A Financial Strategy for the Eighties

Money is in deep trouble. People here and abroad don't trust it to keep its value. They try to exchange it for tangible goods as fast as they can--for gold, silver, land, condominiums, diamonds, art works, antiques, almost anything real.

This started with the U. S. dollar, but it has spread to the other currencies that are linked to our money, which means just about all of them. And that puts modern life in deep trouble. Democracy, technology, well-paid jobs, high living standards, travel, cultural improvement--everything that has lifted our lives above the level of the Dark Ages is in danger of going down, along with the money that made the wheels turn.

Your dollars have been on the point of death twice in less than two years. For those who know the inside facts, it has been much like watching those longhaired cartoon characters with signs reading the end is at hand--and suddenly thinking they might be right. For the past couple of decades, a little band of mavericks has prophesied that the U. S. dollar would finally become almost worthless, would have to be recalled by the Government and replaced with one new dollar for each ten old ones. And first in late 1978, then again in 1979, the world's great panic to get rid of our paper money has made our highest officials wonder--while preserving their frozen smiles--if they might be forced in that direction. "Like a bank that loses the confidence of its depositors, the U. S. Treasury doesn't have to be really broke in order to go broke," says the finance minister of a friendly foreign country. "One more wild run on the money could force actions that would amount to a bankruptcy."

Of course, your dollar is already being eroded every month, as inflation trims its buying power. But that doesn't compare with the jolt that would result from an official decision to give you a smaller amount of new dollars for any old ones you happened to be holding on a certain day. Or to reduce any of your assets numbered in dollars--savings accounts, certificates, bonds, even Government securities. That would also raise the question of reducing the size of your mortgage and auto loans, bringing a ray of sunshine into some lives and disaster to others. So we're not talking about "economics" or "international finance." We're talking about your future, and we'll include some practical ways to protect it.

Based on private discussions with top financial people in several major governments, trying to separate hard facts from mere hopes, and weighing the whole, I don't think the worst is going to happen--not quite. But it is not out of the question. It continues to be a very near thing. No major money has ever recovered from such a grave illness without a tremendous crash. We are on the edge of a precipice that has no footholds. Getting safely away from it will be about like putting a man on the moon--something never done before that turned out to be possible.

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How did the world get into this mess? Gradually. And with the usual good intentions. Ever since the end of World War Two, the U. S. has been printing far too many dollars and sending masses of them abroad. First it was aid to Europe, then to Asia and other parts of the world. Economic help has totaled at least 113 billion dollars, and military assistance has added much more. Our Government has just overspent for everything in sight. It seemed necessary in order to bolster foreign countries and keep them from going Communist. And when all that--plus all the dollars our tourists left overseas and all the dollars that went for imported goods--suddenly were seen to be mountains of American cash in foreign banks, their value began to be doubted. Now there are some 700 billion dollars floating around the world.

Everybody who has lots of those dollars would like to turn some of them into a different kind of asset. But how? Even the great central banks of the leading countries feel trapped. So do the billionaire Arabs. As BankAmerica president A. W. Clausen says, "A massive shift out of dollars would lead to a further depreciation of the dollar and thereby erode the value of their remaining dollar assets." And what can they swap the dollars for? As soon as they try to buy Swiss francs with them, the franc goes up and the dollar down. They switch to buying German marks, and the demand quickly makes the mark overpriced, undermining faith even in the strong currencies. They buy some gold, but it's a tiny market and the price goes crazy. Same for silver, platinum--even copper, cotton, sugar. The superrich grab for all of these, send prices soaring and still have unwanted cash left.

Worst of all, of course, is the fact that we have not stopped pumping out dollars. We're sending more and more abroad. The OPEC countries get tens of billions more each year, try desperately to change some of them into other things but find themselves suffocating under piles of our money. To make up for the decline in its value, they raise the price of their oil still further--and drain more dollars out of the U. S.

It sounds just about hopeless. If our inflation rate goes on like this, it is hopeless--because inflation is really an extra tax levied on anyone who holds dollars. When the Government spends more than it can pay for with the regular taxes that we pay, the deficit is financed by printing too much money. That way, all the money goes down in value and our common loss is the hidden tax that "balances the budget."

But clever people keep trying to dodge this tax. Especially foreigners, who don't want to pay our taxes. They try to get rid of the dollars and buy tangible goods that will go up in value while the money goes down. So they throw even more of the hidden tax burden onto anyone who willingly holds dollars.

The only bright spot in this whole dark picture is that the officials who run most major countries now see that the 11th hour has already passed. "We are badly handcuffed in trying to put things right," one European prime minister told me, "because until more of our people see the danger and agree to painful policies, we cannot take strong action." (Soon after our talk, he was toppled--for trying to take strong action.) But a surprising number of officials have dared to maintain belt-tightening policies for longer than anyone expected: Helmut Schmidt, a socialist, in Germany; the Tory Mrs. Margaret Thatcher in England; Valéry Giscard d'Estaing and Raymond Barre, middle-roaders, in France. And even some unsophisticated people in many countries are starting to understand that their antitax feelings should include a hatred of the hidden tax of inflation and all that causes it. They are more prone to distrust the overpromising politicians, to favor the ones who face up to the limitations on spending.

Putting an eye to that bright spot and looking through it to what is in the background, we see more areas of light:

One is that the U. S. dollar is far from worthless. By some measurements, it can still be a highly desirable piece of paper. "The dollar buys more at home than almost any other kind of foreign currency buys in its own country," says a high officer of Germany's huge Dresdner Bank. "In other words, the dollar is worth considerably more than the foreign exchange markets say it is." The rates for conversion into other money are wrong, pushed down by the panicky desire of dollar holders to switch, but not by reasons of real value. And whenever the rates of any free market are basically wrong, there is a strong chance that they will finally correct themselves.

Another hidden strength that no one seems to notice is gold. The U. S. owns 264,400,000 troy ounces of it. Our officials lamentably sold off a great part of our holdings a decade or more ago at $35 an ounce in a truly stupid insistence that gold had no future in the monetary system. Save for that, we would be in far better shape today. But, as it is, this gold--if valued at recent market prices instead of an arbitrary $42.22-per-ounce bookkeeping figure--would total about 150 billion dollars in hard reserves. That means each dollar now has more gold backing than it did in the Fifties, when it was the supreme currency. Not like the Swiss franc, which has more than 300 percent gold backing, true. But pretty substantial, nevertheless. In fact, we have enough gold to cover all foreign-government claims against the U. S., even in the unthinkable event that they wanted to get rid of every dollar they owned.

This introduces an interesting seesaw into the picture: If inflation erodes the dollar's buying power much more, it will eventually send the price of gold even higher. And since a lot of that gold is ours, its gain would give the falling dollar an ever-rising gold backing. In short, those who foresee doom for the U. S. currency overlook the fact that it is not mere paper. Our mismanaged household is lucky enough to have a healthy chunk of real money--gold--left in the basement. And that gives our paper I.O.U.s a nice metallic ring.

But that kind of pure arithmetic doesn't cure everything. It doesn't rule out the looming danger of a sudden panic to get rid of privately held dollars--by Arabs, by Germans, even by Americans--that would cause financial havoc, crashing stock markets, bankruptcies and joblessness before financial logic could take hold.

The realization of this is pushing many governments into a startling new plan: a massive international rescue effort to protect the U. S. dollar. Hard as it is to get nations to agree, the depth of the crisis has forced governments to "reach a consensus on matters that had been highly controversial before," as (continued on page 230)A Financial Strategy(continued from page 120) Walter O. Habermeier, treasurer of the International Monetary Fund (I.M.F.), understates it.

A series of meetings aimed at setting up a new monetary system is now underway. The truth is that we have no system now. A great meeting at Bretton Woods at the end of World War Two set up a plan of fixed exchange rates that made the prosperity of the Fifties and Sixties possible. But the gradual corrections that countries were supposed to make in those rates were resisted and ignored, so the whole thing blew up. Ever since then, we have been living with "floating rates," which are world anarchy in the financial sense, and it's a wonder that we have done as well as we have.

The new meeting to set up another system may be labeled Bretton Woods II. Eventually, the exchange rates between various currencies will be fixed again--though loosely, allowing much more leeway than before. But the main innovation will be an I.M.F. operation to be called the substitution account. This will allow governments that have more dollars than they want to turn in part of them to the I.M.F. and to receive a sort of world money in return. This is officially known as Special Drawing Rights--a mingling of dollars, marks, francs, yen and many other currencies. Governments that get these S.D.R.s will earn interest on them, and they'll have their money diversified, not all concentrated in dollars. By sopping up some of the excess dollars, it will ease the explosive pressure to swap them for other things.

This won't cure the problem--have no illusions about that. The U. S. Government will still be responsible for our outstanding money and will still owe billions in interest on it each year. But it will buy more time to see whether or not we can learn to control our inflation.

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What does all this tell you to do with your own money? Not to run with the mob, that's for sure. And not merely to copy what worked best before. Never allow yourself to be convinced that performance in the past few years proves what any kind of asset will do in the future. A high price tag need not be a stop sign, but it is certainly a caution light. The Eighties will see a new ball game, calling for a fresh approach. The main elements are these:

• Avoid having much in cash savings. Unless inflation recedes dramatically, you will suffer a steady erosion of value. Savings accounts, certificates of deposit, money-market funds--all are OK only as temporary parking places for cash until you find somewhere attractive to go with it. Earning interest at 14 percent or 15 percent is no gain at all when the value of the money falls by that much, because the Government then charges taxes on the interest. So you really get only seven or eight percent net, while losing twice that much.

• Don't count on real estate to keep zooming. If inflation weakens, so will home and apartment prices. If they don't, higher interest rates and credit controls will hurt the resale market. It's fine to own your home or condominium, but as a secure place to live, not as a profit maker.

• Do own some gold as a solid way to protect against dollar woes. The short-term swings make big profits--or losses--only for the quick speculators. For those who buy a little at a time and hold it, leveling out high and low prices, gold will keep buying power steady. So it is a good hedge. But don't plunge deeply, because gold is already expensive.

• The same goes for silver, especially silver coins. They will trend higher and they may outperform gold. In case of economic disaster, having 15 percent or so of your wealth in precious metals would make up for losses elsewhere.

• Consider buying land, especially fine farm land and very desirable getaway properties. It is somewhat like precious metals, because there is no more where that came from. But it usually involves a bigger investment, mortgage and tax payments, and it takes longer to resell in case of need. So move in more cautiously. And bear in mind that good land, too, is already on the expensive list.

But making real money needs a new Eighties strategy--going after something cheap that nobody else wants at the moment. And what is cheap these days?

• Good common stocks are the outstanding bargain. Stocks have been held down by some psychological factors--foreign crises, Government scandals, and so on--but most of all by high interest rates that have attracted cash to savings certificates and money-market funds to assured earnings of 12 percent, 14 percent and more. That has been overdone, even by very sophisticated money managers. They have left stocks lying on the bargain counter--ownership chunks of the greatest growth companies. If our system were going out of style, the stocks wouldn't be much good; but then, what would be?

Assuming that the system is not about to collapse, the stocks that now sell for seven and eight times their annual earnings will be twice that high before we get far into the Eighties.

The belief that the Seventies proved stocks are not a good inflation hedge is a myth. Statistics that use the early Seventies as a starting point don't look good, because stocks were already overpriced and had a correction. But investors who bought and held on and kept plowing back the dividends got close to 20 percent annual returns--well ahead of inflation--even in the last half of the Seventies. And stocks bought at bargain levels will do a lot better than that over the next five years.

Net, the strategy for winning tomorrow's financial contest is not the cautious, fear-oriented one of the past decade. This is a new world in some ways. Even government has learned a lot about what makes an economy work. The old labels liberal and conservative have been bleached out in the wash. Younger lawmakers in Congress, regardless of party, are pragmatic. They see what has almost scuttled our currency and they want to make things click a lot better. So they realize you have to give people incentives to save, invest and make money. Getting rich is no longer an ugly concept.

"If you really want to help the poor, help the rich. They'll build factories and create jobs"--that's the amazing kind of talk you hear on Capitol Hill these days. So the penalizing of companies and profits is, if not over with, sharply reduced. That is going to start a whole new cycle of expansion in which the stockholders will share the most, if....

If the dollar is saved from a disastrous plunge. Reread the last part of this article and you will see that there are ways to bet on the happier outcome without giving up the safety net of precious metals that can protect against even an overwhelming currency crisis.

This definite lean in favor of a surviving dollar and a rebounding economy doesn't come from chronic optimists. It reflects the views of persons--myself included--who have been pessimistic about the dollar and keen on gold over the past two decades. There is still enough danger to warrant keeping about 15 percent of your assets in the metals that shielded some investors so well in the Seventies. But the world runs in cycles, and the next decade is seldom like the last.

Two main facts about the Eighties will be totally new:

• The return of gold as an anchor for money, which will eventually give currencies a credibility they have lacked for 20 years.

• The new pro-business mood of people who make policies in most major countries.

For the smart investor, those add up to an early signal to abandon the over-caution of the past, to stop being content with illusory fixed-interest earnings and to put cash to work more creatively. The time to get in on the ground floor of an exciting new cycle is just before it starts.