Category: Personal Finance

Inflation is the 24 Hour Tax on Everything

Wallet and stethoscopeInflation is the 24-Hour Tax on Everything

The Wall Street Journal recently reported that inflation, after “being given up for dead,” is coming back to life. While that may appear to be the case on the surface, inflation has been alive and well – hiding out beneath the official government statistics for years.

The WSJ is referring to the data released last Friday by the Bureau of Economic Analysis, known as Personal Consumption Expenditures (PCE), which measures the change in actual spending and prices and is the Federal Reserve’s preferred measure of inflation.

More specifically, the article was referring to Core PCE, which is PCE excluding food and energy, and is currently at a two year high of 1.7% on a year-over-year basis. The other measure of inflation is the Consumer Price Index (CPI), which has also been markedly higher, coming in at a 1.5% annual increase as of this past September.

Inflation is NOT a Good Thing

With inflation getting closer to the Fed’s 2% target, WSJ’s columnist Greg Ip casually comments that “This isn’t bad news. To the contrary, markets and central bankers alike will be relieved the world is no longer skirting a deflationary abyss.” But while central bankers might welcome this news, consumers will not.

Sustained inflation in consumer prices is never a positive for any economy, and is also not necessarily an indicator of a growing one. Prices may rise due to changes in supply and demand, and therefore help to reallocate resources and signal those changes; but an overall and sustained increase in prices is different.

If the price of an item rises for consumers, they will then stop buying it or switch to a cheaper item or cut back on another category in order to accommodate the household budget. Therefore, the only way for all prices to rise indefinitely and consistently is for new money to be constantly created and injected into the economy.

This of course is merely a tax on consumers because the new money and consistent increase in prices makes the consumer poorer. Contrary to popular economic theory today, there is no threat of a“deflationary abyss”. During the nearly 100 year history of the classical gold standard, prices gradually declined an average of 2% to 3% per year as technology and productivity increased, giving consumers the benefit of these advancements in the form of lower prices.

Inflation is Worse Than Reported

This week, Visual Capitalist made a stunning infographic using AEI’s Mark Perry’s (equally as interesting) inflation observations. Over the past 20 years, from 1996 to 2016, total inflation has been 55% as measured by the CPI.

However, digging into the Bureau of Labor’s data and then channeling down to the various items that make up the CPI basket of goods, you can see that inflation varies greatly from one type of good to the next.

For example, things that have increased more than the average 55% include tuition (up almost 200%), childcare (122%), medical (105%), food and beverage (64%) and housing (61%) – in other words, virtually all of the living essentials needed to survive or raise a family.

Counteracting this, items that fell in price included TV’s (96% decline!), toys (67% decline), and software and cell phone service (66% and 45% respectively). Clothing and furniture declined slightly, while new cars increased only slightly.

Obviously the dramatic decline in electronics, software and toy prices has brought wonderful benefits, but these are still largely discretionary items, and they take up a much smaller portion of most household budgets. The average family is therefore likely facing more than the average 55% increase in prices over the last 20 years.

Indeed, in his latest book, David Stockman has modified the CPI to put heavier and therefore more realistic weights on the four essential items of everyday life: food, energy, shelter and medical care. Using this measure, he finds the actual inflation rate over the past 29 years (when Greenspan became Fed Chairman) has been 3.1% per annum, rather than the official CPI rate of 1.7% per annum.

How to Protect Yourselfdates falling dollar

Unfortunately, inflation will continue to be a problem for any person living in a country whose money is a fiat currency that is being debased by their government – which includes nearly all modern economies today.

Thankfully, there is nothing stopping you from converting some of that fiat paper money directly into your own store of hard currency: physical gold and silver. During the past twenty years, while the official CPI increased 55%, gold has increased in value 235% and silver 282%.

Time to buy gold and silver, perhaps?

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Gold is Never a Bad Investment

Gold HistoryGold is Never a Bad Investment

Listen to a gold bug long enough and it seems like gold will always go up in price, and you can never own enough gold. But common sense tells us that “trees don’t grow to heaven” and, likewise, the price of gold won’t go to infinity.

Although we have previously gone over the many reasons why gold is a great investment and a crucial addition to any portfolio, it also helps to take an honest look at when gold didn’t do so great in terms of its price history. Doing this gives us a greater understanding of gold as an asset class, what to expect and why – despite some poor periods – it still stands out as a solid investment.

An Early Wild Ride

Gold advocates will often remind you that “Gold will never go to zero, unlike other financial instruments such as individual stocks or even bonds.” This is true, and will likely remain true given gold’s scarcity and historical precedent as money and a universally recognized medium of exchange. Unless someone figures out how to turn straw into gold, we can be fairly confident in this prediction.

However, while there is great comfort in owning gold, it still technically means that gold could go down in price by a significant amount. So what were some of the worst times for gold?

When the link between the dollar and gold was severed by President Nixon in August of 1971, gold went from an average of approximately $40 per ounce to nearly $200 at the end of 1974, an almost 400% increase!

At this time, President Ford made it possible for citizens to hold gold and bullion once again. If you were someone who eagerly went out and purchased the newly legalized gold for the first time beginning in 1975, you would have seen your shiny new investment’s value cut in half as gold plunged from nearly $200 an ounce to a low of $103 in less than two years.

A Spectacular Bull Run

However, gold then went on to make one of its most spectacular bull runs in its history, reaching a new all-time high of $843 per ounce in January of 1980, from its previous low of $103 in September of 1976. This represented an increase of over 700% in less than three and a half years; annualized, this works out to around 85% per year.

Yet the massive price run in such a short period led to a collapse to $300 per ounce by June of 1982, a more than 60% decline in less than three years. Of course, this entire episode was during the stagflation of the 1970’s where gold took off in the face of extreme inflation, only to be brought back to earth by Federal Reserve Chairman Paul Volker’s very high interest rates.

This shows us that in its early history of trading freely against the dollar, gold had some wild gyrations with drawdowns as much as 50% and 60%. Yet even if someone had terrible timing and purchased gold at nearly $200 an ounce beginning in 1974, holding it through the extreme times of the 70’s and early 80’s still produced a gain of 50% as gold settled down to $300 per ounce.

The Worst Time in Gold’s Price History

The worst time for gold was still to come in terms of its price against the dollar. After its spectacular run and subsequent decline, gold continued to be fairly boring and it gradually declined in price overall.

From $300 per ounce in 1982, gold eventually bottomed out at $253 in July of 1999. In contrast, the Dow Jones Industrial Average racked up over 1,300% in the same period.

Given gold’s bottom of $253 in 1999, and its previous all-time (although very brief) high of $843 in 1980, we can see the absolute worst performance for gold in its entire history: a decline of 70% over a nearly 20 year period. 

Lessons to Learn

On its face, this sounds uninspiring. However, first consider that this unfortunate scenario wouldSt Louis Fed Graph
require some incredibly unlucky timing and poor assumptions. To achieve this, an investor would have to buy their entire gold allocation on one day that just so happened to be an all-time high, and they would then have to sell all of their gold on a coincidentally unlucky day when gold was at an all-time low.

Most investors spread their purchases over time, and rebalance accordingly, taking advantage of price changes. It is therefore not likely that anyone would realize this full 70% loss.

Secondly, even if an investor did experience a full 70% loss over nearly 20 years, this represents an annualized 6% loss per year. This is certainly a painful time, but if this investor was following something like our 10% recommended allocation toward gold, the total effect on their portfolio would only be a drag of 0.6%.

We have often talked about gold being an alternative currency and more of an insurance policy than a high-performing asset class. Although this 20 year period was the worst in gold’s history, it still ended up ‘costing’ the investor only 0.6% per year, similar to or even less than other forms of portfolio insurance. Ironically, that 20-year low period has been followed by a gain for gold of over 350% from 2000 up to the present!

What happened after this low in July of 1999? Gold went on to a new all-time high of nearly $1,900 per ounce in September of 2011, a 650% gain or just over 18% annualized. This is a perfect example of how we as investors cannot predict the timing of these asset class moves, and why a Secure Your Wealthportfolio balanced between major assets takes advantage of this uncertainty.

The Bottom Line

The bottom line is that gold certainly has its ups and downs, and it would therefore be foolish to put 100% of your portfolio into gold. Yet a careful analysis shows that gold is still less volatile and has smaller drawdowns than the stock market.

Given its non-correlation to other major financial assets, it remains an incredible diversifier and a vital form of portfolio insurance.

This Time, it IS Different

This Time it IS Different

It's Different

It IS Different

The four most dangerous words in the world of finance, often repeated, are “This time it’s different.” During both of the last two major booms and busts, a common belief was that the new internet age was different (2000) and later, that housing was also different (2008).

However, used to describe our current interest rate environment (particularly negative interest rates), the over-worked phrase actually does ring true.

Financial journalist and observer Jim Grant noted at a recent investment conference that research on interest rates shows that over the past 5,000 years of history, there has never been an instance of negative interest rates… until now.

The ever quick-witted Grant remarked, “If these are the first sub-zero interest rates in 5,000 years, is this not the worst economy since 3,000 B.C.?” Perhaps. Or maybe this is just the first time in history where we have central banks active in monetary policy, attempting to drive interest rates as low as possible.

Record Negative-Yield Debt

The current amount of debt sporting a negative yield continues to grow. In early 2016, there was over $5 trillion in negative yielding debt. This grew to nearly $12 trillion by the end of June, and it is now closer to $13.4 trillion!

Not only has more debt become negative in yield, but it is increasingly happening to longer term debt. Yields on 10-year government bonds have become negative for Germany, Switzerland and Japan.  

Remember that bond yields are an inverse to bond prices. As bond prices get bid up, their yields go down.

What makes this unique is that bonds are a relatively simple financial instrument. Bonds do not have the subjective valuation that applies to stocks, and this makes the math and the logic of bonds fairly straightforward.

A person can buy a stock from another person while thinking it still has the potential to go higher, given higher growth prospects for the company. The price is based on one person’s subjective valuation.

On the other hand, bonds are not as subjective. If you buy a bond at a certain price, with a certain coupon payment, then the yield is a mathematical certainty. It is the yield you will receive per year if you hold the bond to maturity, and if it pays the principal in full without defaulting.

What Bond Buyers are Saying

By stark contrast, today’s current bond buyers are purchasing a security where they know they will lose money if it is held to maturity. For example, if you buy a bond today with a negative 0.5% yield, and it has five years until maturity, then after five years, you will be paid back less than what you originally paid for the bond. Even with the coupon payments you received during the life of the bond, the total payout will be equivalent to getting a minus 0.5% return on your money.

Therefore, we must make one of two different assumptions about current buyers of negative yielding debt. One assumption is they could be anticipating the bonds will continue to go up in price and that they will then sell them for a profit. In other words, the negative yields will become even more negative, and they will sell the bonds before maturity.

Unfortunately, this requires the buyer to believe there will always be a ‘greater fool’ out there who is willing to accept a higher price than what the original buyer paid. It it not unlike those who bought houses before 2007 on the premise they would flip them to a higher bidder. Remember that with bonds, someone must be holding these financial instruments at all times.  

The second assumption is that buyers are perfectly fine accepting a negative yield, and are willing to ‘pay for the privilege’ of lending out their money. This goes against all basic laws of finance. It only makes sense insofar as these buyers have no other place to put their money, and are therefore choosing the lesser evil.

But this is a weak explanation, because they could put their money in cash and get at least a zero percent return. Also, this doesn’t seem to make sense for longer maturity debt, as it means these buyers think negative interest rates are here to stay for at least ten years or more.

Both of these scenarios point out how this time, it is very different, and we are living in a twisted financial world, a world only exists because of the manipulations and distortions of central banks.

It is always precarious to try to make predictions, but it seems that there will come a time in the not too distant future when people will look back at this period and say “What were people thinking?”Secure Your Wealth

Like a frog languishing in a slowly heating pot of water, investors have warmed up to the environment of negative interest rates, not realizing how absurd and dangerous the situation has become. But take time now to assess, and be well prepared for the inevitable.

In this zero/negative interest rate environment, it is stunning to consider that since 2000, the DJIA (Dow Jones Industrial Average) has increased in value 63% while silver has increased in value 289% and gold has increased 380%…. an annualized return of 23.75%!

Cash, anyone? Or gold!

Millennialisms

piggy-bank-850607_960_720Everyone loves to hate millennials these days. They are characterized as being lazy, entitled and self-absorbed. As is sometimes the case, those stereotypes might have some sort of basis in reality, but as is almost always the case, that’s not the whole story. Laziness, entitlement and narcissism aren’t all that millennials are good for. According to some recent studies, they’re also pretty good at saving. Maybe even better than their elders.

The percentage of millennials saving more than 6% of their income has increased substantially from last year. Not only that, it has surpassed the percentage of people in the 30-49 age range saving more than 6% of their income. Many have attributed these saving habits to the fact that millennials had to watch older generations struggle through an economic recession, as they were growing up. Keeping a healthy savings account is a precaution they can take against the economic troubles that their parents and grandparents faced.

What Investors Can Learn from Sound Economics

Austrian School for InvestorsReaders of this blog will be familiar with the Austrian School of Economics; the school of economic thought whose name derives from the fact that many of its early scholars came from Vienna. The school adheres to the individual as the basic unit of economic analysis, and it focuses on the market process.

The Austrian School is noted for some of the fundamental concepts that endure in mainstream economics today, and one of its prominent scholars, F.A. Hayek, received a Nobel Prize in economics. But does the school have anything to offer in terms of investment advice?

Enter the recent book Austrian School for Investors: Austrian Investing between Inflation and Deflation. Continuing with the theme here at Anthem Vault of being financially responsible by reading and continuing one’s education, I was delighted to read through this book, a volume that sits at the crossroads of my two main intellectual interests: Austrian economics and investments.

If you feel like recent economic developments concerning central bank quantitative easing, negative interest rates and government stimulus programs are leaving you confused as to how to invest your money, then this book is for you.

Do You Really Own Your Identity?

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Who Am I?

This age old philosophical question also has implications for our privacy and our freedoms. While assaults on our personal information seem to occur on a daily basis, it raises disturbing questions about who is actually in charge of our identity. In other words, do we really have control over how our identity is shaped and accessed or are we simply just puppets for third-parties who are using us for their gain. Sadly, my gut tells me that it’s the latter.

What we’re talking about here is our personal intellectual property, the data DNA vapor trail that is minted to us in the form of a  birth certificate and then a social security number.

At some point in our life trajectory, our identity falls prey to the control of the government and corporate entities. Our personal information then gets aggregated by third-parties to create a virtual representation of us. Suddenly, we as citizens begin losing control of the steering wheel.

A perfect example of this is the credit report that, through the use of questionable scoring tactics, provides a dashboard by which lenders make decisions about us. What’s included in these reports is often arbitrary. Case in point; cell phone payments, which most of us pay on time, are not included in most credit reports. That is until you become delinquent and then it does suddenly appear.

And have you ever tried to correct a credit report without having to pay for third-party help? Studies show that the vast majority of these reports have multiple – and at times, egregious -errors, all of which are stains on your online identity trail.

What continues to garner the most attention though are the unrelenting intrusions on our information privacy. Whether the result of security breaches, outside third-party snooping, identity theft or even ransomware attacks, assaults on our identity are occurring with increasing regularity.