Tuesday, August 31, 2010

Dave Ramsey and Suze Orman

Dave Ramsey and Suze Orman (both with television shows now) offer good money advice.  You should pay attention to much of what they say.  You should not pay attention to their investment advice.  They don't understand Austrian economics.  They don't understand that the Federal Reserve can create money out of thin air and cause a massive depreciation of the dollar.  If they do understand it, they don't think it is a threat.  They don't understand the business cycle and malinvestment.  That is why they have told people in the past to invest in mutual funds.

They are both smart in their unique ways.  They offer good advice in paying off debt and living below your means.  They offer good advice on life insurance and other money issues.  It is worth watching their shows if you haven't seen them.  Just don't necessarily take their investment advice.  They don't understand the dangers of a fiat currency.  They don't understand diversifying out of U.S. dollars.

Monday, August 30, 2010

Your Investment Portfolio

This blog is meant to keep you informed and to educate you regarding money and investment decisions.  For some, it may just be confirmation of what you already know or a supplement to what you already know.  This blog is not really meant to tell you what to do.

With that said, some people want advice on their investment portfolio.  This is a difficult thing to do, as each individual's situation is so different.  Do you rent?  Do you own a house?  If so, do you own it free and clear (deflation hedge) or do you have a big mortgage (inflation hedge or perhaps just not smart)?  Do you have any other debt?  Do you have any major upcoming expenses?

So let's assume that you don't have any debt with the possible exception of a reasonable mortgage.  Let's also assume that you have an emergency fund.  Let's also assume that you have an average income with average expenses and you are not retired (although being retired may not necessarily change this).  If you have absolutely no idea on what to do with your money, then you should probably just invest it in Harry Browne's permanent portfolio, as laid out in his short book "Fail Safe Investing".  You can also invest in the mutual fund that is similar (symbol: PRPFX).

If you are more experienced and you want a higher risk/reward portfolio, it would still be a good idea to have some in a permanent portfolio fund.  Here is an approximate suggestion for a portfolio in our current environment.  Please note that this could change at any time and it is also not a guarantee to make you money.  There are no guarantees.

Put approximately 15% in stocks (some index funds, some specialized funds like energy).
Put approximately 5% in gold related stocks.
Put approximately 20% in gold and gold related investments (not stocks) like GLD.
Put approximately 20% in long-term U.S. government bonds.
Put approximately 5% in silver and silver related investments like SLV.
Put approximately 35% in cash or other short-term liquid investments like a cd or money market fund.

Although bonds may seem risky, you need some protection in case of another crash.  If you had your entire portfolio in bonds in late 2008, you would have done very well.  Most other investments, other than shorting the market, did not do well.

If the Fed starts to inflate again and the banks start to loan out more money, then you will want to decrease your cash position and increase your gold and silver positions.

Again, this is a very rough estimate and each individual has a different situation.  Use common sense and what you feel comfortable with.  And again, if you have no clue, just stick with the permanent portfolio.

Sunday, August 29, 2010

Interest on Excess Reserves

There seems to be a little confusion about excess reserves held by commercial banks.  The Federal Reserve started paying interest on excess reserves right around the time the economic crisis became noticeable.  It has been written by some analysts that the banks started holding excess reserves because the Fed is paying interest.

This is bad analysis, as the reason for the boom in excess reserves is probably not due to the interest paid.  The Fed is only paying one quarter of a percent on excess reserves.  Bernanke, in his recent speech in Jackson Hole, Wyoming, said that reducing the rate paid on excess reserves is a possible future weapon for fighting a bad economy (he may have used the term "disinflation" instead of bad economy).  But even Bernanke admitted that it might not have much effect.

The Fed is only paying .25% interest.  They could lower it to zero and it probably won't make much difference.  Now, the Fed could charge a fee (a negative interest rate), but this was not discussed by Bernanke.

The most likely reason the banks are holding these large amounts of excess reserves is because of uncertainty.  The uncertainty just happened to coincide with interest paid on excess reserves and a more than doubling of the monetary base.  It is not necessarily all coincidence, but let's not confuse cause and effect.  Just because the Fed started paying interest on excess reserves around the same time that excess reserves went way up, doesn't mean that one thing caused the other.  The banks made a lot of bad loans in the past and they are afraid of making loans now.  They are afraid that people will default, so they are being very careful who they lend money to.  Reducing the rate to zero on excess reserves will not change these circumstances.

Friday, August 27, 2010

Monetary Base and Excess Reserves

Here are two charts.  The first chart shows the adjusted monetary base.

http://research.stlouisfed.org/publications/usfd/page3.pdf

The second chart shows the excess reserves held by banks (one year chart).

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=EXCRESNS&s[1][range]=1yr

This tells us two things.  First, the two charts are almost identical.  Money created by the Fed is going to the commercial banks as excess reserves.  This means that the newly created money is not being lent out.  This is keeping price inflation down.

The other thing you will notice is that the Fed has had a policy of stable money for over four months.  This comes after the explosion in the monetary base in late 2008 and 2009.

Until this changes, you will not see massive inflation and you probably won't see a massive spike in gold.  You should always hold a portion of your portfolio in gold (say 20-25%) or gold related investments, but you will not see it go sky high until we see a change here.  If the economy hits another major downturn (which looks likely), then we may get a change in policy.  You should look for an increase in the monetary base or a decrease in excess reserves (without the same thing happening to the other chart).  Once you see the charts break the correlation, then you should really prepare for high price inflation.

Thursday, August 26, 2010

Inflation vs. Depression

The Federal Reserve has a choice to make, whether it knows it or not.  The choice is inflation or depression.  There is no in between.  The government has created this situation with all of its horrible economic policies.  Bush gave us two wars while continuing to increase domestic spending.  Greenspan helped with creating money out of thin air.  Before Bush left office, he bailed out the car companies and did a massive bailout of the banks.

Obama has continued these policies.  He continued the bailouts and signed a massive "stimulus" package right after taking office.  The federal deficits are huge and the overall debt to GDP is nearing 100%.

There was a lot of malinvestment prior to 2008.  Interest rates were kept artificially low by the Fed and the government spent like crazy.  It caused bubbles in our economy and misallocated resources.  When Bernanke took over at the Fed, he actually stabilized the money supply.  This exposed all of the bad investments and it drove the economy into recession.  This is what needed to be done.  If Bernanke had continued to create new money, it only would have made the problem worse in the future.

Unfortunately, Bernanke and the Fed did not keep this stance for long.  When the fall of 2008 came, the Fed more than doubled the adjusted monetary base.  Most of this new money went to the banks and the banks kept it as excess reserves.  This is why we haven't seen significant price inflation.

Instead of letting all of the bad investments get cleansed out, the government tried to prop things up with more spending, more bailouts, more money creation, and more debt.  This has only caused more bad investments and a severe misallocation of resources.  At this point, the economy needs to cleanse itself in the form of a severe recession.  This is what the government should let happen.  It will be tough medicine, but it is the right cure.

More likely, the government will continue to spend and create money out of thin air.  If and when the economy shows another recession (did the first one ever end?), the Fed will most likely choose the wrong path of more inflation.  This will make things worse still.  It would be wise to prepare for massive inflation in the next several years.

It is unlikely that we will see hyperinflation.  We probably won't see price inflation of 100% per year.  We could easily see price inflation of 20% per year.  The future is unpredictable and you never know what will happen, but it is unlikely that the Fed will go to hyperinflation because they will destroy themselves and the banks in the process.  The most likely scenario is high inflation, followed by a severe recession or depression (call it what you want).  It might play out like the 1970's and early 80's, but more severe.

Just remember, the damage has already been done.  There are bad investments that need to be liquidated.  There needs to be a shifting of resources and we need people to save and invest, which is the basis of growth.  The government should allow this to take place.  It will probably do a lot more damage before it does.

Wednesday, August 25, 2010

Cramer

Rumor has it that Cramer on CNBC is advocating holding some gold positions in your portfolio.  If ever there was a perma-bull, it is Cramer, and even he is concerned and cautious about the stock market.  The Dow is hanging just above 10,000 right now.  If you have any money in stocks that you care about, you should get it out, unless it is balanced with other investments like bonds.  If you have any more than 25% of your portfolio in stocks right now, you are taking a big gamble.  There is a lot of malinvestment in the economy and it is trying to fix itself.  The government is not allowing the fix to take place.

Although we may still see rallies, it is unlikely that stocks are going much higher from here in the short-term.  The only thing that can drive them a lot higher is massive inflation.  In that case, you are better off in other investments anyway.

The future is unpredictable and anything can happen, but stocks are not looking good right now.  When Cramer is cautious about stocks, that means "sell, sell, sell".

Monday, August 23, 2010

Japan and Deflation

If you pay much attention to the financial news, you will hear how we (meaning Americans) don't want to end up like Japan of the last 10 or 20 years.  If the American economy, in the next ten years, is like Japan's economy of the last ten years, we will be lucky.

We hear that Japan has been trapped in a deflationary spiral that it can't get out of.  First, it is hard to call it deflation.  There have been a few times where the price index reports show a slight drop.  Basically, Japan has experienced stable prices over the last couple of decades.

But even if Japan really did have deflation (monetary or price), it is a myth that it is trapped.  The Japanese government has had some horrible policies in the past.  It has done its fair share of stimulus packages and the debt to GDP ratio is near 200%, bigger than any major country.  The one thing it hasn't done is gone crazy creating money out of thin air (at least relatively speaking).

Any central bank that wants to avoid a "deflationary spiral" can do so.  The Federal Reserve or any central bank can buy assets at any time.  The Fed could buy more bonds.  That is the most typical method.  It could buy mortgage-backed securities as it did in 2008.  It could buy stocks.  It could buy baseball cards and used furniture.  Bottom line, the Fed can create money out of thin air any time it wants.  It doesn't do this because it could eventually lead to hyperinflation.  The Fed is walking a tightrope right now, but it can cause high price inflation at any time.  Bernanke has said so himself.  The Fed just has to credibly threaten to dramatically increase the money supply.  It could also force banks to lend.

The purpose of this commentary is not to predict inflation, but just to make you aware that the Fed and any other central bank can inflate at any time.

Friday, August 20, 2010

Human Action

It ain't what you don't know that gets you into trouble.  It's what you know for sure that just ain't so.
~Mark Twain

This site is to help you not do things as much as it is to help you do things.  It is always amazing how you can give a set of facts to ten different people and they will all come away with something different.

Investing is difficult.  You should know what you are doing and what your risks are.  There are so many people that will read a particular story or look at some data and think that they have an investment that can't go wrong.  If you think it is impossible for it to go wrong, it will.

If there is one thing you should take away from this site, it is that you can't predict the future with certainty.  You can take good guesses and manage your risk accordingly.  If you study the Austrian school of economics, you should know that the market is made up of millions of people acting according to their own wants and needs.  It is impossible to predict the behavior of everybody.  It is almost impossible to predict the behavior of just one person, even yourself.

Remember that economics is really the study of human action.  Perhaps you are certain that interest rates should go up or that gold should go to $5,000 an ounce.  But you can't be certain and you should realize that it is impossible to predict with absolute certainty.  The rest of the people on this planet may act differently than you expected.  You should take this into account when you invest your hard-earned money.

Wednesday, August 18, 2010

Bush Tax Cuts

There is a lot of talk about the Bush tax cuts.  The "Bush tax cuts" has this name for the same reason that "Obamacare" has its name.  Bush spent a lot of time promoting these tax cuts (even though they were only temporary).  It was probably the only significant thing that Bush did during his presidency that libertarians can compliment him on.

The debate now is whether the tax cuts will be extended.  They are set to expire at the end of the year.  The question is whether they will be allowed to expire or perhaps expire for just the "top one percent".  This will only get more coverage as we get closer to the end of the year.

While the debate is not completely irrelevant, there is too much weight put on it by both sides.  The Republicans act as if the economy will be destroyed if they aren't extended.  They might be right, but the economy is in ruins due to many other factors, many of which can be blamed on past spending by Republicans.

The Democrats act as if the budget will all of a sudden be in balance if we can tax the rich.  It won't.  It won't even be close.  The supply-siders and the Laffer curve have it right on this point.  Raising taxes could actually lead to less taxes collected by the government.

While letting the tax cuts expire (for any group) would be harmful, it is not as significant as it sounds.  Tax rates were higher in the 90's and it didn't completely destroy the economy.  The spending levels and the Federal Reserve are far more significant issues.  Tax rates can go up and down like crazy, but as long as the government is spending 4 trillion dollars a year, we are still in trouble.  Anything not collected by taxes will be printed or borrowed.

In conclusion, while the tax rates are not irrelevant and we would certainly rather see them lower, it isn't the big issue.  Keep your eye on the ball.  Watch overall spending and watch what the Fed does.

Monday, August 16, 2010

Politics

While it probably isn't important to pay too close attention to the political scene, it is important to understand what is going on.  Politics affects how much and in what ways the government will take and spend your money.

It is looking more likely that the Republicans will win the majority in the House of Representatives in the fall election.  Will it have a big impact?  Probably not.

The Republicans will slow things down a bit.  Obama will not be able to hammer through legislation like he did with the "stimulus" or Obamacare.  But we will not see a reduction in spending.  The only things that can reduce spending at this point are economic laws and a citizen revolution (and both seem likely at this point).

Greece was somewhat forced to cut back on spending, although not nearly enough because it was bailed out by other countries.  But Greece is more like a state in the U.S.  It cannot print money.  It could only ask the other countries to print money since it uses the euro.  The federal government of the U.S. can print dollars.  That is why states have been forced to start making some tough decisions and to at least show some kind of concern for spending.  States don't have a Federal Reserve.

This is why the U.S. government is out of control.  They don't have to raise taxes directly.  They can keep deficit-spending because they can print money.  Until there are severe consequences imposed by the voters or until the laws of economics really kick in, there will be no significant spending cuts.  The Republicans will oppose Obama, but they will not control spending.  They already proved that from 2001 to 2009.

Friday, August 13, 2010

Dollar Down

The U.S. dollar has been down quite a bit over the last several weeks.  It has had the effect of causing the U.S. dollar price of gold to go up.  But gold has not exploded and it will not explode until a major event happens or until price inflation becomes a more obvious threat.

It is always interesting to keep an eye on the dollar.  Just remember that you are comparing it to other fiat currencies.  Everything is relative.

If the U.S. economy hits another major downturn (which looks likely), then don't be surprised to see the dollar strengthen as it did in the fall of 2008.  There is still a mindset that when there is fear in the economy, the place to go is to the U.S. dollar.  The tide will have turned when fear in the economy causes people to get out of dollars and into something that can't be created out of thin air, such as gold and silver.

Wednesday, August 11, 2010

Down Day for Stocks

The stock market went down significantly today, a day after the Fed announced that it would rollover some of its previous purchases to buy government bonds.  The market decided a day later that it wasn't all that good of news.  Of course, the stock market investors really wants to hear something more drastic from the Fed and they aren't getting it right now.

Until the Fed announces something significant (like forcing banks to lend excess reserves), then we will likely continue to see stagnation or worse.  It looks like the only thing that will send stocks straight up at this point is some massive money injections (which we obviously don't want).  Unemployment remains high and interest rates remain low.  People are scared and rightly so.  The government has created massive malinvestments in the economy and it isn't letting the problem fix itself.  As long as the government continues to spend like crazy and bail out failed businesses, the economy cannot flush out all of the bad investment.

Tuesday, August 10, 2010

The Latest on the Fed

The Federal Reserve met today and announced that it would spend a relatively small amount of money buying more government debt.  The Fed is not sounding as optimistic as it did a couple of months ago.  After the announcement, the stock market recovered some of its losses and the interest rates on bonds went down further.  You can now get a 30 year fixed-rate mortgage for 4.5% or less.

While this announcement was not insignificant and it certainly symbolizes that the Fed is still worried about the economy, it was not a drastic move.  A drastic move would have been an announcement that the Fed would start forcing banks to lend their excess reserves.

This whole thing goes to show that hyperinflation will probably not happen.  The word hyperinflation is thrown around casually quite a bit these days.  Hyperinflation basically means the destruction of a currency.  In our modern world, with a high division of labor, hyperinflation could mean death and destruction if there are no competing forms of money at the time (as is the case now because of legal tender laws).

The Fed and the people working there may be stupid, but they aren't that stupid.  They could force the banks to lend and all of this talk about deflation would go out the window.  We would see massive inflation in a short period of time.  The Fed is not ready to go there yet and it may never go there.  While the Fed tries to accommodate the politicians and the bankers, it probably will not risk destroying the currency.  If the Fed destroys the currency, it destroys itself along with it.

Prediction:  The Fed will inflate and we will see high price inflation, but just like the late 70's and early 80's, the Fed will tighten up and let interest rates rise.  We will see a worse recession/depression than the early 80's.  We will not see hyperinflation.

If the above prediction is wrong and we do get hyperinflation, then the people at the Fed really are that stupid and we will all pay for it dearly.

Monday, August 9, 2010

An Easy Inflation Hedge

The best way to hedge against inflation is to buy "stuff".  You wouldn't want to buy bonds or an annuity, as you will get paid back in depreciated dollars.  When you buy stock, you are buying a very small piece of ownership in a company.  Some of this represents buildings and other equipment that the company may own.  But buying stocks is certainly not a very good way to hedge against inflation.  In an inflationary environment, the economy may be in very poor condition and, hence, company profits also do poor.

Gold is still one of the best hedges against inflation.  In a mild inflationary environment, gold may not do all that great.  But if price inflation starts going at 10% per year or higher, gold will likely do well.  Not only will it keep up with the price increases, it will probably go up much higher in real terms.  If prices start going up at a 20% annual rate, you could easily see gold going up at 50% or 100% per year.  That is what makes it a great hedge.  You can have just 25% of your portfolio in gold and it will protect your entire portfolio from inflation as demonstrated in the above example.

There is also another way to hedge against inflation, and you may already do this a little bit.  It is not nearly as good as buying gold and it should not replace buying gold, but it is easy.  If you have some extra space where you live, you can buy things that you know you will use in the future.  Perhaps you are going to need a new appliance of some sort.  Maybe it is better to get it now before prices go up.

There are many bad things that Federal Reserve inflation causes.  It allows for big government politicians to spend more.  It causes boom and bust cycles.  The obvious bad thing is that it causes prices to rise.  You can buy things now instead of later when the price goes up.  This goes even for small things.

You obviously can't buy milk right now that you are going to use next year, but there are a lot of things that don't have near-term expiration dates.  You can buy toilet paper, razor blades, canned soup, soda, paper towels, soap, laundry detergent, etc.  All you need is a little extra space to store it.  If you see a good sale at the store, why not buy a few extra things if you have a little extra cash laying around?  Just make sure you use the FIFO method of accounting (first in, first out).  In other words, use the older stuff first.

Again, this isn't to replace gold or anything else as an investment hedge.  But it could save you a few depreciated dollars in the future.  If you knew that dishwashing soap would cost 8 dollars next year and you can buy it for 3 dollars this year, why wouldn't you buy a few extra now, especially if you have the money to buy now?

Sunday, August 8, 2010

Inflation and Prices

One topic that libertarians/Austrian economists discuss is the definition of inflation. Inflation is generally defined by Austrians as an increase in the money supply. This was the original definition of inflation. Now, when people use the term inflation, they are usually referring to a general rise in prices of goods and services. The statists have changed the definition over time to suit their agenda.

When inflation is defined as a rise in prices, then it is easier to blame big business, speculators, greed, etc., rather than blaming the actual culprit, the Federal Reserve. When inflation is defined as an increase in the money supply, then it is obvious that the Fed is to blame, since the Fed is solely responsible for creating money out of thin air.

It is important to differentiate between monetary inflation and price inflation when necessary. With that said, monetary inflation will usually lead to price inflation. The only thing that can offset an increase in the money supply is having the banks increase reserves (which is happening now) or to have an increase in the demand for money (which is also happening now). If people decide not to spend as much money, then prices could still go down or remain the same, despite an increase in the money supply. People might do this because they are fearful of the future or perhaps they expect the money supply to tighten up in the future.

It is also important to note that when there is price inflation, it is not necessarily uniform. From the late 1990's to about 2006, prices were going up, but housing prices were going up much more. After that, housing prices went down (when the bubble burst) even though most other prices were not going down (think food).

If you are ever talking about inflation, make sure to differentiate between monetary inflation and price inflation if it is relevant to your discussion. Although they are often related, they are not the same thing.

Friday, August 6, 2010

Predictions

It is always dangerous to make predictions. All we can really do is take our best guess based on the facts that we have. It really is amazing how many people make crazy predictions though and they are things that are completely beyond our control. It even happens with libertarians.

If you have a basic understanding of Austrian economics, then you should understand that economics is really a study of human action. Human Action is the name of Mises' biggest and most famous book. You should understand that economic activity is made up of the decisions of millions of different people acting in their own way.

If we are going to make predictions, they should be reasonable. For example, if the money supply goes way up (and the money doesn't sit as excess reserves at banks), then it is reasonable to predict there will be price inflation. But we should realize that this isn't even a guarantee. It is likely, but not a guarantee. The money supply could double, but it is technically possible for the demand for cash to increase dramatically and for prices not to go up.

It is also reasonable to predict that politicians will continue to try to spend more and more money and make government bigger and bigger. It is generally a safe bet. But again, you are predicting the behavior of individuals. It is possible that a bunch of politicians will see the light and become honest and make government smaller. It is highly unlikely, but not necessarily impossible.

But then you get completely ridiculous predictions. There are predictions that we will have hyperinflation, or war with Iran, or a new world order, or a new currency in the next year. There wouldn't be anything wrong with these predictions if the people making the predictions admitted that it is only their best guess based on the circumstances. But for some people to make it sound like it is an inevitability is crazy. If it were Ben Bernanke predicting hyperinflation, we might want to listen because he might be able to make it happen. But everyone else is predicting human behavior and they shouldn't be so certain about their predictions.

If someone makes a prediction and says it like they are guaranteeing the outcome, you should think twice about listening to what they are saying. You can take a guess at human behavior, but you can never be certain.

Thursday, August 5, 2010

Gold Price and Interest Rates

This has been discussed here before, but it is an important point to mention again. The price of gold (compared to the U.S. dollar) has done well in the last few years and especially well in the last 10 years. There is a lot of uncertainty in this world and the rise in price is certainly justified.

Although some people are fearful of inflation down the road (and probably rightly so), it is not a huge factor right now in the price of gold. The reason for this is interest rates. If massive inflation were an imminent threat, interest rates would not be so low right now. Investors in bonds would demand a higher rate to compensate for the threat of inflation (being paid back in depreciated dollars).

While the gold price can still go higher, barring some catastrophe, the price is not likely to explode until we see interest rates go way up. Higher interest rates will signal the threat of high inflation as bond investors demand higher rates.

With all of that said, don't try to time things too much. If you don't own gold, get some. If the price drops, get some more.

Tuesday, August 3, 2010

Can the Fed Successfully Exit?

That is the title of an important article posted on the Mises Institute's site today. It explains a couple of important points that have been made on this blog.

First, the reason we have not seen high price inflation is because most of the new money created by the Fed in the last couple of years has gone to the banks. The banks have kept this money as excess reserves and have been unwilling or unable to lend it out.

Second, the Fed will have trouble exiting its "quantitative easing" (creating money out of thin air) from the past. When the Fed created this new money, much of what it bought were bad assets. For instance, it bought mortgage backed securities that are considered subprime. The bottom line is that these assets are not worth near as much as what the Fed paid for them.

If the Fed paid $1 trillion dollars for some bad assets that are really only worth $600 billion, then the Fed could only sell back these assets on the open market for $600 billion. What happened to the other $400 billion? It is new money in the system. If it sits on reserve with the Fed, this helps keep a lid on price inflation. If it finds its way out of the banks, it will eventually cause price inflation.

The Fed is in a tough place. It will not be as easy as they say to "exit". Watch the adjusted monetary base and watch the excess reserves held by banks. This will be your guide in preparing for high price inflation.

Monday, August 2, 2010

Harry Browne

Sometimes there will be certain themes repeated on this blog. It is only to serve as a reminder (probably because the issue is important) and also for the benefit of new readers.

Harry Browne, best known as the presidential candidate on the Libertarian Party ticket in 1996 and 2000, was also an investment advisor. He became somewhat famous by predicting the devaluation of the dollar and also the surge in gold in the 1970's. Later in his career, he wrote a book called "Fail Safe Investing". This book is highly recommended if you can get a copy. There are a lot of simple but important tips in it.

The best part about the book is his explanation of his permanent portfolio. Basically, he suggests dividing up your investments into 4 parts: cash, long-term U.S. bonds, stocks, and gold. It is explained in more detail in his book. If you have trouble sleeping at night because of your investments, this is highly recommended. It will do good in most times and for the short periods where it has lost money, it hasn't been much. For instance, in the fall of 2008, the portfolio would have gone down, but a lot less than someone with all of their money in stocks. In addition, it made a nice comeback and would be higher today (also unlike stocks).

In Harry's book, he recommends this permanent portfolio but says that there is nothing wrong with speculating with other money you have, as long as it is money that you can afford to lose.

A good plan of action: take 75% of your money (more if you are conservative, less if you are a gambler) and put it in the investments suggested for the permanent portfolio. There is also a mutual fund (symbol: PRPFX) that invests similarly to the permanent portfolio. Then you can speculate with the other 25% or whatever you decide. For instance, you could leave it in cash waiting for an opportunity or you could buy gold options or you could split it up into your favorite gold and oil stocks. But again, this is money that is somewhat of a gamble. It is money that you should be able to afford to lose. If you can't afford to lose it, then put all of your money into the permanent portfolio. You will sleep better at night.

Sunday, August 1, 2010

The Monetary Base and Excess Reserves

Take a look at these two charts:

Adjusted Monetary Base

Excess Reserves

If you look at them together with the same time period (1 year, 5 years, etc.), they look very similar. This is no coincidence. In the fall of 2008, the Fed began creating money at an unprecedented rate. It eventually more than doubled the monetary base, which is really the monetary chart that the Fed most controls.

When the Fed created all of this new money, it went to the banks. The banks were, and still are, scared to lend. They are afraid of future defaults (and probably rightly so). They would rather keep their excess reserves sitting at the Fed earning less than .25% interest instead of lending out this money. The banks could loan out this money as they are only required by law to keep about 10% on reserve.

The fact that the banks have kept these excess reserves with the Fed instead of loaning out the money is what has kept price inflation from skyrocketing. If the banks start to lend and the Fed doesn't reign in this new money, then we will see prices jump substantially. Keep an eye on these two charts. If the monetary base goes up without excess reserves going up, or if the monetary base stays about the same with excess reserves going down, then you should be prepared for massive price inflation and should prepare your investments accordingly.