Inflation Nation Presentation [Compatibility Mode]


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Inflation Nation Presentation [Compatibility Mode]

  1. 1. INFLATION NATION Wise Investing in a Foolish Age (2010) 1
  2. 2. I. Introduction 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 2
  3. 3. Who Said It? “Inflation is always and everywhere a monetary phenomenon.” (Milton Friedman) 3
  4. 4. The Financial Tug-of-War Deflation vs. Inflation 4
  5. 5. II. Return of the Stagflation Trap Opposing Economic Philosophies: 5
  6. 6. What is the Stagflation Trap? Stagflation: economic stagnation and inflation occur simultaneously 6
  7. 7. Causes of Stagnant Growth Diminishing Impact of New Debt Growth: 7
  8. 8. Causes of Stagnant Growth (cont.) Demographics – aging population Rising Taxes Excess Capacity/Productivity Enhancements House Mortgage Resets: 8
  9. 9. Stagflation Implications Negative real wage growth Increased financial stress: especially the middle class & the elderly Increase in crime rates Financial stress on state and local governments Social Unrest 9
  10. 10. 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) 10
  11. 11. 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 Types: Cost-push & Demand-pull Currency debasement (bad) 11
  12. 12. The $100 Trillion Entitlement Black Hole The current trend of government spending is clearly unsustainable. Just take a look at this chart: 12
  13. 13. Your Share of the Debt This chart shows each household’s share of federal debt plus unfunded entitlements: 13
  14. 14. 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). 14
  15. 15. 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 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. 15
  16. 16. 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 16
  17. 17. The Importance of Real Interest Rates Simple calculation: 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): 17
  18. 18. Gold & Commodities Are Used As A Store Of Value When Real Interest Rates Are Negative Gold vs. Real T-Bill Interest Rate: Monthly Data 3/31/1968 - 3/31/2010 Gold vs Real T-Bill Yield 1140 Gold Gain/Annum When: 1140 Gold 1080 1080 Gain/ % 1020 Real T-Bill Yield Is: Annum of Time 1020 960 1.2 and Above -2. 0 48. 6 960 900 900 Between 0.2 and 1.2 14. 8 17. 9 840 840 * 0.2 and Below 21. 3 33. 5 780 780 720 720 660 660 600 600 540 540 480 480 420 420 360 360 300 300 240 240 180 180 120 120 60 60 6 Real T-Bill Yield 6 High Real Yields 5 5 4 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 Low Real Yields -3 -4 Low Opportunity Cost -4 -5 -5 -6 -6 -7 3/31/2010 = -2.2% -7 (DAVIS74) 1970 1975 1980 1985 1990 1995 2000 2005 2010 ©Copyright 2010 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at . For data vendor disclaimers refer to . 18
  19. 19. 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 Supply/demand/inventory 1.80 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 Management Company 19
  20. 20. Commodity Price Changes Over The Past Year 20
  21. 21. 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 for them.” (Ludwig von Mises, 1953) 21
  22. 22. 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): 22
  23. 23. Currency Debasement Inflation (page 2) Factors to consider when looking at monetary statistics: money supply and money velocity. See the charts below: 23
  24. 24. 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 inflation. 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 24
  25. 25. 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 25
  26. 26. 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 Inflation victims: Savers and lenders 26
  27. 27. 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) 27
  28. 28. 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 inflation: 28
  29. 29. 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) investments, and speculative investments should come last. 29
  30. 30. 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). 30
  31. 31. 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. 31
  32. 32. 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). 32
  33. 33. 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 – before taxes). 33
  34. 34. Thematic Investing 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 Infrastructure Emerging markets Basic materials Defense and personal security Certain types of real estate (such as farmland) 34
  35. 35. 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. 35
  36. 36. Is My House A Good Inflation Hedge? Sometimes “yes”; sometimes “no”. 36
  37. 37. 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): 37
  38. 38. 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”: 38
  39. 39. Government Debt is Exploding! Country 2010 Projected Fiscal Projected Increase in Balance as a % of GDP Public Debt/ GDP – 30 Years (Baseline Projection) 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% Asia -3.5 Central Europe -4.4 Latin America -2.4 Source: BIS Working Papers, March 2010 39
  40. 40. Not Only A U.S. Problem: Gold vs. Major Currencies Daily Data 12/02/1986 - 4/26/2010 Gold in Terms of Foreign Currencies Gold in Japanese Yen (x 100) 1050 Scale Right 975 900 825 750 675 600 850 525 800 450 750 375 700 300 650 600 550 500 450 720 Gold in Euros 400 680 Scale Left 640 350 600 300 560 250 520 480 Gold in British Pounds 440 Scale Right 400 1200 360 1125 320 1050 280 975 240 900 200 825 750 675 600 525 450 Gold in Canadian Dollars Scale Left 1991 1996 2001 (AA422) 2006 ©Copyright 2010 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer data vendor disclaimers refer to at . For . 40
  41. 41. 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 Sovereign Debt Commodities: Structurally short supply (copper, platinum, silver) > Excess capacity (aluminum) 41
  42. 42. S&P Sector Correlation With CPI 42
  43. 43. 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.” 43
  44. 44. 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 following advice: Don’t let the rat race kill you; Don’t let the funny money destroy you; Live frugally; Save and invest wisely now; Don’t let disaster preparedness consume you; Help others along the way. 44
  45. 45. 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 – copyright 1974 “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 2, 2010 45
  46. 46. Embrace Reality! 46
  47. 47. It’s Going To Be One Heck Of A Ride! 47
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