The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged 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.
Five Stages of Inflation
With talk of inflation in the air, I thought I’d mention what I call: The Five Stages of Inflation
Be on the lookout for the early symptoms and act accordingly. Not acting before Stage 5 is damaging to your wealth. Sometimes stages 2 and 3 are swapped and/or combined:
Stage 1
Denial – “Prices are stable and the currency is strong! We don’t know what’s causing inflation!” – First sign of trouble is not admitting you have a problem.
Stage 2
Anger – Blame the Victims – “Greedy businesses are responsible!” – May also involve idiotic government campaigns that blame consumers for causing the currency to fall in value instead of reckless government spending.
Stage 3
Bargaining – Price and Wage Controls – “We are doing this to protect the economy!” – Welcomed at first by a naive public (until the product shortages kick in).
Stage 4
Depression – Pointing Fingers and Acting Hopeless – “It’s the previous administration’s fault! We don’t know what to do any more.” – While making no serious effort themselves to remedy the situation even though they know what needs to be done.
Stage 5
Acceptance – Screw the Populace – “It is our fault. But it’s your patriotic duty to lose your life savings.”- May also involve confiscation of hard assets, freezing of bank accounts, capital controls to prevent citizens from sending money offshore, etc. By this point much value in the currency has been destroyed.
The five things above have happened in one form or another in all countries that have had high inflation (even in the US).
How to protect yourself from The Five Stages of Inflation:
1) Hold some hard assets all the time. You won’t be able to react fast enough to a serious currency problem. You need to have protection in place before it happens. If you can put some money offshore beforehand it’s a good idea to do so.
2) Don’t believe government figures on inflation. Rely on the markets. The markets don’t care about political speeches and aren’t up for re-election. If the markets say inflation is higher than government numbers, then it is.
3) If price controls are being proposed, stock up on everything that they are thinking of controlling. Shortages will always follow price controls. If you are a speculative daredevil, invest some money in a way to take advantage of the price controls when they eventually fail and are forced to break.
4) Don’t listen to words. Only actions matter. If the discussions you hear in the news are not addressing the over-printing of money then it’s not a solution. The people in charge are just stalling.
5) Ignore pleas for patriotic duties to ruin your life savings and allow your assets to be confiscated. You didn’t cause the problem so you don’t have to pay for it while those in charge continue without penalty. Do what you need to do to protect yourself and don’t feel guilty about it.
Fighting Inflation by Making Cheaper Coins
From the not-as-witty-as-he-thinks department:
Will Nickel-Free Nickel Make a Dime’s Worth of Difference?
“Making coins from more cost-effective materials could save more than $100 million a year, which isn’t just pocket change,” said Dan Tangherlini, the Treasury Department’s chief financial officer.
That Dan Tangherlini. What a card! Is that the best the PR flaks at the Treasury Department could come up with?
Still, industrial porcelain, embedded with an identification chip, is seen as an outside possibility. A more likely candidate: an aluminum alloy, used by other countries for coins. But any switch is likely to be controversial. (emphasis added)
The aluminum alloy part is concerning enough, but not nearly as bad as an RFID chip inside the money. I analyzed RFID applications and vulnerabilities in the past as an information security researcher. My feeling afterwards is that there would be a big push for RFID in all money to remove the ability to have anonymity in cash transactions. It would first be put out into the public as an “anti-counterfeiting” measure. From there it could be stepped up easily to require banks to scan all money to check for “counterfeits.”
Banks could then refuse to accept money that couldn’t be RFID scanned as a risk control measure. This would then force stores to want to RFID scan money given to them so they are not left holding the bag. Finally, having money dispensed from banks and ATMs linked to the person who took the money out could be done. Why? Well, nobody would want to have non-RFID money because it could be counterfeit and the stores wouldn’t take it. Once this is done the circle of tracking the cash can be closed completely.
What then? No anonymous cash transactions could be accomplished. Links between cash could be made between people. Bills could be tracked from the bank to the ATM to the pocket of a person to a store and back to the bank. All RFID checked along the way. Every purchase could be tracked and, if necessary, a few quick keystrokes could disable the money in someone’s pocket by marking the RFID identifier as invalid in a central database.
Not plausible? No, it’s completely plausible.
The point of the metal in the coins is that it is a commodity value just as gold and silver are. The reason the nickel and penny are worth less is because the dollar is worth less. The markets are not fooled by this kind of rhetoric of saving money. As for RFID in the money? Yikes. I don’t want to consider the implications.
