craigr

Someone wanted to know: Are we sure there are no more than four economic investing climates that can affect the Permanent Portfolio?

What the question refers to is the core idea in the Permanent Portfolio that we have to only contend with four states in the economy:

1) Prosperity
2) Inflation
3) Deflation
4) Recession

This is a critical concept in the portfolio and why it works so well in protecting and growing money against an unknown future.  Because there are only four economic climates, we need to own just four assets to deal with each:

Stocks are for Prosperity
Gold is for Inflation
Long Term Bonds are for Deflation
Cash is for Recession

So are we really sure that’s all that exists? Is there a fifth case that could blindside the portfolio?

This is an excellent question.

Aside from Harry Browne and Terry Coxon who created the strategy, a lot of other people have put many brain cycles into this. My own review of history agrees with what Browne and Coxon postulated. I’ve only ever seen four economic cycles.

A review of US market history and other market history you can find various events on the timeline and see how the markets reacted. Before we went off the gold standard there were periods of inflation and deflation in the US - During the Civil War (inflation) and Reconstruction (deflation) for instance.

In other economies we can see similar cases of how the stock market, bonds and the money supply expanded and contracted. Recently I had a person in Greece write and they are facing huge problems that could very likely impact their savings due to bad inflation if they leave the Euro. In that country people are responding by buying gold if they are able. So even in that unpredictable situation inflation is the likely predicted outcome and people are responding to it by buying gold just as the Permanent Portfolio idea would suggest.

In 2008 we had a currency crisis in Iceland that caused bad inflation and gold was again the asset to hold for Icelanders.

Yet in that same year 2008 we had a deflationary event kick off in the US and LT bonds were the asset to have. But in 2009 the markets righted themselves and the stock market recovered sharply as deflation threats seemed to fade so stocks responded well.

Are you dizzy yet?

These were different countries with different results but the economic climates were each respectively accounted for with the portfolio.

But here’s the thing: These events were not predicted by the portfolio at all. Yet they all fell into the four economic climates model perfectly fine and the portfolio weathered the storms.

Could another economic climate exist? What history we have across multiple countries shows that some pretty serious events have occurred and the four economic climate model has pretty much accommodated them all as far as I can tell. So from my view I think the four economic climates are all we need to worry about.