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    It’s Simple: Trust Yourself

    by Chris Martenson

    Sunday, January 18, 2009, 10:11 PM

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    Sunday, January 18, 2009

    I was recently asked how it was that I knew to sell my house prior to the bursting of the housing bubble, why I sold out all my stock holdings in favor of gold and silver long before that was an obviously sensible move, and why I am convinced now that the recent actions by the Fed and the Treasury Department are likely to fail.

    But most of all, how did I get it right, when so many others missed it entirely?

    While I do root around in masses of complicated data, the answer to these questions is surprisingly simple: I trusted myself.

    More specifically, I trusted myself enough that when I saw something that didn’t make sense, something that just “felt wrong,” I took actions accordingly.

    • It didn’t make sense to me that a nation could consume beyond its means forever.
    • I was stumped by how an economic system predicated on continual expansion of credit would make a graceful transition to a no-growth environment.
    • I didn’t understand how people making $50k per year could buy $500k houses with no money down and have any hope of paying that back.
    • The concept of turning a bunch of subprime loans into higher grade securities, while extracting money along the way, puzzled me deeply.
    • It didn’t seem possible to me that money could continue to expand faster than the economy, long-term.

    My work and my passion are centered on helping you spot these same sorts of disconnects listed above, so that you can see things more clearly and with less confusion about the direction of things.

    Trust yourself

    The key to navigating during moments when the dominant story is ‘wrong’ is to consciously block out the ‘programming’ that is constantly reinforcing the status quo and to examine each assertion made by authorities (and by advertising and journalists, and any and all experts, myself included) as though it were possibly a live hand grenade.

    While you may ultimately end up agreeing with the assertion or claim, your first instinct should be one of suspicion. Often my first clue that I need to do more research into a particular assertion is simply a gut feeling that “something is not right here.” Even when I cannot quite articulate why, and maybe have almost zero hard data on the matter, I have learned to trust my instincts for when a story just doesn’t add up.

    This principle can be applied to the Bernie Madoff swindle. Many investors have recently described that they had suspicions and concerns over the years about the steadiness of Bernie’s investment returns. Yet they kept their money with him. If they had simply trusted themselves and decided to move their money to an institution where they did not have these gut-level concerns, they’d be in infinitely better shape right now.

    Here are examples of recent assertions that have sent up my warning flags:

    • Stocks always go up over the long haul.
    • Hydrogen is a suitable replacement for oil.
    • Our economic health depends on “unlocking the credit markets.”
    • There’s “cash on the sidelines” waiting to go to work. (Which of course, as we know, will drive up prices).

    Taking responsibility

    I want you to take full responsibility for your future. Heck, I want everybody to take full responsibility for their futures. This begins with educating ourselves about what’s really going on in our world, which you are already doing.

    One of the main impediments to this, as I see it, is that we have long been trained to trust authorities. We are constantly told, in ways both direct and subtle, that our job is to carry on while the big players take care of things. Our schools teach us that the right answer comes from the front of the classroom, and our jobs often reinforce the value of keeping one’s head down and one’s opinions to oneself.

    But now that the track record of our authorities reveals that relying on their competence alone would be a bad strategy for us, how do we break out of our longstanding habits and forge off on our own to make our own decisions?

    The key, again, is to begin by trusting yourself and then acting on what you know to be true, beginning with small steps.

    Economic disconnects

    So here, in January 2009, are the three major economic disconnects that I am focusing on:

    1. How is it possible for an insolvent nation to borrow money from an insolvent financial system to bail out insolvent financial institutions?

    This is the biggest of them all. It is the primary disconnect that makes me go quiet when someone expresses their hope that “Obama will fix things.” While I also carry the hope that smarter decisions will someday soon be made in Washington DC, the disconnect emerges when I compare the enormity of the task against the abilities of a new administration, let alone one man.

    Until and unless I gain an appreciation for how we can borrow our way out of this mess (and I must confess that this completely eludes me at the moment), I will maintain a hyper-protective stance on my financial holdings.

    Remember, the point of a bear market, and we are in the beginning stages of what will probably be the largest one on record, is to destroy everyone’s wealth. In 1929, it was said, people lost money. In 1930, the smart people lost their money. In 1931, the really smart people lost their money.

    At times like these, when I have very large questions about the overall solvency of the entire system, I strongly resist any and all calls to “get back in the pool” and buy stocks “before they go up” because “they always go up over the long haul” and “there’s money on the sidelines.”

    If you are hearing any of these sorts of urgings from your friends, family, or broker, just ask them the question in bold above.

    Because I am stumped as to how an insolvent system can borrow from itself I remain deeply skeptical of any and all claims that we’ve seen the bottom in the market.

    2. How are we supposed to return to a renewed period of economic growth predicated on more consumption, when baby boomers (the wealthiest generation) have seen their two primary forms of wealth, stocks and houses, fail in the same decade?

    The near-desperate maneuvering by the federal government and the Federal Reserve are aimed squarely at returning our economy to a position of growth. Growth requires consumers to spend more money on more things going forward.

    But our consumer landscape is still dominated by a demographic feature (anomaly?) known as the “baby boomer bulge.” As Bill Bonner wrote in Financial Reckoning Day, “Older people down-scale their lives, cut back on their spending, pay down their debts, and add to their savings. As people move from middle age into old age, they increasingly save for retirement and sell any stocks they had during their middle age.”

    The outlandish spending of the 2003 – 2007 period, which our authorities are now attempting to resuscitate, faces two powerful headwinds:

    1. People’s asset-based wealth has been mauled, and will have to be largely rebuilt before the “wealth effect” kicks back in to support spending based on a restored confidence in asset-based wealth. This will take years, if not decades, and boomers will be selling their assets into any attempts to reinflate the housing and stock markets (bubbles).
    2. Much of the recent spending boom was supported, not by assets, but by credit and by spending beyond our means. While the desire to spend beyond one’s means is an ever-present human condition, the desire to lend is a more fickle sentiment. It will take a while (years?) to revert back from saving to borrowing and spending.

    I see many commentators already calling for a bottom and searching for signs that a recovery in consumer spending is happening. In many cases, these folks are drawing upon historical examples of recessions that have typically lasted about as long as our current recession, implying that this one may already be drawing to a close.

    The danger here is failing to appreciate the extent to which our recent excesses were simply over the top and are very unlikely to be repeated any time soon. The greater the excess, the larger the hangover.

    3. How can US dollars be considered a “safe haven,” given how many of them (trillions and trillions) are being newly created out of thin air?

    In a luncheon speech (Jan 15th 2009) in San Francisco recently, Janet Yellon of the Federal Reserve had this to say about the Fed’s actions:

    Yellen said the Fed is already buying mortgage-backed securities and has begun a program to do the same for bundles of “auto, student, credit card, and…Small Business Administration loans – sectors where the issuance of new securities has slowed to a trickle.”

    She said this novel pump-priming tactic has already helped push down the rates for 30-year, fixed-rate mortgages.

    As for where the Fed has gotten the cash, Yellen said it’s simple.

    In a sense we are printing money,” she said, adding that she is not worried about inflation right now but the reverse – falling prices that make it harder for businesses to boost sales, prompting more layoffs and causing the downward spiral called deflation.

    Let me shorten that up for her. What she meant to say was, “We are printing money.”

    While I recognize that other countries are doing the same thing, the US is the most indebted country and is printing the most (by far). Sooner or later, investors and countries will lose confidence in a currency that is printed with wild abandon whenever the mood or circumstance strikes. After all, fiat money is founded on confidence, which can evaporate rapidly if the motives and/or competence of the managing authority are called into question.

    Without mincing words, the Fed is now “monetizing debt” and runs the very real risk of a massive devaluation of our currency. Of course, I would strongly suspect that this is actually the goal of the Fed, although they will not come right out and say that. Competitive currency devaluations have been a feature of every global financial crisis and are the preferred way of relieving the strains built up by the past periods of excess.

    What should you do about this?

    Trust yourself, and take actions accordingly. Take responsibility for your actions by educating yourself well about issues that you do not fully understand, and do not trust or assume that the authorities know better than you do. Listen to your instincts, act on what you know to be true, and steer clear of the things that don’t make sense to you.

    As you gain comfort with this material, the actions you will need to take in your own life will become evident.

    It’s really that simple.

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    Is the medicine worse than the illness?

    by Chris Martenson

    Saturday, December 27, 2008, 1:29 PM

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    Saturday, December 27, 2008

    In this report, I explore a remarkable article by Mr. James Grant that appeared in the December 20th edition of the Wall Street Journal.  This article is remarkable because Grant correctly identifies the Fed as the source of current economic troubles and makes the case that, under a gold standard, we might have a different set of troubles, but we wouldn’t be facing an extinction-level event for finance.  With the deft use of historical examples, he makes a strong case that our current ills stem from very common mistakes that have plagued central banking ever since it was first invented.  I expand on several of his arguments to steer towards the conclusion that inflation lies in wait.

    James Grant writes The Interest Rate Observer, a financial newsletter with an $850/yr subscription price. If you are not impressed by high numbers, then you might care that James Grant has been in the business a long time and has been especially good about providing a conflict-of-interest-free newsletter since 1983.

    I always enjoy his commentary and consider him to be one of the best in the business.

    Imagine my surprise to see him openly discussing the abolishment of the Fed in a Wall Street Journal editorial last week. And extolling the virtues of a gold standard. You could have knocked me off my stool with a feather.

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    The Zero Bound

    by Chris Martenson

    Wednesday, December 17, 2008, 3:48 PM

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    Wednesday, December 17, 2008

    This report looks at the latest move by the Fed to drop interest rates to zero and to print massive amounts of money as part of a quantitative easing effort. It looks at the most recent Fed statement that accompanied the rate decision in some detail and closes with an exploration of what this could mean to the dollar (hint: not good) and our financial future.  I offer my view on the dollar, stocks, bonds, gold, and real estate.

    Welcome to a brand new world. Today the central bank, stewarding the world’s reserve currency, took a step so bold and so fraught with danger that it is difficult to envision all the possible ramifications. The US now has an official interest rate of zero and a strongly worded promise from the Fed that monetary printing (a.k.a. “quantitative easing”) will now begin in earnest.

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    A Crisis Is A Terrible Thing To Waste (Part II) – Quantitative Easing

    by Chris Martenson

    Sunday, December 7, 2008, 8:58 PM

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    Sunday, December 7, 2008

    The Fed has begun a very aggressive program of money printing (that goes by the fancy name “quantitative easing”) and shows every indication of continuing this program into the indefinite future. Chances are that the Fed will err to the inflationary side with this program, raising the prospect of serious inflation emerging at some point over the next year.

    As we discussed last time, the Federal Reserve is taking heroic (foolish?) steps by essentially becoming the credit market. Where private participants have stepped away from lending and borrowing in anything remotely close to prior quantities, the US government and the Fed have stepped in to plug this hole.

    If this was all that the  folks at the Fed were doing, it would be risky enough, but they are doing something even riskier, and for which there is precious little history or precedent to guide them. This goes by the name “quantitative easing.”

    You should care about this arcane-sounding economic term, because if the Fed gets this wrong, they will ruin the economy for many years (decades?) to come and quite possibly ruin the dollar along the way. Understanding this dynamic will be essential to answering the question, “When will deflation turn into inflation?”

    We will get to that question soon.  But first, what is quantitative easing?

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    A Crisis Is A Terrible Thing To Waste (Part I)

    by Chris Martenson

    Saturday, November 29, 2008, 10:39 PM

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    Saturday, November 29, 2008

    The Fed has engaged on a path of “quantitative easing” (defined in Part II of this report), which has only been tried by Japan, where it was met with limited success.  Success rests on the hopeful, but possibly flawed, assumption that cheap money will lead to renewed borrowing. 

    Understanding the mechanism and implications of this requires an appreciation of the credit markets, what they are, and how they operate.  In Part I we discuss the credit markets and the extent to which the government is now a credit market participant. In Part II we examine the Fed’s chosen strategy of fighting the collapse in lending activity with the tool of quantitative easing, and what this could mean for you.

    Often, the present financial crisis is misrepresented in the media as being one of bad loans dragging down the balance sheets of unlucky banks. Justification (or political rationalization) for the extravagant loans and outright gifts to the major banks rests on the false implication that if their past losses were covered, then “normal” bank lending would resume, and all would be well again. Insofar as this is a regretfully incomplete view, it is false.

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    Financial breakdown?

    by Chris Martenson

    Thursday, November 20, 2008, 4:39 AM

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    Thursday, November 20, 2008

    In this Martenson Report ALERT, I detail the breakdown in the stock charts of several very large banks and insurance companies, relate these breakdowns to their past use of accounting shenanigans (Level III assets) and derivatives, and make the case that we are closer than ever to a financial breakdown. This is only my third alert ever and is warranted by the companies involved and what they signify.

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    Post-Election Blues

    by Chris Martenson

    Friday, November 7, 2008, 2:48 PM

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    Friday, November 7, 2008

    The credit bubble has burst.  Twenty-five years of spending more than we’ve earned has finally caught up with us.  Now that the continuous expansion of credit has ceased, it is no longer possible to finance the carrying costs of the prior debt, and collapse is the inevitable outcome. But how will it play out?

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    Market Predictions and Outlook Update

    by Chris Martenson

    Wednesday, October 29, 2008, 12:47 AM

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    Tuesday, October 28, 2008

    In this report I will review the advice and predictions I made on May 27, 2008 (exactly five months ago) in a report entitled Charting a Course Through the Recession.

    In striving to be accurate, fair, and complete, and in the spirit of constant improvement, it’s important to review where we went right and where we went wrong.  I’m pleased to say that many of my predictions were right on target.  I didn’t anticipate such an aggressive dollar advance, but now I see this trend continuing for awhile.  I am continuing to recommend some of the same prudent actions as always.  Stay out of debt, keep cash close by, get some money out of the dollar (gold), and know your neighbors.  And stay tuned for more from me in future reports.

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    Warren’s Risky Play

    by Chris Martenson

    Friday, October 17, 2008, 8:01 PM

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    Friday, October 17, 2008

    One of the most emailed stories at the NYT website today is an Op-Ed piece by Warren Buffett entitled Buy American. I Am.

    I think this piece deserves some closer attention because Warren Buffett is so influential in the world of money. Let’s examine his ideas closely.

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    How the Credit Markets Affect Us All

    by Chris Martenson

    Thursday, October 9, 2008, 5:12 PM

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    Thursday, October 9, 2008

    In this Martenson Report, I cover the importance of the credit markets to the smooth functioning of our just-in-time economy.  If the credit markets fully seize up, it is not a stretch to state that most businesses and the flow of many goods will also seize up.

    In fact, this has already happened, to a limited extent.  Should this extend further, there are a few basic precautions that you should consider as a means of mitigating the impact of a potential banking/credit lock-up.

    Okay, time for a little chat about the reasons that a credit market freeze-up has the potential to change your life in sudden and dramatic ways.

    Many people mistakenly believe that at some point in the distant past we moved from a barter economy to a money-based economy. In truth, we have a credit-based economy.

    In a money-based, or “cash-based,” economy, the whole thing would work a lot like your debit card. Businesses would immediately swap money for goods at the point of the transaction.

    But that’s not how our system operates. Instead, when goods flow between distributors, suppliers, and retailers, they do so on the basis of credit. For example, if your local grocery chain orders additional food from their distributor, credit is what gets that transaction moving right away. The grocery store has a line of credit with the distributor, which has a line of credit with their bank, which has lines of credit with other banks, one of which has a credit arrangement with the grocery store.

    Typically, businesses carry 30-60-90-day terms on cash settlement for goods and services sent/received. So the lines of credit are an important ‘lubricant’ to the process of buying and selling goods, with cash settlement coming after-the-fact and often comprising a bulk payment for numerous credit-based transactions that might have occurred over a period of time.

    At the larger level, credit transactions worth trillions of dollars are occurring between importers and exporters, with municipality paychecks, between nations, in stock margin accounts, and so forth. Credit is everywhere and it is how we conduct business. Without credit, we’d need to revert to a cash-based economy (hard cash or the electronic equivalent) and the simple fact is that our financial and judicial machinery are just not set up to handle a cash-based economy. They could be, I suppose, but right now they aren’t.

    So we need to ask ourselves, “What will happen if the credit markets completely freeze up?Here’s an example from Tuesday (Oct 7th, 2008), neatly illustrating the confusion and stasis that results from a credit market seizure:

    The credit crisis is spilling over into the grain industry as international buyers find themselves unable to come up with payment, forcing sellers to shoulder often substantial losses.

    Before cargoes can be loaded at port, buyers typically must produce proof they are good for the money. But more deals are falling through as sellers decide they don’t trust the financial institution named in the buyer’s letter of credit, analysts said.

    "There’s all kinds of stuff stacked up on docks right now that can’t be shipped because people can’t get letters of credit," said Bill Gary, president of Commodity Information Systems in Oklahoma City. "The problem is not demand, and it’s not supply because we have plenty of supply. It’s finding anyone who can come up with the credit to buy."

    In the article above there are willing buyers and sellers but believable bank credit is the missing element.

    Banks are essential intermediaries in a credit-based system, and the flow of goods comes to a shuddering halt without available, and, most importantly, believable credit. Sure, I suppose it is possible for a buyer to wire over the cash money to release the goods, but that type of exchange takes a different form of trust that is very likely to be in short supply during a crisis. Who would want to send off money without a system of assurances that the products will be shipped? Where there is an entire system of checks and balances erected around credit transactions, there are fewer for cash transactions.

    Think of an Ebay auction where you use your credit card vs. sending off cash in an envelope. If the deal goes bad, you have more options for recourse under the credit transaction than the cash transaction. This is also true for businesses of every size.

    This is why the recent decision to allow banks to “mark (all of their toxic assets) to maturity” was a bad move. While it helped the balance sheets appear to be healthier, which I am sure made some CEOs happy, it also served to make the banks’ financial positions less transparent, causing an offsetting erosion of confidence. After this move there is now less certainty about anyone’s solvency. And so our credit markets are seizing up, and grain is not being shipped from docks. On the surface this may not seem like a huge problem, but once you understand how our entire economy is predicated on a “just in time” delivery system, the problem is obvious. A couple of examples:

    • Grocery stores typically only have 3-5 days of food on hand. The continuous arrival of new trucks on a daily basis is essential to keeping them supplied. Credit allows this to happen.
    • The US imports 17% of its daily gasoline needs from foreign refiners. Credit allows this to happen.

    Literally every single supply chain in our complicated consumer network is dependent on the smooth functioning of the credit markets. (Okay, maybe not the illegal drug market, but you get the drift.) While it is possible to switch to a cash-based scheme for normal business transactions, that process will take time, possibly years, and the credit markets are currently imploding at a rate that suggests we have only a few weeks to sort all this out.

    This is what is happening behind the scenes, and this is why the Treasury Department and the Federal Reserve are operating in such a panic mode.

    In a larger sense, what we are seeing is the inevitable result of a fractional reserve banking system that has burned itself out. In 2003, Alan Greenspan reduced the US interest rate to the emergency level of 1% and held it there for a year. The rest of the world’s central banks followed suit, and the rest is history.

    As a result, we had the greatest expansion of debt that the world has ever seen. Credit bubbles always end in a bust, and they do not end until all of the prior excesses are wrung out of the system. For the US, this presents quite a tricky bit of landscape to navigate, because we mainly financed our excesses through foreign borrowing. Plus, we still own the world’s reserve currency. Together these facts compound the difficulty of managing a successful conclusion to the crisis.

    So we are now forced to admit, at least to ourselves, that it is now possible that both the dollar and the entire fractional reserve banking system could implode.

    In the case of the dollar, trillions and trillions of them are now held by foreigners. In order for the dollar to merely maintain its value internationally, foreigners must keep buying it at the same pace as before. If they continue to maintain their current dollar positions, but stop buying more, the dollar will fall. If they stop buying more and decide to unload the ones they already have, then the dollar will crash.

    We have, in essence, three generations of excess spending out there in the hands of foreign nations, some of them openly hostile to the US. Our future rests upon their kindness. In the case of the banking system, it is already, obviously, in terrible shape. The entire network, in aggregate, is insolvent. The damage in several key financial stocks this week has been staggering, if not frightening.

    Recalling my earlier statement about “marking to maturity,” we can see evidence of the resulting level of concern by viewing the stock price of Citigroup, which holds slightly more than $1 trillion (with a “t”) of the so-called “Level III” assets, which are equivalent to the “marked-to-maturity” assets that I spoke of earlier. Here we can see that Citigroup is rapidly approaching its recent lows, having lost all of the momentum that the “no short” rule change gave it a while back:

     

     

    And here are several other major insurers that are certainly going down soon. MetLife starts the ball rolling here:

     

     

    That chart, my friends, is a complete disaster. Something is very broken at MET that will require a lot of fixing. MET “…offers life insurance, annuities, automobile and homeowners insurance, retail banking and other financial services to individuals, as well as group insurance, reinsurance and retirement and savings products and services to corporations, and other institutions."

    And here’s Prudential Financial. This, too, is a very ugly chart:

     

     

    PRU “…offers an array of financial products and services, including life insurance, annuities, mutual funds, pension and retirement-related services and administration, investment management, real estate brokerage and relocation services, and, through a joint venture, retail securities brokerage services.

    And here’s Aegon, a major holding company offering insurance, pension, and financial services and products. This chart shows the complete breakdown of yet another gigantic company with financial tendrils that reach far and wide:

     

     

    And here’s the last one, Hartford Financial Services (HIG – primarily an insurance company), slightly larger than AEG but smaller than MET:

     

     

    These are all gigantic companies, each as large as Enron and each with charts indicating that utter failure is just around the corner. We can all hope that a financial rescue is in the works that will be able to fix all of this, but we’d be better off planning as if that weren’t going to happen.

    What you can do about this

    First, I want you to accept the possibility that the entire banking system could go into a form of financial cardiac arrest and fail to work properly. If this happens, uncertainty and fear will rule the day. Jobs will be lost, goods will grow scarce, and rumors will fly.

    The most obvious impacts will be felt locally. Towns, municipalities, and states will have to navigate the loss of significant portions of their budgets. Services will be cut. Some stores and supply channels will not be able to operate, either because their cash flow got pinched and they went out of business as a result, or because their credit facilities dried up and prevented normal operations. Some goods will rapidly become scarce.

    The first step in preparing yourself for this scenario is to understand why this has happened. By taking the Crash Course, you already know the mechanics of this situation and that everything that the Treasury and Fed are trying to fix (at least publicly) are merely symptoms. The cause was a 25-year-long credit binge that finally ran out of steam.

    The second thing you can do is to adopt a highly defensive posture with respect to money and your basic living arrangements. Let me reiterate the basic Tier I actions that you should all have taken by now:

    • Trim your expenses as far as humanly possible.
    • Keep cash out of the bank. Three months’ living expenses if you can; otherwise as much as possible.
    • Do you have essential medicines that you count on? If it’s possible, keep an extra supply around the house.
    • When you can, keep things topped off around the home. I recommend keeping at least a three-month supply of food on hand, in case the trucks stop rolling for any reason. I know this may sound “out there” for some of you, and if this goes too far in your mind, simply ignore it. But for anybody who has even the slightest worry in this regard, when all is said and done it takes relatively little effort and no extra money to make this fear go away. I say “no extra money,” because you would eventually have bought and eaten the food anyways. Through all of human history, up until about 50 years ago, it would have been unthinkable for the average family not to know exactly where its food for the winter was located. Our modern dependence on just-in-time delivery is a very, very recent development, and one for which we may potentially pay a very high price
    • Hold gold and silver, physical only. How much? That depends on how many of your US-dollar-denominated holdings you’d like to be absolutely sure do not go to zero.

    And here are the Tier II actions that you should consider in preparing for a potential credit market collapse:

    • Develop a sense of community and get to know the people you can count on and who will count on you.
    • Don’t take on any more purely consumptive debt for any circumstances, unless you are speculating and can manage the risks. This means you should not buy a house that is a stretch, you should make the old car go a little longer, and you should not be putting anything on the old credit card that you cannot find a way to do without.
    • Keep your job! I don’t care how much you hate your current position, keep it until and unless you have another one (or until you retire, but even then, please be very sure of how you will pay your living expenses).

    Let me close by saying that I fervently hope that this whole banking crisis blows over and does not result in you needing to draw upon any of the safeguards that I have laid out above. That is my most sincere wish.

    But as I see things now, the chance of a banking collapse and/or dollar crisis remains unacceptably high.

    Do what you need to do. Do what you believe is right, and tune out the rest.

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