by Kevin Mcinturff

Created on: October 18, 2008   Last Updated: October 27, 2008

A year ago the good times were rolling. The Dow Jones Industrial (DJIA) was at 14,000 points and everyone was making money. The unemployment rate was at 4.6% and new housing starts were at 1.47 million units. However; dark clouds began to loom on the horizon with the financial sector or our economy showing signs of trouble. The stock market began to become unstable as major institutions such as American International Group (AIG), Fannie Mae (FIN), Freddie Mac (FRE), Lehman Brothers (LBC) and Merrill Lynch (MER) struggled to stay solvent. The Federal government has passed a $700 Billion buyout to save these companies and the economy in the process. Many questions which now arise are how will this affect my retirement? Will my investments be safe? What should I do to protect myself? The purpose of this article is not to give specific investment advice, but rather to explain how this problem occurred and how the current actions of the government will affect the value of investment income in the days ahead.

Over the last decade, China has grown prosperous due to their major manufacturing and exporting activities. With the increased income, the Chinese government made the decision to invest in the U.S. economy. As a result, there was additional money available which the banking institutions used to make sub-prime loans for home mortgages. Many people purchased homes on initial low interest, variable rate loans. These loans were then bundled and sold as investment packages on the open market. Along with these packages credit default swaps were also sold as a form of insurance on these investments. As long as the money flowed, the party continued, but as soon as the US economy slowed so did the demand for Chinese exports which in turn, showed their economy and their investments creating a downward cycle. In time, people began losing their jobs and were not able to pay on those now high interest mortgages which defaulted in great number. With all the bad debt, the institutions making the loans began to stumble. In addition, because credit default swaps were not regulated by the Federal government, there were not enough cash reserves in place to pay off the contracts.

The decision for the bailout is based on restoring confidence in the financial markets and the US economy. With the US government now underwriting the cost of these loans, everyone can now go back to business as usual or so it seems. But what is the true result of this decision and how will it affect investment income?

On the surface, the bailout appears to be stabilizing the stock market which is desirable. However; there is a hidden cost of inflation. It is important to note that all the currency used in the US is fiat money. In other words, the money is not based on anything of value such as gold or silver; just the good will and faith of the people using it. As more money is injected into the economy, the less value it holds. So while investments may appear to be holding their value, they are in fact not.

So what can be done to protect investments? Again, specific investment advice will not be given here, but a good dose of commonsense is in order. It was said that a $20 gold piece would buy a man two nicely tailored suits in 1908. Today, that same $20 gold piece would buy the same, which is something to think about. What is important to realize is that those things which have held value in the past will probably hold value in the future. In the end, protecting your money will require more diligence than ever before.

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