The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged hyper-inflation
Governments Like Inflation
51 week ago
Let’s talk about Treasury Inflation Protected Securities (TIPS) again. It’s no secret that I dislike them vs. gold in the Permanent Portfolio. But will they ever “default” as some say? No, they won’t. But this doesn’t mean they don’t have other serious problems.
I don’t believe the US will ever default on its debt because they control the money it is denominated in. They can simply print money to pay it all off. Not a good thing, but technically not a default. If you own $10,000 in TIPS and the Treasury hands you a $10,000 bill in the future they technically paid off the obligation. Of course the money may be worthless, but you did get paid back as stated in the agreement.
Now, what causes inflation? Inflation across an entire economy is caused by politics, not economics. It’s different than a shortage of a crop like corn that cause prices to spike in that one area. Inflation as a policy makes all prices go up together. This is a unilateral truth if you look at financial history.
Therefore, the idea of relying on the government causing the inflation to protect you from the inflation is a really bad idea. If the government really cared about protecting you from inflation they would implement monetary policies that balanced the demand for new money each year with the supply so inflation was 0% +-. But that’s not what they do. They target 3-4% inflation and often get it wrong and all sorts of things happen as a result.
Governments like inflation. They have no desire to protect their citizens from inflation or they wouldn’t use it as a monetary policy at all.
What does this mean? Simple:
Governments like inflation. They have no desire to protect their citizens from inflation or they wouldn’t use it as a monetary policy at all.
Why buy a product like TIPS from an entity that is actively working against your interests behind the scenes?
Even the much vaunted “independence” of the Fed is an illusion. Enormous pressure can be put on the Chair of the Fed to react in certain ways. I really enjoyed this paper for instance that discussed the Nixon tapes and the pressure put on Fed Chair Arthur Burns. Nixon wanted an easy money supply for political reasons at the risk of sending inflation even higher and it appears Burns complied. The taped quotes are interesting:
How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes
What’s the lesson from this (and likely other manipulations by later administrations)? Well it’s that true inflation protection is not going to be gained by trusting the people with their hands on the printing press.
TIPS may be wonderful if inflation is low and steady. But I have a very difficult time believing they are going to do any better than a simple short-term Treasury fund in terms of offering inflation protection under higher rates. In other words, they are very likely to just tread water or probably lose a little each year in the game of catch up if bad inflation comes to the US.
Don’t buy TIPS for the Permanent Portfolio. Gold is immune from a lot of political shenanigans that can affect the actual reporting of inflation and subsequent inflation adjusted payments. There’s nothing wrong with keeping 25% of your wealth in a form of money (gold bullion) that is not subject to the whims of those in power.
TIPS Are a Bad Idea: Argentina’s CPI
As a follow up to another post, I am blogging to mention this article I read today about Argentina. Yes, we’re not Argentina. But it is very constructive to look at other countries handling high inflation to see what lessons can be gleaned. This article exposes one of the issues with relying on the Consumer Price Index (CPI) to protect investors against high inflation. Namely, political risk. Specifically, political risk of having the CPI manipulated to make those in power look less culpable than they really are.
The point I’m driving at about TIPS for inflation protection is that when the CPI is very high, and you really need the inflation protection, is the point when CPI is the most likely to be gamed against you.
No One Cries for Argentina Embracing 25% Inflation
Index Underreported
And when inflation remained stuck at about 10 percent in 2006, Kirchner replaced the officials in charge of the CPI report. Since then, Lavagna says, the government has underreported the consumer price index. The bureau says prices rose just 10.9 percent last year, while research firm Ecolatina, which Lavagna founded 30 years ago, says the gain was 26.6 percent.
(emphasis added)
Again, just a possible risk what could happen with relying on TIPS or other inflation indexed products to protect you under high inflation. For all its faults, at least gold doesn’t need to worry about getting fired for going up too much in value against a collapsing currency.
This is one of many reasons why gold is held in the Permanent Portfolio for inflation protection, and not TIPS.
Analysis of the Icelandic Economic Collapse of 2008
The Mises Institute just released an e-book analyzing the root causes of the economic collapse in Iceland in 2008. I have just started reading it, but the authors are building a case of the usual suspects (Central Banks, fiat currency and economic planners) behind the debacle:
Deep Freeze: Iceland’s Economic Collapse
Failure analysis is an important part of learning. And, it’s cheaper to learn from other’s mistakes than to repeat them yourself. I like reading about these kinds of extreme events and what measures did and didn’t work to protect investment capital. As it were, Marc DeMesel did an analysis of how the Permanent Portfolio would have performed for Icelandic investors in 2008 here:
Permanent Portfolio in Iceland
Also there is an interesting book from FerFal that details what happened in his home country of Argentina. I reviewed it here and it contains some very interesting first-hand accounts of what happens when a currency does a swan dive:
Surviving the Economic Collapse
I’m not a doom and gloomer, but I do think that all portfolios should have some protection in place for sudden currency problems. It is often way too late to respond once the markets for a currency begin to go sour. You need protection in place well before and you must hold it at all times no matter what the market sentiment may be. This is why the 25% gold allocation in the Permanent Portfolio is so critical to have at all times in the allocation.
H/T to Lew Rockwell’s Mises Institute for this.
Time to Rebalance?
3 years ago
Economist Robert Higgs comments in the following piece about the prospect of inflation in 2009 and beyond:
The Fed versus the Banks: Who Will Blink First?
I have never been inclined toward touting doomsday financial scenarios. I raise the possibility now only because, as I consider the situation portrayed in the graph of excess reserves linked above, I am unable to foresee how the Fed and the Treasury can navigate through these treacherous waters – waters that their own previous actions have whipped to a foam – without creating terrible financial and economic harm. If the dollar survives the ministrations of Bernanke, Paulson, Bush, and the Obama gang, its survival will be something of a miracle.
Earlier in 2008 inflation fears were the bogeyman. Oil was at $150 a barrel (it’s now $40). Gold hit $1000 an ounce (it’s now in the $800′s). And the Dollar was at record lows against the Euro and other world currencies (it recovered greatly). The markets were sure that inflation was coming on strong.
Ahhh, but Fall 2008 came and so did the popping of the Real Estate bubble. This caused a massive destruction of paper wealth that rippled through the financial markets taking out many large banks. By December, Long Term bonds (a powerful deflation shield) swapped places with gold, commodities and other inflation hedges for being the winning asset of the year. The US Dollar shot up in value at a rate never seen against the Euro. Deflation was on everyone’s mind and Long Term bonds proved their mettle as they powered ahead with 30-40% gains. This boost erased almost all market losses in the Permanent Portfolio strategy during the October/November stock crash.
Who would have thought that we’d start 2008 with the prospect of inflation only to end the year with our illustrious central bankers scrambling to prevent an all out deflation? The markets are like that though. Moody. Random. Unpredictable.
But what should we do now?
Terry Coxon Discusses the Possibility of High Inflation
Terry Coxon, co-creator of the Permanent Portfolio, discusses the possibility of high inflation as the US economy stagnates. Is it possible? Sure. The Fed is biased towards creating inflation because that’s what they were designed to do. Their worst fear is deflation because their tools are so limited. In my opinion, they will continue to try to inflate the dollar to force people to spend money. They’ll worry about the inflation it causes later.
Will it work? Hard to say. It didn’t work in Japan for the past 20 years and may not work here. Economics is just as much about psychology as anything else. If people don’t want to spend money and take on new debt it’s hard to force them to.
People often wonder why the Permanent Portfolio holds a 25% gold allocation at all times. After all, isn’t gold a zero real return asset? Well, this is the reason. If bad inflation comes the other components of the portfolio will do poorly, but the gold will react so strongly that it’s likely all the other losses will be overcome. But what about a deflationary situation and these predictions of inflation are wrong? Well, the portfolio holds 25% in Long Term Treasury bonds which will do very well under that scenario.
