MonTexan
Contributor
Last October I read two interesting books that were fairly insightful about our current economic situation and discussed inflation in great detail. They were: “The Coming Economic Collapse†by Stephen Leeb and “The Little Book of Bull Moves in Bear Makets†by Peter Schiff. Below is a summary of the notes I took while reading these two books. While not exactly addressing the concerns of “hyperinflation,†they may help us understand what could be headed our way. I am by no means an expert on inflation, so follow-up questions are best directed to google. :smx9:
General notes on inflation:
•
• Rising oil prices, economic growth, and increased government spending result in inflation….oil prices certainly have room to go higher from here and the US gov’t is certainly keeping those printing presses running to fund the various bailouts.
• From the great depression, the US gov’t learned the best way to deal with economic slowdown is to stimulate growth with a fast infusion of cash
o The gov’t infuses cash by lowering interest rates, increasing spending, or lowering taxes….all of which appears to be happening now!
o If the economy then grows too quickly, causing inflation, the gov’t will raise interest rates and lower spending…this may be impossible because of current debt levels.
o When inflation hits, the gov’t will have two options: either fight inflation by choking growth and risking a deeper recession or continue to stimulate growth and allow inflation to reach double digits
• In the 1970’s, the US gov’t chose to fight inflation. They brought inflation under control by curtailing growth (rising interest rates far above the level of inflation)
o This tactic could be much more troublesome today because of our highly-leveraged society. A large percentage of consumer debt is secured by homes….housing prices could get crushed even further.
• Long-term interest rates are still artificially low, meaning bond prices are artificially high. Bonds may be the next bubble to pop. (I think the Oracle of Omaha made a similar comment recently).
• Additional “economic stimulus†packages by the gov’t only means more $$ chasing a given supply of goods = inflation
• The US gov’t stopped making public it money printing activities in 2006 with the creation of the “M3.†This prevents analysts from using the knowledge to figure the amount of inflation being created.
• Since inflation is difficult to quantify, we must compare changes in nominal prices to price changes in gold. Ratios representing these relationships can be a good guide (see below)
• The continued recession and coming inflation will require a non-traditional investment approach…get out of the US dollar and into commodities, precious metals, and foreign equities whose currencies are appreciating against the US dollar. Cash not needed in an emergency fund should be placed in a non-dollar money market fund.
What if home prices fell?? (one of the most interesting parts of the Leeb book because the events are currently playing out)
• Massive amounts of gov’t intervention would be required (happening now)
• There would be record levels of unemployment (evidently on the rise)
• Interest rates would go to zero (basically there now)
• The economy would emerge with much higher debt levels than before (that’s scary)
• Oil prices would decline temporarily (they have)
• Unable to fight inflation, the gov’t will put all efforts into keeping the economy growing so that wages rise faster than interest rates and debt doesn’t overwhelm Joe-the-plumber….they will have to let inflation go crazy!
TIPS – Treasury Inflation Protected Securities:
• Often said to be a safe haven against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index (CPI). When the TIPS matures, you are paid the adjusted principal or original principal, whichever is greater (ie. your principal is guaranteed). TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.
• It is best to hold TIPS in a tax deferred account because inflation adjustments (increases in principal) are taxed in the year they occur even though you don’t get the $$ until maturity.
• Inflation-linked municipal bonds offer additional tax exemption and may be better than regular TIPS for people in higher tax brackets
• Investing in non-currency-hedged foreign bond funds will protect against both inflation and a falling U.S. dollar
• The gov’t has many incentives to under-report the real levels of inflation. This is problematic for an owner of TIPS because their return is directly related to the flawed calculation of CPI. When asset prices are lifted by inflation, the effect is not included in the CPI or PPI indices used by the gov’t to measure it! Other issues impacting the CPI calculation include the notion of “owner equivalent rent†and creation of the “M3†as discussed above. The CPI currently shows inflation at 4% while Mr. Schiff suggests it’s really at 8-10%.
Gold and other precious metals:
• The DOW was worth 20 oz of gold in both 1929 and 1980. The recent bear market began with the DOW priced at 43 oz of gold…and it’s now worth less than 9 oz of gold! Despite rising from 380 in 1929 to 11,000 recently, the DOW has actually lost half its real value over the past 80 years.
• There is much more leverage in precious metals stocks than in the metals themselves. In 1980, gold and precious metals stocks made up 7% of the S&P 500’s market cap. Today is makes up less than 1%...if investors increased their allocation to 5% of the total capitalization; it could mean a 5-fold increase in precious metals stocks.
• Gold bullion preserves wealth, avoids risk, and maintains liquidity but does not grow wealth. Rather than going up, it holds its value as fiat currencies lose theirs.
• In 1933 President Roosevelt issued an order confiscating gold bullion, but the order did not extend to private ownership of shares in gold mining companies. Gold stocks soared during the great depression. Also, in the 1973-74 bear market, stocks dropped by 50% while gold mining stocks quadrupled.
Hope these notes are helpful to you.
General notes on inflation:
•
The rate of inflation is calculated based on a fixed basket of goods at a 1982 value of $100. It is “conservatively calculated†because it hasn’t taken into account the inflated values of residential real estate since they use “owner equivalent rent†in the calculation. In allowing practically everyone to qualify for mortgages, rents in many places were effectively lowered thus keeping the CPI (consumer price index) artificially low. (looks like this is currently reversing course)• Rising oil prices, economic growth, and increased government spending result in inflation….oil prices certainly have room to go higher from here and the US gov’t is certainly keeping those printing presses running to fund the various bailouts.
• From the great depression, the US gov’t learned the best way to deal with economic slowdown is to stimulate growth with a fast infusion of cash
o The gov’t infuses cash by lowering interest rates, increasing spending, or lowering taxes….all of which appears to be happening now!
o If the economy then grows too quickly, causing inflation, the gov’t will raise interest rates and lower spending…this may be impossible because of current debt levels.
o When inflation hits, the gov’t will have two options: either fight inflation by choking growth and risking a deeper recession or continue to stimulate growth and allow inflation to reach double digits
• In the 1970’s, the US gov’t chose to fight inflation. They brought inflation under control by curtailing growth (rising interest rates far above the level of inflation)
o This tactic could be much more troublesome today because of our highly-leveraged society. A large percentage of consumer debt is secured by homes….housing prices could get crushed even further.
• Long-term interest rates are still artificially low, meaning bond prices are artificially high. Bonds may be the next bubble to pop. (I think the Oracle of Omaha made a similar comment recently).
• Additional “economic stimulus†packages by the gov’t only means more $$ chasing a given supply of goods = inflation
• The US gov’t stopped making public it money printing activities in 2006 with the creation of the “M3.†This prevents analysts from using the knowledge to figure the amount of inflation being created.
• Since inflation is difficult to quantify, we must compare changes in nominal prices to price changes in gold. Ratios representing these relationships can be a good guide (see below)
• The continued recession and coming inflation will require a non-traditional investment approach…get out of the US dollar and into commodities, precious metals, and foreign equities whose currencies are appreciating against the US dollar. Cash not needed in an emergency fund should be placed in a non-dollar money market fund.
What if home prices fell?? (one of the most interesting parts of the Leeb book because the events are currently playing out)
• Massive amounts of gov’t intervention would be required (happening now)
• There would be record levels of unemployment (evidently on the rise)
• Interest rates would go to zero (basically there now)
• The economy would emerge with much higher debt levels than before (that’s scary)
• Oil prices would decline temporarily (they have)
• Unable to fight inflation, the gov’t will put all efforts into keeping the economy growing so that wages rise faster than interest rates and debt doesn’t overwhelm Joe-the-plumber….they will have to let inflation go crazy!
TIPS – Treasury Inflation Protected Securities:
• Often said to be a safe haven against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index (CPI). When the TIPS matures, you are paid the adjusted principal or original principal, whichever is greater (ie. your principal is guaranteed). TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.
• It is best to hold TIPS in a tax deferred account because inflation adjustments (increases in principal) are taxed in the year they occur even though you don’t get the $$ until maturity.
• Inflation-linked municipal bonds offer additional tax exemption and may be better than regular TIPS for people in higher tax brackets
• Investing in non-currency-hedged foreign bond funds will protect against both inflation and a falling U.S. dollar
• The gov’t has many incentives to under-report the real levels of inflation. This is problematic for an owner of TIPS because their return is directly related to the flawed calculation of CPI. When asset prices are lifted by inflation, the effect is not included in the CPI or PPI indices used by the gov’t to measure it! Other issues impacting the CPI calculation include the notion of “owner equivalent rent†and creation of the “M3†as discussed above. The CPI currently shows inflation at 4% while Mr. Schiff suggests it’s really at 8-10%.
Gold and other precious metals:
• The DOW was worth 20 oz of gold in both 1929 and 1980. The recent bear market began with the DOW priced at 43 oz of gold…and it’s now worth less than 9 oz of gold! Despite rising from 380 in 1929 to 11,000 recently, the DOW has actually lost half its real value over the past 80 years.
• There is much more leverage in precious metals stocks than in the metals themselves. In 1980, gold and precious metals stocks made up 7% of the S&P 500’s market cap. Today is makes up less than 1%...if investors increased their allocation to 5% of the total capitalization; it could mean a 5-fold increase in precious metals stocks.
• Gold bullion preserves wealth, avoids risk, and maintains liquidity but does not grow wealth. Rather than going up, it holds its value as fiat currencies lose theirs.
• In 1933 President Roosevelt issued an order confiscating gold bullion, but the order did not extend to private ownership of shares in gold mining companies. Gold stocks soared during the great depression. Also, in the 1973-74 bear market, stocks dropped by 50% while gold mining stocks quadrupled.
Hope these notes are helpful to you.