The only other time I’d ever seen this was in my school history books, learning about the Great Depression…
In September 2007, Britain’s most overleveraged mortgage bank – Northern Rock – asked the government for an emergency loan. When its customers heard the news, they rushed to the nearest branch of Northern Rock to withdraw their savings. They formed queues around the block.
The next day, the government announced it was guaranteeing Northern Rock’s deposits, and the panic went away. Then a funny thing happened…
Suddenly, people started draining money from all the other banks in Britain and depositing it at Northern Rock!
The government intended to make the financial system stronger by shoring up Northern Rock. But it made the financial system weaker by undermining the financial strength of all other banks. In the end, the government ended up nationalizing the whole system.
The same thing happened in Ireland. It was the weakest financial system in the euro-zone. Then it guaranteed all its deposits. All the money in Europe started flowing into Ireland. This weakened the banking systems in the other European countries, and they had to guarantee their bank accounts, too.
In the United States, the government is doing everything it can to help homeowners stay in their houses. These people couldn’t afford their houses in the first place, but the government wants to keep them happy. So it won’t let the banks foreclose their properties, and it’s making banks reduce the principal on the loans.
Would you lend money to a home buyer knowing the government won’t let you take the house if he doesn’t pay you… or that the borrower doesn’t have to pay the whole loan back? No way. Not unless you could charge an astronomical interest rate. The government won’t let you do that either. Government regulations cap the interest rates you can charge on a mortgage.
So the government thinks it’s helping unfreeze the credit markets. But it’s actually making them worse.
Here’s the point: Government intervention makes the whole system weaker.
Intervention kidnaps money that would otherwise be available to businesspeople and entrepreneurs… and it invests it in places that businesspeople and entrepreneurs would never put their money… like uncompetitive car companies or failed banks. Then it creates unintended consequences that make everyone poorer.
Government stimulus does not stimulate, it stifles. So when you look at the current levels of government intervention all around the world… India, Australia, China, Taiwan, Britain, Europe, and the biggest of all in America… you have to conclude it will lead to the biggest loss of productivity ever.
When the government controls an economy’s financial decision-making, no one makes any money. This is why the government interventions haven’t had any effect so far. It’s also why stock prices will fall to valuations far lower than at normal bear-market bottoms of the past few decades.
So I’m not ready to call a bottom in the stock market. I’m only willing to buy a stock if it has a balance sheet with no debt, it generates tons of cash flow from selling a simple product, and it pays a dividend I know cannot be cut under any circumstance.
Besides that, I’m sticking to gold and cash.
• This article was written by Tom Dyson for the free daily investment newsletter DailyWealth