Wise Investing in a Foolish Age (2010)
The question that inspired the book: I.O.U.S.A. documentary film
and the live panel response.
The goal of this book: to help save and invest wisely now
The book has 3 Major Sections:
Return of the Stagflation Trap
A World of Funny Money: The Inflation Time Bomb
The Inflation Survival Guide
It may not occur in the short-term, but inflation will come
Caused by currency debasement rather than economic growth
The goal: maximize inflation-adjusted investment returns
Who Said It?
“Inflation is always and everywhere a monetary phenomenon.”
The Financial Tug-of-War
Deflation vs. Inflation
II. Return of the Stagflation Trap
Opposing Economic Philosophies:
What is the Stagflation Trap?
Stagflation: economic stagnation and inflation occur simultaneously
Causes of Stagnant Growth
Diminishing Impact of New Debt Growth:
Causes of Stagnant Growth (cont.)
Demographics – aging population
Excess Capacity/Productivity Enhancements
House Mortgage Resets:
Negative real wage growth
Increased financial stress: especially the middle class & the elderly
Increase in crime rates
Financial stress on state and local governments
Who Said It?
“By a continuous process of inflation, governments can confiscate,
secretly and unobserved, an important part of the wealth of their
citizens. By this method, they not only confiscate, but they
confiscate arbitrarily; and while the process impoverishes many, it
actually enriches some… The process engages all the hidden forces
of economic law on the side of destruction, and it does it in a
manner that not one man in a million can diagnose.”
(John Maynard Keynes, 1920)
III. A World of Funny Money: The
Inflation Time Bomb
Up to this point, I agree with the deflationists. However, I part ways
with them at this point because of the nature of our money.
What makes money “money”, anyway?
Recognized medium of exchange
Unit of account
A trustworthy store of value
Inflation: The Hidden Tax
Webster’s definition: a rise in the general price level; my
definition: loss of purchasing power of the currency
Cost-push & Demand-pull
Currency debasement (bad)
The $100 Trillion Entitlement Black Hole
The current trend of government spending is clearly unsustainable.
Just take a look at this chart:
Your Share of the Debt
This chart shows each household’s share of federal debt plus
Who is Going to Fund This Mess?
Projected funding deficit this year: $400 - $700 billion! (projected
supply vs. demand for Treasury bonds). The only solution I can see:
monetization (Fed buying the Treasury debt).
What is the True Inflation Rate?
To me, this is not an easy answer, for the USA or for other
countries. Most governments are incentivized to report low
inflation rates (COLA adjustments). For the U.S., the calculation
methodology has changed so much over the years that I question
comparing current results to historical numbers.
For reference purposes, I use the information on
www.shadowstats.com to see what the current reported CPI rate
would be using the old calculation methodologies. My own personal
conclusion from researching this matter is that CPI is understated by
approximately 3-5%. I am well aware that Wall Street and most
investors only look at the government (BLS) reported CPI numbers.
What is the True Inflation Rate? (cont.)
The graph below shows the difference between the current
calculation methodology for CPI and the result that you would get
using the 1980 calculation methodology (from ShadowStats.com):
The Importance of Real Interest Rates
Nominal interest rate – Inflation rate = Real interest rate
If the result is positive, money should retain its function as a store
of value, and vice versa. My personal opinion is that most asset
price bubbles can be tied to periods of negative real interest rates.
Here is a chart showing the real interest rate chart for the USA over
time (using reported CPI):
The Copper Example: Copper Price Drivers
Price Drivers – dollars/pound November 2009
Weak U.S. dollar $0.30
Energy prices 0.15
China trade balance 0.15
Total Fundamentals $2.40
Commodity Trading Accounts (CTAs) $0.30
Hedge Funds 0.38
Index Funds 0.26
Total Fund Influence $0.94 (28% of the price!)
LME cash price $3.34
Source: CRU – Commodity Metals
Who Said It?
“But then the masses wake up. They become suddenly aware of the
fact that inflation is a deliberate policy that will go on endlessly. A
breakdown occurs. The crack-up boom appears. Everybody is
anxious to swap his money against “real” goods, no matter whether
he needs them or not, no matter how much money he has to pay
(Ludwig von Mises, 1953)
Currency Debasement Inflation
Inflation is the loss of purchasing power of money. Here is a chart
showing the purchasing power of the U.S. dollar going back to the
year the Federal Reserve Bank was established (1913):
Currency Debasement Inflation (page 2)
Factors to consider when looking at monetary statistics: money
supply and money velocity. See the charts below:
Currency Debasement Inflation (page 3)
Can a determined Central Bank turn deflation into inflation?
According to Ben Bernanke, the answer to this question is a
resounding “yes”! Here is his famous quote from November 2002:
“Like gold, U.S. dollars have value only to the extent that they are strictly limited in
supply. But the U.S. government has a technology, called a printing press (or, today, its
electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at
essentially no cost. By increasing the number of U.S. dollars in circulation, or by even
credibly threatening to do so, the U.S. government can also reduce the value of a
dollar in terms of goods and services, which is equivalent to raising the prices in dollars
of those goods and services. We conclude that, under a paper-money system, a
determined government can always generate higher spending and hence positive
The conclusion that deflation is always reversible under a fiat money system follows
from basic economic reasoning.” Ben Bernanke speech: “Deflation: Making Sure ‘It’
Doesn’t Happen Here,” November 2002
Currency Debasement Inflation (page 4)
Conclusions I draw from the Bernanke speech:
Japan didn’t try hard enough to get out of its deflation;
You can bypass the banks if you need to;
Velocity and inflation will go up when people see that you intend
to continually debase the currency.
What can cause velocity to increase?
Healthy economy with sound bank loan growth;
Forced or unsound loan growth;
Capital flight (people fleeing the currency).
Common arguments from the deflationists:
Japan – 20+ years economic stagnation
U.S. Fed – Paul Volcker
Currency Debasement Inflation (page 5)
Beware of the Deflation head-fake (we may be here now!)
Weimar Republic – Germany
Beneficiaries of inflation:
Federal government (on two fronts – liabilities and taxes)
State and local governments
Underfunded pension plans
Debt-laden consumers and businesses
Savers and lenders
Who Said It?
“To preserve [the] independence [of the people], we must not let
our rulers load us with perpetual debt. We must make our election
between economy and liberty, or profusion and servitude. If we run
into such debts that we must be taxed in our meat and in our drink,
in our necessaries and our comforts, in our labors and our
amusements, for our callings and our creeds, as the people of
England are, our people, like them, must come to labor sixteen
hours in the twenty-four, give the earnings of fifteen of these to the
government for their debts and daily expenses, and the sixteenth
being insufficient to afford us bread, we must live, as they do now,
on oatmeal and potatoes, have no time to think, no means of calling
the mismanagers to account, but be glad to obtain subsistence by
hiring ourselves to rivet their chains on the necks of our fellow-
sufferers.” (Thomas Jefferson, 1816)
IV. Inflation Survival Guide
How will inflation impact you? The diagram shown below gives a
general rule of thumb of how assets respond under various rates of
Build A Solid Foundation
Many investors skip building a solid foundation. I believe this is a
serious mistake. Below is a diagram that shows my opinion of how a
solid investment process should work. At the base is savings and
financial insurance assets such as gold and silver.
From there, an investor should
focus on cash flow investments,
then capital gain (growth)
should come last.
Investing In Gold & Silver
Going forward, I expect gold and silver to continue to do quite well.
I believe silver will outperform gold. Continuing with the solid
foundation theme, here is how I recommend investors approach
investing in this sector. You could also use this approach for
investing any commodity-related industry (such as energy).
Diversification Benefit of Gold & Commodities
Chart: 5-year weekly return correlation on key assets and gold (US$)
BarCap 1-3 month T-bills 0.03
BarCap US Tsy Agg 0.05
BarCap US Credit -0.03
BarCap US High Yield -0.04
S&P 500 -0.02
DJ Industrial Average -0.06
Russell 3000 -0.01
MSCI World ex US 0.18
Dow Jones Wilshire REITs 0.01
Brent crude oil (US$/bbl) 0.35
DJ UBS Comdty Index 0.49
-1.0 -0.5 0.0 0.5 1.0
Source: Global Insight, Barclays Capital, WGC Data ending 26 March 2010
Whilst every effort has been made to ensure the accuracy of all information used in this document, the WGC cannot guarantee such accuracy;
nor does the WGC accept responsibility for any losses or damages arising directly, or indirectly, from the use of this document. This report is
intended for information purposes only, and is not and should not be construed as a solicitation to buy or sell gold or any gold-related product.
Building Wealth In The New Age of Volatility
It may be advantageous to have investment strategies that take
advantage of volatility (because I believe it is sure to rise).
Focus on Inflation-Adjusted Returns
Our goal is for investment returns to outpace inflation and taxes.
The following chart shows the Dow and the inflation-adjusted Dow
going back to 1900. The average return is 6.5% excluding inflation
and is about 3.4% inflation-adjusted (government-reported CPI –
If you believe, as I do, that inflation will be a problem going
forward, then some investments should do better than others.
Inflation-fighting investments that should do well in this
environment include the categories shown below. The book has a
list of ETFs for most of these various categories.
Precious metals – gold, silver, and platinum
Energy and clean energy
Food and water
Defense and personal security
Certain types of real estate (such as farmland)
One Example: Investing In Water
Clean drinking water is in short supply in many parts of the world. In
addition, water infrastructure, like highway infrastructure, is in a
state of disrepair in many areas. I believe there will be an increasing
trend to privatize water resources because most local governments
do not have the financial resources needed to upgrade their
facilities. American Water Works (AWK) is the largest water utility in
the U.S. The chart below compares cost of water in the U.S. with
other countries. There is also
a global water ETF – ticker PIO.
Is My House A Good Inflation Hedge?
Sometimes “yes”; sometimes “no”.
Short-Term: Deflation Will Be A Powerful Force
Just take a look at this graph of M-3 money supply growth (re-
constructed per ShadowStats):
A World In Transition: Wealth, Power & Influence Are Being
Transferred From The West (G7) To The East
Greece is currently the hot topic. Prediction: the next 10 years will
contain one currency and bond market crisis after another. Here is
Bill Gross’s “Ring of Fire”:
Government Debt is Exploding!
Country 2010 Projected Fiscal Projected Increase in
Balance as a % of GDP Public Debt/ GDP – 30
France -8.6 400%
Germany -5.3 300%
Italy -5.4 200%
Japan -8.2 300%
U.K. -13.3 500%
USA -10.7 400%
Greece -9.8 400%
Central Europe -4.4
Latin America -2.4
Source: BIS Working Papers, March
The “Inflation Trade”
Implications of Wealth & Power Transfer & Rising Inflation:
Stocks: Emerging Markets > Developed Markets
Currencies: Positive Real Rates > Negative Real Rates
Real Assets > Financial Assets
Bonds: Emerging Markets > Developed Markets and Developed
Market Corporate (Investment Grade) > Developed Market
Commodities: Structurally short supply (copper, platinum, silver)
> Excess capacity (aluminum)
Concluding Thoughts: The Flood Is Coming
Can disaster be avoided? Perhaps, if we:
Dramatically cut government spending. This requires a
recognition that we can no longer afford the “welfare state”
form of government.
Reach agreement with the people regarding unfunded liabilities
(entitlements) – these must be significantly reduced.
People must insist on honest government. Have term limits.
Politicians must “re-earn” voter’s trust.
Maintain positive real interest rates and show commitment to
this policy. If this is not done, investors will continue to seek
alternative “stores of value.”
Concluding Thoughts (cont.)
Since the beginning of the financial crisis in 2007, the primary
accomplishment of the U.S. government and the Fed has been to
shift debt and risky assets from the private sector to the public
sector (taxpayers). Problems have not been solved, only delayed.
The next crisis can occur at any time. History shows that once a
currency loses its function as a store of value, it will also cease to
function as a medium of exchange. With this in mind, I offer the
Don’t let the rat race kill you;
Don’t let the funny money destroy you;
Save and invest wisely now;
Don’t let disaster preparedness consume you;
Help others along the way.
Two More Quotes
“$100 placed at 7% interest compounded quarterly for 200 years
will increase to more than $100,000,000 – by which time it will be
worth nothing.” Robert A. Heinlein – Time Enough for Love –
“You can’t solve a debt crisis with more debt. Ask Greece in about 6-
12 months, as the “fixes” are temporary. Things go along until there
is a loss of confidence in the bond market, and then all hell breaks
loose. When is that? Who knows? But it is not ten years away, and
probably not five. Rates skyrocket and the currency takes a hit…I
think we avoid it, as there will be a growing backlash at the polls
against government deficits. But then, I am an optimist. If you think
politicians cannot muster the will to make the cuts, then bet on the
disaster scenario. Think gold and hard assets and foreign assets and
absolute-return funds.” John Mauldin, “Is This a Recovery?,” April