyone everywhere had credit, this is how people lived. In fact, you probably lived this way through college, assuming your tuition bills were taken care of elsewhere through savings or scholarships. You didn’t have income, so—at least in the pre-1990s “old days”—you probably didn’t have credit, because no one figured that you could pay it back once it turned into debt.

As soon as you need something that you can’t pay for right away, credit assumes a center stage role in your economic life. That could be college tuition, if you, your parents, or your grandparents didn’t save for it. Or, through the course of life it could be a car or a home or furniture for a home. Credit enables you to purchase those things when you need them and pay them off over time. You can have them and use them, and if you earn enough to pay for them plus the interest accrued, you’ll come out okay. If they are things you really need, it makes sense to use credit to buy them. However, if they aren’t really needed, then credit is simply enabling you to buy things that you can’t afford. Do that enough, and you’ll create a debt, which has a rather persistent tendency to grow once it gets started—it’s too easy!

Credit can make your own personal economy work better if used to buy things that you need, or things like college tuition that have a greater payoff down the road. But do you really “need” all the things many take out credit for? One can make an argument for college tuition; however, college tuition may be the one bubble yet to burst, as there has been a popular mindset for too long that thinks that the more expensive a college is, the better it must be. At some point, when we cannot afford the tuition anymore, even with the help of loans, college tuition should come down. There’s certainly an argument to be made that you don’t “need” most of the things you consume. You don’t need that TiVo, you don’t need that vacation in a five star resort, you don’t need that new pair of sneakers or that pedicure.

As the U.S. economy digests the “credit crisis” of 2008-2009, many are wondering just what the proper role of credit is. It is an important question to ask, as there are pros and cons to credit. There’s a saying that those who understand interest charge it; those who don’t understand interest pay it. In my humble opinion, a society that embraces credit had better understand it—as that society otherwise will pay dearly. If you buy everything on credit, your monthly paycheck may get you much further: you pay $200 for your car and $13 for your mattress every month, rather than waiting until you can pay for them in full. Former Federal Reserve Chairman Alan Greenspan (who was Fed chair from August 1987 through January 2006, and largely oversaw the transition to using credit in every facet of our lives) praised this trend, as it made the U.S. economy more “efficient”—money sitting idle in your bank account is money that does not contribute to economic activity; conversely, when you make a down payment on a loan, you are leveraging the usefulness of that down payment.

But it’s a two-edged sword—borrow too much, and the burden of paying back the debt, plus the cost of the interest, can get you in trouble. Too much debt makes a consumer—or a business or a society—more vulnerable to shocks and surprises. A job loss, big medical bill, or car repair is a lot harder to accommodate with a debt burden to service in addition to ordinary, current expenses. If you know how to deal with credit, you may thrive; if you don’t, you become a slave of your debt. As a result, easy access to credit without the proper training for those who receive it increases the wealth gap.

The Debt Spiral

So credit, used to fund the right things, can help both a consumer and a business. But used too much, or used for the wrong things, it can lead to trouble. Consumers, businesses, even responsible governments can run out of steam.

Credit excesses create a downward spiral. When consumers or businesses have too much debt, there’s a tendency to borrow more, either as a perpetuation of bad habits, or to “clean up” the debt—to consolidate it and make it more current. Remember the push to get you to sign up for a home equity loan during the boom phase of the credit bubble, to “pay off all those bills?” That’s an excellent example of the so-called debt spiral. Essentially, the message is “borrow your way out of debt.” That sounds like a pretty strange idea, right? I’ll come back in Part II of this book to give more pointers on managing personal debt.

Access to credit has major implications for the social fabric of a nation. As a result, it is high time that a public debate be held addressing how much credit we deem is healthy for society as a whole and for the government. Most would quite likely agree that credit plays an important role, provides opportunity, and has contributed to our standard of living; returning to a society based on barter alone is something most would not favor. Conversely, however, the credit bubble has shown that extreme credit may lead to catastrophe. The level of credit in a society is not simply decided by bankers, but influenced by tax and interest rate policies, among others.

To a great extent, it is a political choice. Every citizen should have a view as to whether we want to move further toward a Latin American society, with a thin class of the very wealthy, but the masses living in poverty, or foster a strong middle class. While most have views about how tax policies influence wealth distribution, few are aware that interest rate policies play at least as significant a role: Higher interest rates tend to make for a more robust middle class, as they encourage saving by discouraging borrowing and paying higher returns on the savings; conversely, extended periods of low interest rates lead to a growing wealth gap, with a select few who thrive, but a great many who can’t cope with the easy credit.

Credit as Money

What is credit then? Credit, simply defined, is the creation of money to be paid back in the future. Let’s look at what we commonly understand as credit. The most basic form of credit is currency in circulation—the dollar bills in your pocket. It’s credit because currency represents a loan issued by the Federal Reserve to you. The money printed by the Fed is credit; a dollar bill is a Federal Reserve Note, the most basic form of “money supply.” The only peculiar thing about this most basic form of credit is that it is not redeemable unless the Fed chooses to retire the bills. If you were to take your dollar bill to a bank or the Fed itself, all you would get in return would be a sheet of paper stating that you may exchange it back for a dollar bill. I’ll talk more about the Fed’s ability to print money further below.

How Banks Create Credit

Most of us think of credit as what happens when a bank issues a loan. Banks take deposits and use them as a base to extend loans. Banks lend out a multiple of what they have as deposits. That bank lending is money creation, too; money is not physically printed, but created nonetheless. And indeed, the person receiving the loan will buy something with it; let’s say the borrower took out a loan to buy a car. The car dealer may then deposit the proceeds from the car sale with his bank. As that is a deposit, the bank can make fresh loans. While an initial deposit may be leveraged about 10 to 1, by the time every loan has made it through the system as new deposits, an initial $1 deposit may increase to serve about $100 in loans. Healthy banks are crucial to a credit-driven society, as they are a key engine for creating credit.

How the Fed Creates Credit

The Fed influences the amount of credit available, not only by printing currency but by other means. The Fed also sets the reserve ratio, the amount banks must keep as collateral when making loans. The Fed is a membership-based organization, and member banks are required to keep a deposit at the Fed.

But Fed money creation goes a step further. Whenever the Fed buys something, it creates the money—it’s merely a bookkeeping entry, done with the stroke of a keyboard. When the Fed buys a typewriter or a car for a staff member, the Fed provides a stimulus to the economy. To stimulate economic growth, the Fed is better known for buying securities, traditionally Treasury securities, from banks. When the Fed buys a Treasury bill from a bank, the Fed receives the T-bill and the bank receives cash; this is all done electronically through bookkeeping entries—no physical cash changes hands. With the cash received, the banks can make fresh loans. This activity is commonly referred to as “adding liquidity” to the banking system. Conversely, if the Fed wants to reduce the credit available in the economy, it can sell securities to banks, typically Treasury securities. By selling securities to banks, the Fed “drains liquidity”—it removes cash from the banks, reducing the banks’ ability to extend loans. This adding to and draining of liquidity is what is referred to as the Fed’s open market operations; typically, the goal of these operations is to get short-term interest rates to where the Fed targets them to be.

How Credit Is Created (and Taken Away) by Everyone Else

After the tech bubble burst in 2000, the Fed lowered target interest rates from 6 ½ percent over three years to as low as 1 percent to stimulate the economy. In 2004, the Fed started raising interest rates again. Money supply, however, continued to grow. That’s because credit creation is not limited to banks. Homeowners, too, create money when they borrow against equity in their homes. So do hedge funds when they leverage their investments. In a world where homeowners thought the value of their homes always went up; where banks thought their clients were creditworthy; where hedge funds thought that the more leverage they applied to a trade, the more profitable that trade would be—in such a world, everyone created money. What a great world, right? Not so, in fact. Indeed, I like to argue that the Fed lost control of money supply as it allowed the private sector to unleash a credit bubble.

When everyone creates money, the money has to flow somewhere; and it did: into real estate, stocks, bonds, commodities, art, and antiques, to name a few areas. Indeed, the best way to spot a bubble is when asset prices go up uniformly across asset classes. Such bull markets make for seemingly very smart investors, but when such moves are not accompanied by an increase in real wages of similar proportions, you may want to be cautious. In a healthy market, money flows from one type of asset—or asset class—to another, rather than into all asset classes at once.

Partially because interest rates were so low, banks, hedge funds, pension fund managers—everyone—looked for ways to increase their returns: Pension funds, for example, needed to ramp up their returns to achieve their target returns to pay obligations in the future. The obvious answer was to apply leverage, which seemed like a good idea. How else can you get a 20 percent return when interest rates are in the low single digits? At the peak of the credit bubble, no project seemed too exotic to finance. Banks created off-balance sheet vehicles—structured investment vehicles (SIVs)—to circumvent reserve requirements and apply even greater leverage than banks take as part of their normal course of business. Characteristically, the risk recorded on the books was merely any accrued losses, rather than the bank’s full exposure.

The amount of credit created by the private sector during the boom that recently ended in 2006 creates another problem: While the private sector creates credit, it is also the private sector that takes it away. When former Fed Chairman Greenspan said that central banks in today’s world are “less relevant,” that’s precisely what he was referring to: If you allow the private sector to create money, the private sector can also destroy money through a process known as deleveraging. It’s money that simply vaporizes as risk takers from banks to hedge funds to homeowners pare down their risk profile, reduce their debt, and deleverage.

The Power (and Un-Power) of Central Banks