For those who believe they can protect their wealth against hyperinflation and currency collapse - a reality check. by Bill Gee
(centrist)
Friday, September 16, 2011
As the numbers keep coming in, it is becoming more and more clear that the American Economic Empire is suffering from rapidly deteriorating stagflation that will likely give way to an economy completely incapable of sustaining the status quo. According to the US Census, Poverty Rates are up, and the Unemployment rate (the official one, anyway) continues to hold steady at 9.1%. Meanwhile, the CPI for August was twice as high than forecast. While there remains little doubt that we have entered into a double-dip recession, gasoline and food prices continue to inch upwards.
If you happen to be one of the tens of millions of people who have seen your family’s wealth disappear while you work longer hours (assuming you have a job), this news should be nothing new to you.
It may come as a surprise to you that the ultra-rich have started to notice that things are not looking too good for them either. After all, as I stated in my previous article, if you have millions of dollars invested in fixed-rate securities, you have every right to be concerned about your economic future.
Hedging Against Inflation
BlackRock, the world’s largest asset manager by volume, has recently been providing advice to its clients regarding their asset portfolios. In a paper distributed in their August Research Journal, Investment Insights, they seek to advise the investing public to evaluate their portfolios against the real possibility of high inflation. What is remarkable about their analysis isn’t what is in the report itself – what is remarkable is that they are saying it at all, given all the naysayers out there in the media who believe that inflation is still under control by the Fed!
The BlackRock report evaluates five general categories of assets and ranks them as to their ability to hedge against inflation. What I will do in this article is describe each asset type in reverse order - #5 to #1, while evaluating the possible effects on the macro economy if enough of BlackRock’s clients decided to follow their advice to the letter.
#5 US Treasury Bonds
As I stated in my previous article, Nominal US Treasury Bonds are hardly a hedge against inflation. In fact, under current rates, investors are losing money for every US Treasury bond they buy due to the fact that current yield rates are below the rate of inflation. The only reason why an investor will want to buy US Treasuries at this point is because they have zero confidence in any other asset type and they figure that it’s better than sticking their cash in a shoebox.
As inflation rates continue to rise, I believe investors will start heeding BlackRock’s advice and we will see a rapid decline in the market values of newly issued treasury bonds. This will make our Government’s budget problems even worse as investors that they usually depend on decide to take their money elsewhere. What we’ll end up with is a government that is even more broke than it already is, as they try to print their way to paying for the interest and maturities of the bonds they will be losing.
In an announcement yesterday, banks in China, Russia, Brazil and India have agreed to bail out Greek sovereign debt in order to avoid a total meltdown of the Euro Zone. Wall Street took this as a good sign, but what they are neglecting to notice is that if the world’s largest emerging economies are placing more resources in Europe, they will have less capital and less inclination to prop up the faltering US economy. It’ll be interesting to see how long it takes for Wall Street to get wise to the fact that the dollar’s status as the world’s reserve currency took a horrible blow.
#4 Equities & Real Estate
Despite the fact that market values on Wall Street are as much effected by changes in inflation as other commodities, the conventional wisdom that so-called “ownership assets” are considered a hedge against inflation is now firmly in the past.
The Stock Market: At the beginning of this year, I took out a modest portfolio of stocks that I felt were a hedge against inflation. I even wrote two impassioned columns about my stocks that continue to receive a fair number of readers each month. Each week, I completed an analysis of my portfolio and measured its effectiveness against inflation and other economic indicators in order to test my theory. In the Spring, my portfolio was up, but by late June it was down by over 5% and I was forced to sell it at a loss because I needed to use the money elsewhere. If I had kept the portfolio going into July, I would have been up again, but if I kept it into August, I would have been down by almost 20%.
Real Estate: One only needs to observe that housing prices have declined by 30-50% since 2007 to know that owning property is no way to retain any value. In fact, if you own property that you obtained within the last twenty years, it is very likely that it has declined in value when you factor inflation into the equation. My parents, members of the Baby Boom generation, were counting on the value of their real estate and their retirement pensions to get them through retirement. That dream is now gone and they’re still struggling to come to grips with that. In yesterday’s news, home foreclosures due to payment default went up to a staggering 33%, which will only drive home values even lower.
My conclusion: The stock market is way too volatile in order to be an effective hedge against inflation. The ups and downs are more effected by changes in the news cycle than anything else, and lately investors appear to have put on blinders to the fact that the economic indicators are all pointing to an eventual catastrophic event.
#3 Cash & Gold
So if you invest US Treasuries, Stock and Real Estate your money is likely to lose value at a faster pace than inflation, what if you just threw your money into Money Market Funds and/or Gold futures?
Cash: I see two problems with holding onto cash. First of all, it is hardly a hedge against inflation. In fact, as the dollar continues to lose value, the dollars stuffed into your mattress lose purchasing power. The second problem with cash is the inevitable collapse of the dollar and most other fiat currencies in the world, which will turn your dollars into worthless green pieces of paper with the faces of dead men stamped upon them.
Gold: Gold as problems of its own. First, gold is traded in US dollars. Therefore, as the dollar loses value, so does gold. Second, gold is hardly an “active asset”. Gold does not provide capital to make or grow anything, and is simply used as a hedge against a currency’s possible collapse, which is fine if your sovereign currency is anything but the US dollar, but if the dollar collapses, how much is your gold actually worth?
#2 TIPS
Treasury Inflation Protected Securities (TIPS) are US Treasury securities with a built-in mechanism to protect them against inflation. The way they work is that the nominal or book value of the security is adjusted according to the Consumer Price Index (CPI). In other words, if the CPI, which is the indicator that we use to measure inflation, goes up, so does the nominal value of your investment. As you may have guessed, the market values of TIPS are very high at the moment as investors are clamoring to get their hands on these coveted inflation hedges.
But before you start writing a check to the Treasury Department, consider the risks. First, TIPS typically pay a much lower interest yield than Nominal US Treasury bonds. So how low can they go? Many newly issued TIPS are actually paying a NEGATIVE yield. In other words, if you purchase a newly minted TIPS, you will be paying the government the interest, not the other way around! The other problem is the fact that the CPI is now being calculated in a new way. The new Modified CPI takes into account the “Substitution Effect”, which simply states that when the price of apples is too high, consumers will typically purchase more pears if the price is lower. Many economists have been very critical of the modified CPI because we know that the measurement assumes that all goods and services are Demand Elastic, which is not typically how consumers behave. Therefore, your TIPS are likely to not gain in nominal value in pace with the real rate of inflation. Lastly, as a US Treasury bond, in the event of a currency or government collapse, your investment will be worthless.
#1 Commodities
This is probably the scariest recommendation of all for investors to protect their assets against inflation. Speculation in the commodities market is one of the items that is driving our current rate of inflation, and one of the reasons for the collapse of the economy during the Great Depression! Commodities consist of so-called “working assets”. These include wheat, pork and corn futures as well as oil, steel, and copper.
How it generally works is that an investor agrees to pay a certain sum for a product to be produced at a future date. When the date arrives, the investor hopes that the price of that product will be higher, and they can then reap the profit of the transaction. What makes it a good hedge against inflation is that the investor’s price is fixed in the past, so that when the product actually comes to market, the investor can then sell that product at the current market rate.
The major drawback with commodities investing is that it is VERY risky. As the investor, you have already paid for goods that have not yet been produced. If you purchased cabbage futures in Vermont, for instance, you would have very good reason to be concerned right now following the floods produced by Hurricane Irene. If you purchased timber futures, you would be very concerned by the fact that new housing starts are hitting record lows. In other words, should inflation or a currency collapse cause the economy to come to a grinding halt, you are more likely to lose your investment in the commodities market.
What To Do?
My recommendation is to invest in yourself and prepare for the impending economic catastrophe that awaits us. Despite what the pundits and the politicians are saying, the upcoming disaster is as clear to see as a hurricane swirling in the Atlantic as it makes a bee-line for the coast. Only those suffering from Normalcy Bias are failing to see the signs.
The only way I see how we are going to weather this thing is to form self-sufficient agricultural communities much in the same way that feudal communities provided food and protection for its people during the Middle Ages. We have the means and the technology to do this with minimal risk, but we need to get started now before prices get too high, and raw materials become impossible to obtain. But this is an idea I will explore in more detail in a future column.
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Posted By: Walt
Date: September 16, 2011 09:50:44 AM
I see a major flaw in your argument. You argue that gold and the dollar move together, but that's not so. Actually, they are far more independent than you suggest. In fact, even with all the gold price suppression going on, over the past 10+ years gold has gained tremendously against the dollar.
Remember, if gold moved with the dollar, the price of gold in dollars would never change much. Yet, since the turn of the millennium, gold's pricing in dollars has increased roughly six times over. In 2000, gold sold for around $300/ounce. Today it's around $1800/ounce. So no, the dollar and gold do not move together.
Posted By: Bill Gee
Date: September 16, 2011 10:22:07 AM
Walt - That's okay. But the major thrust of my argument was the fact that gold is not an active asset since it cannot be used as currency to provide capital to make or grow anything. It's really just used as a hedge against currency collapse.
