Friday, December 31, 2010

Predictions for 2011

I don't like making predictions, particularly when it comes to economics and investing.  The problem is that there are too many variables.  The economy (and hence investments) are dependent upon human action.  The market is made up of billions of people acting according to their own needs and wants.  In addition, in a somewhat government controlled economy, we are also dependent on the actions of public figures and politicians.

I will not make a prediction for 2011 except that I think there will be more interesting times.  I think we will see gold cross well over $1,500 per ounce OR we will see the stock market drop by 20% or more.  It will mainly depend on the Fed and the banks.  Will the Fed carry out its QE2 (money creation) like it said?  Will it do even more?  If so, will the banks lend out this money or continue to increase excess reserves?

At some point, the Fed will have to choose between inflation and depression.  If it chooses more inflation, it will eventually have to choose between hyperinflation and severe depression.  I don't think the latter choice will have to be made in 2011.  The Fed will try to string things out for as long as possible.  It is much the same way that Congress deals with Social Security and Medicare.  Everyone tries to kick the can down the road so that the tough decisions have to be made by someone else.

The situation of state and city governments will grow more interesting.  These governments do not have the luxury of printing money.  Their day of reckoning is closer at hand because of this.  States like California, Illinois, and New York are in real trouble.  If DC bails out these states, it only pushes up the day of reckoning for DC and the Federal Reserve.

These state governments will have to default on at least some of their promises.  The sooner this happens, the better.  In Florida, there is a pre-paid tuition plan that parents can pay into when their child is young.  It is then promised that the child can go to any state university at no cost later on.  If you are a participant in such a plan in your own state and there is any hint of financial trouble for your state government, you should seriously consider pulling your money out if you can, particularly if your child is still young and years away from college.

As far as politics, 2011 will also be an interesting year to watch.  It is doubtful that Obama will get any serious challenge for the Democratic nomination, but the Republicans will be in campaign mode fairly soon.  The most interesting person to watch is Ron Paul and whether he runs for president.  Any other Republican will most likely be a typical establishment politician.  The only other exception may be Gary Johnson (former governor of New Mexico).  I would have to hear what he would say to see if he is worth supporting.

We will continue to watch the monetary base and excess reserves in 2011 to see if you should worry about a stock market crash or massive price inflation.  We will see how Ron Paul does chairing his subcommittee and we will see what kind of answers Bernanke provides to him.  We will see if this calms Bernanke down or if he will live up to his nickname of Helicopter Ben.

Pay attention to what is going on in the world, but remember to focus on things that you can control.  Do something good for you and your family.  Happy New Year to everyone and I wish you a safe, healthy, and prosperous new year.

Wednesday, December 29, 2010

Japan and Deflation

According to many, Japan has essentially been in a recession for the last 20 years or so.  Some of the "experts" say that Japan has been in deflation mode and we (meaning the U.S. government and Fed) need to make sure that it doesn't happen here.  There are a lot of myths to sort through here.

First, Japan has not really been in deflation mode, whether you define it in terms of the money supply or prices.  The central bank of Japan has inflated the money supply, but not anything like the Fed has inflated in the last couple of years.  Japan has had a few years with very minor decreases in the overall price level, but there have been many years with minor increases too.  Basically, the price level has been fairly flat over the last two decades.  Even in terms of prices, there hasn't been any significant deflation.

The Japanese people tend to save more and spend less than the American people.  This means that the velocity of money is lower as money changes hands less frequently.  This keeps prices down.  This explains why there has been some monetary inflation while prices have stayed relatively flat.

Of course, the biggest myth is that deflation causes recessions and depressions.  While deflation (prices or monetary) could be an effect from a recession, it doesn't cause it any more than a wet sidewalk causes rain.  Price deflation is actually a good thing for people as their money buys more, even if wages are going down.  In a free market economy (including a free market in money), there would be a tendency for prices to gradually fall.  This would represent an increase in technology and production which would allow people to buy more with their money.

There is one thing that is amazing about the Japan situation.  The debt to GDP is around 200%.  This is by far the highest of any first world country.  The debt to GDP in the U.S., as bad as it is, has not hit 100% yet.  The really amazing thing is that with such high government debt, that interest rates have remained as low as they have.  It just goes to show that human action is all that matters.  It seems that it would be irrational for people to buy bonds at really low rates when the debt is so astoundingly high.  But it doesn't matter what you and I think.  It matters what everyone else thinks and does.  There are obviously investors who think that bonds are a good investment despite the low rates.  I can't argue with the market.

If the Japanese government does not stop its Keynesian ways, rates will eventually go up.  But they have stayed low for 20 years, so maybe they will stay low for another 20 years.  It isn't likely, but anything is possible.

The people of Japan have a lower standard of living than Americans.  The Japanese government is ripping off the people of Japan as all governments do.  But the Japanese people tend to be hard workers and good savers.  Americans could learn a few lessons from the Japanese people on this.  The Japanese people could learn a few lessons about free market economics.  For the amount of productivity and investment by the Japanese, their standard of living should be much higher than it is.

Tuesday, December 28, 2010

Price Inflation, Monetary Base, and Velocity

This topic is discussed frequently on this blog, but it is a very important one.  It affects the economy in huge ways and it therefore affects our investments.  In most transactions that take place (which is billions of transactions in a day), money is on one side of them.  That is why money is such an important topic.

After the fall of 2008, the federal government, hand in hand with the Federal Reserve, bailed out failing businesses, particularly the banks.  The Fed more than doubled the adjusted monetary base, which is the money supply that is directly controlled by the Fed.  This doubling of the monetary base was unprecedented as nothing anywhere close to this had occurred since the Fed was created in 1913.  Many Austrian free market economists thought this would lead directly to price inflation.

However, another historic thing happened in all of this.  The banks are required to keep a certain percentage of money in reserve that is on deposit.  In the U.S., it is currently around 10%.  If someone deposits $100 into a bank, the bank will typically lend out $90 and keep just $10 in reserve.  The banks are counting on the fact that most depositors will show up at the same time to withdraw their money.  If this did happen (a run on a bank), then the FDIC would reimburse the depositors.  This protects the banks from runs and it allows riskier behavior for the banks.  But 2 years ago, the banks dramatically increased their excess reserves voluntarily.  The money that was created by the Fed did not flood the system.  Banks did not lend this new money.  This kept the fractional reserve process from taking place.

This is one of the major reasons that we have not seen massive price inflation.  There is one other reason too and that is velocity.  Velocity is the speed at which money changes hands.  After the fall of 2008, people became more conservative with their money.  As people were losing their jobs, housing prices were going down, stocks were going down, and people were becoming more concerned with the future, habits changed.  People did not spend as much.  Instead they paid down credit card debt and other debts.  They saved more money in their checking and savings accounts, even if the interest rate was really low.  The demand to hold cash went up.  In a recession, cash is king.  This means that money changes hands less frequently.  This has the effect of keeping prices down.  There are less people bidding prices up.  It has the equivalent effect of a deflation of the money supply.

This is why we have not seen massive price inflation.  While the CPI is certainly questionable, there is no doubt that the rate of increase has been low.  Prices also vary depending on what it is.  Housing prices have gone down lately while gold prices have gone up.  Food prices are going up, but certainly not as much as they could.

This is an important subject that should be monitored constantly.  Keep an eye on the monetary base and the excess reserves held by banks.  But it's also important to realize that velocity is a huge factor and it could change at any time.  It is almost impossible to measure velocity, but sometimes you can get a sense just by talking to people and listening to what is happening in the world around you.  When people start buying things because they expect the prices to go up later, then we should expect prices to go up even higher as velocity increases.

Monday, December 27, 2010

A New Year

The end of a year and the beginning of a new year is always a good time to assess things.  The new year is just a date on the calendar, but for some reason people use it as a time to reflect and look forward.  People make resolutions for the new year, but they could just as easily do this in the middle of July.

As far as resolutions, there is nothing wrong with them and you should do them if they work.  However, you shouldn't put off to January things that should be done before then.  Also, if a resolution consists of a good habit (like eating well or spending less), then this should be done year-round.  It is better to form good habits with exceptions than bad habits with exceptions.  It is better to eat well for most of the year but let yourself indulge during the holidays than it is to eat poorly for the year and then spend a couple of weeks in January trying out your resolution.

The end of the calendar year can be a good time to assess your situation in life and this includes your financial situation.  It is a good time to figure our your net worth and where you can do better financially.  You could just as easily do this in July or any other month, but will you remember to do it then?  That is why the end of the year is a good time.  You will be more likely to remember to do this exercise.

Take a piece of paper and write down your assets and liabilities.  Take your year-end statements from any 401ks, IRAs, brokerage accounts, bank accounts, etc.  Write down the amounts.  If you have anything else, estimate the value and write down the amounts.  Also, do this for your liabilities.  If you have car debt, a mortgage, or any other debts, write them down.  Figure out your net worth.  If you do not rent, figure out two figures.  Figure out your net worth with your house (minus your mortgage) and figure out your net worth without your house (also leave out any non-investments like cars or furniture).

After you do this, put this in a place where you can find it next year.  It may be in a filing cabinet or you may want to put it on your computer.  It will interest you to see what changes have taken place and if you are saving and investing the way you want.

In addition to this being a good exercise to seeing what you have done right and wrong, it is also good looking forward.  You can see where you can do better.  If you are not an active trader, it is also a good time to re-balance your portfolio.  If you like to keep an equal amount of stocks, bonds, cash, and gold, and stocks have gone up significantly in the last year, it is a good time to sell some stocks and add this to an investment that had done poorly.  Don't count on stocks to keep going up.  Put your investments back into balance.

Again, you can do this any time of year, but you will more likely remember to do this at the end of the year.  You weigh yourself to see where you stand.  Do the same for your finances and step on the scale.

Friday, December 24, 2010

The Possibility of Hyperinflation

I was talking to a libertarian friend the other day who said that we would have hyperinflation in this country (the U.S.).  I said that I didn't think it would happen here and we debated the topic.  I said that I would bet him 100 bucks that I would be right.  I figured that even if I was wrong, then I would be paying him 100 dollars that was basically worthless.

It is important to define hyperinflation.  Different people have different definitions.  Austrian free market economists talk about inflation as an increase in the money supply, which was originally the definition.  Most people today, when they talk about inflation, are referring to a general increase in prices.

The next question is what the "hyper" part means.  Does it mean an increase of 100% or more annually?  Does it mean an increase of 25% or more?  If someone says that hyperinflation means that prices will go up by 25% or more, then I wouldn't disagree with them that hyperinflation is a good possibility.

My friend was defining hyperinflation as prices going up every day.  It means that when you receive a paycheck or other money, you will be running to the store to spend it on almost anything.  It means that the velocity of money is very high.

I don't think this scenario is likely.  I think we will see massive inflation.  I think we may see prices going up 20% or 30% annually.  I think at that point, the Fed will pull back like it did in the late 1970's and early 1980's.  Bernanke is an elitist and a Keynesian, but he is not completely stupid.  I understand that hyperinflation has happened elsewhere.  I don't think we are in the same position as Zimbabwe of a couple of years ago or 1920's Germany.

You can never say never, but hyperinflation is not a high possibility in today's world in the U.S.  The Fed cannot get away with things as easily now.  With the internet and the virtually free flow of information, there will be too many people that understand that the Fed and its increasing of the money supply is what leads to massively rising prices.

In addition, I don't see why the Fed and bankers would allow this to happen.  They would be destroying themselves and the system that they built.  Gary North has made this point before.

When people talk of hyperinflation, I don't know that they think through the ramifications.  If I thought it was coming here, I would be looking for another country to live in.  We have a high division of labor society.  We are not farmers like 1920's Germany or 21st century Zimbabwe.  If hyperinflation happens, the trucks and trains will stop and there will not be food in your grocery store.  We are talking massive food shortages and riots.  You would not want to be here.

You should prepare your investments for a depreciating dollar.  You should expect 5 or 10 dollar per gallon gasoline in the next few years.  You should expect your grocery bill to double.  Let's hope I'm wrong and it isn't this bad.  If it is worse and we go to hyperinflation, don't worry about your investments.  Worry about moving yourself to another side of the earth.

Merry Christmas to everyone!

Wednesday, December 22, 2010

Austrian Economics and Predictions

Walter Block has an article on LewRockwell.com in which he lists all of the Austrian (free market) economists who predicted the housing bubble.  In it, he does give some interesting commentary about economics and making predictions.

Although I am not against making predictions, I always try to caution readers about them.  If I could predict the future with great accuracy, I would be richer than Warren Buffett and Bill Gates.  If there is one thing that Austrian economics teaches us, it is that humans act.  Because of this, it actually is impossible to predict the future with certainty.  For anyone who says they are 100% sure that something is going to happen (economically speaking), you would be wise to proceed with caution and take what they say with a grain of salt.

Because humans act freely, anything can happen in the economy.  Ben Bernanke could wake up tomorrow morning and read Mises and decide that he needs to stop expanding the monetary base at once.  He could take all of the Fed's documents and turn them over to WikiLeaks.  Now of course this is highly unlikely and we can predict with a fair amount of certainty that this is not going to happen, but anything is possible.

We could be sure that interest rates will be going up in the next few months due to the fear of a depreciating dollar.  And while you may be correct that the dollar is depreciating, not everyone else will see things the same way.  There might be some rich investors who are waiting to buy bonds at the beginning of the new year because they think it is a sound investment.  There is no way for you to know this.

If Keynes got one thing right, it is when he said that the market can stay irrational longer than you can stay solvent.  This is so true.  Nothing is a sure bet when it comes to the economy.  The closest thing to a sure bet is that governments will be incompetent and corrupt, but there are even exceptions there at times.

This is important to remember when investing.  It is important to get a good education in free market economics and it can certainly help you in your investing strategy.  At the same time, human action always makes investing unpredictable at least to some degree.

Tuesday, December 21, 2010

China, the Fed, and Bonds

I read an interesting comment a couple of weeks ago, but unfortunately I don't know who to credit for it.  The person said that with the Fed's announcement of QE2, it would give cover for the Chinese government to sell U.S. bonds.  The Chinese government has a little under a trillion dollars in U.S. bonds.  If and when the Fed keeps debasing the U.S. dollar, then the Chinese government will get paid back in dollars that are worth far less.  In other words, U.S. bonds may be a bad investment to have and the Chinese government has a lot of them.

Let's say that Bill Gates wants to sell a bunch of his Microsoft stock.  He would not sell it all at once.  Doing so would tank the stock and he would get less money for the sale of his stock.  He would sell it slowly so that he could get as much as he can for it.  The same goes for the Chinese government or another major holder of U.S. bonds like the Japanese government.  To the individual bond holder, he can sell at any time and he doesn't have to worry about moving the market in any significant way.  If a foreign government that owns hundreds of billions of dollars of U.S. bonds wants to sell, then it can't just sell it all at once or it would crash the bond market.

With the Fed's announcement of QE2 and buying $600 billion or more in U.S. bonds, it provides a buyer to those who want to sell.  All of a sudden, it would make sense for the Chinese and/or Japanese governments to sell their bonds since they have a willing buyer in the Fed.  This would have the effect of preventing interest rates from going lower, which is actually what we've seen since the Fed announced QE2.

This is all under the assumption that foreign governments would want to sell their U.S. bonds.  It makes sense to me why they would, but these politicians aren't always that bright, so it is hard to say what their mindset is.  But don't be surprised to see interest rates not go down while we see a big increase in the adjusted monetary base.  Wouldn't it be ironic if the Fed's big QE2 announcement to lower interest rates simply provides cover for the Chinese to sell their bonds?  It may be the perfect way out of the falling dollar for the Chinese and others.

The bond market is very unpredictable in the short run.  Other than a small portion for your permanent portfolio, I wouldn't bet a lot either way on bonds these days.  There will be a good time to short the bond market.  It might be now, but I still wouldn't bet against the Fed and its money creation.  Interest rates will eventually go up, but the Fed still may succeed in the short-term of keeping rates fairly low.

Monday, December 20, 2010

Government and Contracts

For anyone who has been paying any attention, the U.S. government is in over its head in debt.  The national debt is almost $14 trillion and the unfunded liabilities (mostly Medicare and Social Security) are estimated at as much as $100 trillion or more.  This will never be paid.  The "benefits" for Medicare and Social Security will be cut.  It is just a question of when, how much, and by what method they will be cut.

Now what about the national debt?  To pay back $14 trillion isn't totally impossible.  It would take considerable restraint and discipline by the government, so I guess it really is impossible from that aspect.  It is an interesting question for libertarians on what to do with the national debt.  Some libertarians believe that the debt should be paid back because the government entered into a contract with others.  There are many holders of U.S. bonds including foreign governments, foreign citizens, U.S. citizens, U.S. corporations, and the Federal Reserve.

It seems that the libertarian thing to do is to honor contracts and that usually is the case.  There is a major problem here though.  These contracts are not legitimate from a libertarian standpoint.  The U.S. government has sold bonds to others with a promise to repay the buyer with the interest agreed upon.  But the problem is that the government does not create any wealth of its own.  The only wealth the government has is by confiscating it from others, whether through taxation or inflation.

If person A loans person B some money and person B agrees to pay back person A by stealing money from person C, then this isn't a legitimate contract.  If person B is broke, then person A should take the fall, not person C.  Person C did not enter into the contract.  Just because his name was on the contract doesn't mean he should have his money stolen from him for person B to make good on his contract.

The same holds true for the government.  Since the government has to confiscate (tax) Americans to pay for the bonds, then the contracts are not legitimate.  The bondholders should take the fall.  The only other option is to treat it like any corporate bankruptcy.  You liquidate the assets and pay off the creditors.  In this case, the federal government should sell off its properties to make good on at least some of its promises.  Although we can't know the amount, there is property worth at least hundreds of billions of dollars, but probably more like trillions of dollars.  There are forests, national parks, oil fields, government buildings, government monuments, and many more things to auction off.  These should be sold to the highest bidder and the funds can be used to pay off bondholders (at least a portion) and those currently dependent on Social Security and Medicare.  This is similar to what Harry Browne suggested when he ran for president.

The government does not want to default, but it will be forced to eventually.  It will default through inflation first.  It will be painful.  At some point, it may default outright.  From a libertarian standpoint, this would actually be a good thing as compared to the alternative of hyperinflation.

Saturday, December 18, 2010

Legislation to Extend Tax Rates and Increase Spending

There are a lot of mixed emotions on the latest legislation to extend tax rates and increase spending.  The legislation extends the current income tax rates for 2 more years.  The estate or death tax goes up, but not quite as much as what was scheduled to happen.  The payroll tax on the employee portion of Social Security will be cut from 6.2% to 4.2% for one year.  Meanwhile, the legislation also includes increased spending, particularly an extension of unemployment payments.

The Republicans and Democrats compromised on this.  The Republicans got the tax cuts extended and the Democrats got more spending.  Meanwhile, we all get a bigger national debt.  Ron Paul supported the legislation because he said doing nothing would mean that taxes would rise.  I almost always agree with Ron Paul's votes, but I disagree with him on this one.  I completely understand his position and I am sympathetic towards it, but I think he should have voted no.

This legislation was a bribe to get the tax rates extended.  Other than the payroll tax being cut, this was not a tax cut.  This was preventing current tax rates from going higher.  If the tax part of this bill had stood alone as its own bill, then it would be appropriate to support it.  But it wasn't.  This was legislation that contained good and bad.  Ron Paul has typically voted against such legislation.

Extending unemployment is a joke.  If someone can't get a job after 2 years, they are either severely handicapped or they are just not trying hard enough.  Obviously 99.99% of the people fall into the latter category.  It is understandable.  If you are collecting unemployment checks and you can't find a job making significantly more, what is the incentive?  There are many people that wouldn't be looking for a job anyway.  Some people may have wanted to leave the workforce anyway and unemployment payments are just icing on the cake.  Any person that is not severely handicapped can find a minimum wage job within 2 years.  The government is just encouraging unemployment.  Unemployment paid by the government is unconstitutional and unlibertarian to start with.  Having it go for longer than 2 years is just plain ridiculous.

This legislation will just add to the deficit and debt because it doesn't address spending.  The federal government keeps on spending money like crazy and there seems to be no end in sight.  The end will be when the Fed has to stop buying bonds because of massive inflation.  Then interest rates will go really high and the government will be forced to cut back.  Then we will get a depression.  This is all reasonably predictable.  The hard part is trying to time it.

Thursday, December 16, 2010

Robert Murphy on Payroll Tax Cut

Robert Murphy has written an article discussing the payroll tax cut and its possible effect on unemployment.  Murphy is a clear writer and clear thinker.  This article today may be a little bit harder to follow than some of his other material, but you can still get a good idea of what he is talking about even if you don't understand his graphs.

The gist of the article is saying that the payroll tax cuts probably won't help the unemployment situation and may even hurt it.  Obama and the Republicans compromised on a tax and spending package.  It will retain the current income taxes and, like most things coming out of DC, will increase or retain spending on programs such as unemployment.  The other piece of the legislation is that it will cut the Social Security payroll tax from 6.2% to 4.2% for one year, but just on the employee portion.

In this article, Murphy discusses and confirms comments by Bryan Caplan.  Basically, he says that by reducing the employee portion of the payroll tax and not the employer portion, it could actually cause an increase in unemployment.

This makes some sense.  There are several ways to reduce unemployment (reducing government), but basically wages need to fall or productivity needs to increase.  If we have high inflation in the future, this could help with unemployment in one sense because it could reduce real wages even if people don't see a number reduction on their paycheck.  In giving a payroll tax cut to the employee, it actually increases their take home pay.  This has actually increased wages, in a sense.  But we need wages to fall if the market is going to clear the unemployment problem.

Aside from this argument, the problem once again is spending.  The Republicans and Democrats compromised.  The Republicans got tax cuts and the Democrats got more spending.  We need lower taxes with lower spending.  This whole thing just adds to the deficit and the debt and brings us closer to the day of reckoning.  We should take advantage of any money that we can get now and convert it into real assets, whether it is gold, silver, housing, food, or toilet paper.  You don't want to be in dollars when the massive inflation comes.

Wednesday, December 15, 2010

Hoarding is Good for Society

There are many fallacies that exist in the world of economics.  One of the worst fallacies is the Keynesian myth that spending drives the economy.  Spending does not make someone or a nation rich.  Almost everyone likes to spend.  The problem is having the money to spend in the first place.  In the case of an entire nation, the issue is production.  You can only buy something that is first produced.  If spending was all that mattered, then everyone on earth would be rich.  Don't you think that people in poor countries around the world would like to buy things as much as Americans do?

To go along with this myth, there is another economic issue in which we need clarity.  Even some libertarians don't understand this point.  Hoarding money does not hurt the economy any more than spending helps the economy.  Many people think that if people aren't spending, then they should at least be investing or loaning their money out.

Let's walk through this carefully.  Let's say there is a billionaire who decides to take a billion dollars and put it under his mattress.  If this is too extreme of an example, let's say he puts his money in an offshore bank and for the sake of argument, let's even say that the bank keeps all of the money in reserve and doesn't lend it out.  Is this billionaire hurting the economy?  Not only is the answer no, but I would argue that he is helping the economy.

Let's say you build a shed from scratch.  You cut down a tree in your yard, you saw up the wood, and you hammer it together to make a finished product.  You then sell your shed to your neighbor for $100.  At that point, you take your $100 and you put it under your mattress, you bury it in your yard, or you burn it.  The point is, you don't spend the money or loan it out or invest it.  You just did the economy a favor.  You just built a shed for free.  It wasn't free to your neighbor who spent his $100, but it was free to society.  You just deflated the money supply by $100.  Now everyone else that owns U.S. dollars has just benefited by your action.  Their money is now worth more than before because you took $100 out of circulation.  Of course, one hundred dollars is negligible, but the point stands.  Everyone benefited at your expense.  You labored and made a shed and you did it for society for free.  There is one more shed in existence now that didn't exist before and you still haven't consumed anything for your labor.

The same thing happens with the billionaire.  Assuming he made his money honestly by selling his labor or goods and services, then the billionaire is doing society a favor by hoarding his money.  It is less money to bid up prices.  It makes things just a little bit cheaper for everyone else.

We so often hear that you should help the economy by going out and spending some money.  It is really the exact opposite.  If you want to help the economy, take your money and hoard it.

Tuesday, December 14, 2010

Foreigners Buying Real Estate

The news on real estate continues to be bad, at least for those owning real estate.  Since the government tax credits (subsidies) expired earlier this year, housing sales have struggled.  Now interest rates have gone up in the last few weeks, which makes housing seem even more bearish.

Today, there is an article saying that foreigners are flocking to Florida for real estate bargains.  This should not be surprising.  Prices are way down from where they were 4 years ago, interest rates are still relatively low, and it is even more attractive to foreigners because the dollar is weak.  Some foreigners may be paying one quarter of what they would have paid 4 years ago due to the huge drop in prices and the weaker dollar.

It really astounds me how many articles are out there saying, essentially, that you'd have to be an idiot to buy a house right now.  Unless these people were saying the same thing 3 or more years ago, then they are not worth listening to.  If someone thinks that only an idiot would buy a house right now, then what does that make someone who actually bought a house 4 years ago that is now only worth half of what was paid for it?

If you are considering buying a house, then you should do it for the right reasons.  If you are going to live in it, then it is a consumer good you are purchasing.  You should be able to afford it.  If you are buying a house as an investment, then you should be able to afford it and you should be able to get positive cash flow from it.  If you meet these criteria and you plan to own it for a while, then there is absolutely nothing wrong with buying right now.  You can find some really good deals in some areas and you can still get a relatively low interest rate on your mortgage.

While housing will continue to struggle with the down economy, high unemployment, and a lot of foreclosures, I think it will be ok longer term.  This is not a prediction, but if I had to guess what housing prices will look like in 5 years, I think they will be down in real terms (adjusted for inflation), but I think they will be up in nominal terms.  In other words, housing prices may not keep up with inflation in the next few years, but prices will still be up from where they are now.  Food and gasoline are likely to go up in price by a greater percentage.

As the dollar weakens and price inflation starts showing up more, people will get back into housing for the simple reason that a house is a hard asset.  The Fed can't print houses like it can money.  If you buy a house now with a 30 year fixed rate mortgage, there is a good chance that your last payment in 30 years will be about the equivalent of a nice dinner.

Monday, December 13, 2010

The Importance of the FDIC

During the Great Depression, there were runs on banks.  Even though the Fed was printing money, the runs on banks led to, in effect, a contraction of the money supply, due to a reversal in the fractional reserve lending process.  Out of this, came the FDIC, another Roosevelt government program that is still causing massive damage to this day.

It sounds scary to most people today when they consider a world with no FDIC.  After all, how are they supposed to be assured that their money is safe?  First, it should be pointed out that there are no guarantees in life no matter what.  There are a million different ways that you could lose your money, with or without the FDIC.  Second, with no FDIC, consumers would actually pay attention to the solvency of banks.  Now you many think that you don't have the time or knowledge to research banks, and that would be the case for most people.  But like anything else in our economy, it would be done by the whole market.  You are not a mechanic and yet you manage to buy a car.  You are not a farmer or food inspector and yet you manage to buy safe food.  It would be the same with banking.

The FDIC has created huge moral hazard.  Banks have taken on far more risk than they ever would without this insurance.  In addition, it is the Federal Reserve with its power to create money out of thin air that allows the FDIC to exist.  Without the Fed, the FDIC would not be able to guarantee deposits.  The FDIC would be broke in no time.

This whole system creates a huge problem.  It is one of the reasons for the panic that happened 2 years ago.  It was one of the reasons for the huge bailout.  If there had been no bailout, there would have been bankrupted banks with depositors losing their money.  Then the FDIC would have stepped in and gone broke.  Then the Fed would have bailed out the FDIC.  This chain of events would have been better, because at least the bailouts would have just gone to depositors and would not have propped up failing banks.

In a libertarian world, there would be no Fed and no FDIC.  The best case scenario now is to phase out the FDIC.  Everyone would be surprised by the changed behavior of the banks.  You might have to start paying a fee to have a checking account with a bank.  But at least we wouldn't have huge bailouts and a constantly depreciating currency.

The FDIC is a tough issue for libertarians.  Should depositors be stiffed?  How do we go about eliminating the FDIC without causing a major crisis?  Do we abolish the Fed first or the FDIC?  Or do we abolish them in tandem?  There are a lot of interesting questions.  One thing for sure though is that there is no place for the Fed and the FDIC in a free market.

Sunday, December 12, 2010

Payroll Tax Cut

There is an article, linked on DrudgeReport today, that says some Social Security advocates fear a cut in the payroll tax.  Obama recently proposed cutting the payroll tax for Social Security from 6.2% to 4.2% for one year.  It can be assumed that this would just be the employee's share of the tax and not the employer's.

This is a joke.  Social Security is a Ponzi scheme.  Not only that, but any additional tax collections that should have been saved have been spent.  There is a Social Security trust fund that is filled with IOUs.  The federal government basically owes itself this money.  It really doesn't make a difference at this point.  The taxes collected for Social Security have been mixed with the general fund for decades.  The Social Security surplus money of the past has been spent.  Now that it is in deficit, it will be the general fund that makes up the difference.  We can't say whether it is federal income taxes, excise taxes, corporate taxes, or money printing that will fund the shortfall in Social Security.  All of this money is mixed together.

This is what allowed Clinton to declare a surplus in the late 1990s.  This was a lie.  The payout for Social Security was less than what was collected at that time.  This money should have gone to the Social Security trust fund.  Instead, part of the money was spent and the remainder was used to proclaim a surplus.

Now Social Security is in the red as the payouts are greater than the tax collections.  It isn't an insurance program and it never has been.  It is broke and there is no way the government will be able to keep all of its promises.  There is going to be a default eventually.  The question is whether it will be a default through inflation or outright default.  I think it will be a combination.  Either way, the whole system is in jeopardy.  It will be painful for many, especially those who are highly dependent on the government.  But the laws of economics have caught up with the system. It will go bust and will be cut back severely.  Long-term, this should be a good thing.

From a personal standpoint, support any cut in taxes that you can, even if it is the payroll tax.  The government is going bust anyway.  We might as well get what money we can now.  The environment continues to point to high future inflation.  We should use any tax cut to increase our positions in hard assets that will hold their value with high inflation.  Take what you can get while it is still there.

Thursday, December 9, 2010

Obama, Tax Rates, and Unemployment

The current tax rates are still set to expire at the end of the year.  If nothing is done, the rates will rise.  It had looked like Obama and some of the Republicans had a deal, but now the House Democrats are shooting down the plan.

There are a lot of reasons for unemployment being so high.  One big reason is the Austrian Business Cycle Theory.  The prior Fed inflation caused an unsustainable boom that went bust.  Now, resources are trying to realign themselves to more sustainable things.  Other reasons for high unemployment include the minimum wage, other labor laws, and taxes.

There is another factor in the unemployment situation.  In 22 days, the current tax rates will rise if nothing is done.  How are businesses or individuals supposed to plan in this kind of environment?  There is enough uncertainty with the current economy and the unstable dollar (QE2).  That is bad enough.  But we don't even know what our tax rates will be in 22 days.  This is really truly unbelievable if you think about it and you can blame both major parties in DC.

The Republicans never made the tax cuts permanent.  Instead, they only passed tax cuts through 2010.  Then the Democrats had almost 2 years, along with Obama, and nothing has been done yet.  On top of it all, this deal that was supposed to happen between Obama and some Republicans wasn't really a good deal for us citizens.  There were a couple of good things like maintaining the current income tax rates and possibly reducing the payroll tax for a year.  But then there were all kinds of welfare included in the bill, including extending unemployment and funding Obamacare.  So yes, the Republicans have already caved on Obamacare.  To top it off, the death tax would come back at a rate of 35% with an exemption on the first $5 million.  So I guess it would only be the really rich people committing suicide on December 31.

DC is so far gone, it really is hopeless.  We just have to make sure that when the house of cards falls down, that we have done a good job of educating people on the benefits of liberty.  Until then, we should hope for reduced taxes.  The government will continue to spend and inflate, regardless of what the tax rates are.  We might as well try to get our benefit now and convert some of our money into hard assets while they are still relatively cheap.  In the meantime, sit back and enjoy the show and let's see if Congress can get the tax rates figured out in the next 3 weeks.

Wednesday, December 8, 2010

Bonds Take a Beating

The bond market has taken a beating in the last couple of days.  Interest rates have gone up quite dramatically over just a 2 day period and mortgage rates are following.  This is ironic, considering the fact that Bernanke's reasoning for QE2 is to lower interest rates.  Rates have gone up since his announcement of QE2.

I have been saying that for gold to go to the moon, interest rates would have to start rising.  It's not that high interest rates cause gold to go higher, but there should be some correlation if gold starts to rise dramatically due to price inflation.  It has been a battle between gold and bonds up to this point.  Both did poorly today. Bonds have been telling us that there is little to worry about as far as inflation because rates have been so low.  Gold has been rising, which is possibly telling us something different.

I think for gold to go to $2,000 per ounce or more, interest rates are going to rise.  This is not to say that you should wait to invest in gold until rates rise.  You should be significantly invested in gold or gold related investments now.  But again, for gold to really go sky high at this point, we need to start seeing some price inflation.  You may see a little price inflation at the gas pump and the grocery store, but the bond market has been telling us that it is not a significant threat in the future.  I think the bond market is finally waking up to the reality.

With all of that said, I would not short the bond market at this point.  If you do, you should know that it is a total crap shoot.  Bernanke has barely started QE2, if at all.  QE2 means the Fed will be buying bonds.  Although it means the Fed will be inflating the money supply (despite what Bernanke says) which could ultimately be negative for bonds, for now the Fed will be bidding up bond prices.  It's not to say that the Fed will be successful in driving down rates in the short term, but I wouldn't bet against the Fed at this point either.

Tuesday, December 7, 2010

More on Bernanke and His Interview

Yesterday I talked about Ben Bernanke's interview on 60 Minutes.  It is still a fascinating topic.  Here is one of the most powerful men in the world.  I won't say that he is the most powerful because he can't launch a nuclear attack, but he could certainly fund it.  This is a guy that essentially controls the nation's money supply.

The interviewer asked some decent questions, but the problem is that he had no follow ups.  This makes him almost useless as an interviewer if he is not going to challenge Bernanke on the things he says.  I keep going back to Bernanke's comment that he is not changing the supply of money in circulation.  How can he make this comment and not elaborate?  How can the interviewer not follow up?  Up until this point, his statement is true.  The monetary base has not risen, even after his QE2 announcement.  I'm not sure when it will start to rise.

But if he goes through with QE2, then the monetary base has to go up.  It will be an increase in the supply of money.  The Fed is technically not printing money, but they are doing the equivalent and creating money out of thin air.  It is done on a computer instead of a printing press.  But the key word in his comment is "circulation".  He is saying that the increased money supply won't be in circulation.  If he really means this, then that means that banks will continue to accumulate excess reserves.  But then if they are doing this, then that defeats the whole purpose of him lowering interest rates.

This whole thing has to be price inflationary at some point.  The velocity of money has been low since the fall of 2008.  This has helped keep prices down.  At some point, some of this money will end up in circulation.  Bernanke cannot time when he is going to withdraw the money.  He will get into a situation, something like the 1970's, with high price inflation and a stagnant economy.  He will eventually have to choose between massive inflation and depression.

The problem, as I've pointed out before, is that he will not be able to withdraw all of the new money.  In 2008 and early 2009, the Fed bought assets from the banks in the form of mortgage backed securities.  Some of these are now only worth a fraction of what the Fed paid for them.  Selling them back into the market will only withdraw a portion of the money that was used to buy them in the first place.

Bonds are the same way.  If interest rates go up, the bonds they have bought will be worth less.  They can withdraw some of the new money, but not all of it, if interest rates rise.  I really don't think Bernanke knows what he is doing now.  He cornered himself in many years ago when he apologized to Milton Friedman on behalf of the Fed for allowing the Great Depression to happen.  Bernanke thinks that it was the Fed's fault, not because of the initial artificial boom, but because the Fed did not print enough money once it was there.  This is his legacy.  He is trying to make sure that he doesn't allow another Great Depression on his watch.  In the process, he will just about destroy the U.S. dollar.

Monday, December 6, 2010

Ben Bernanke on 60 Minutes

Ben Bernanke was on 60 Minutes last night.  If you didn't get to see it, go ahead and watch it.  This is one of the most powerful men in the world.  Even if you don't like him and think he is a total liar or a total fool, you should still pay attention to what he is saying.

The interview is quite interesting.  The first thing I noticed is that he sounded nervous.  Maybe I don't listen to him enough and this is the way he always sounds.  While there were a lot of interesting soundbites, the most interesting one was about inflation.

The interviewer asked him about inflation.  Bernanke said that "the amount of currency in circulation is not changing.  The money supply is not changing in any significant way."  He said they are lowering interest rates to stimulate the economy.

I don't understand what he is talking about here.  Is he saying that the banks will increase their excess reserves (as was done 2 years ago)?  That is what one economist thinks (see halfway down the article).  That is really the only explanation for his comment.  If the Fed is buying U.S. bonds, then it is creating money.  The government could sell bonds to individual investors, to companies, or to foreign governments and none of these actions alone would be inflationary.  But if the Fed is buying U.S. government bonds, then the Fed is creating money out of thin air to buy them.  Therefore, for him to say that the amount of currency in circulation is not changing, would have to mean that the additional money gets bottled up at the banks.

Of course, he didn't say this and the interviewer didn't follow up with him.  It contradicts his other statements.  If he is engaging in QE2 to lower interest rates and encourage lending, then how is lending taking place if the banks are increasing their excess reserves?  So are the banks going to lend or are the banks going to increase reserves?  Which is it Bernanke?  And what is it you want them to do Bernanke?

The man is either a liar or a fool.  But he is in a position of great power and we must listen to what he says. His actions dictate the future of the economy and they dictate how certain investments will behave.  If he is right that there will be no additional money in circulation, then we should be cautious about stocks and gold.  If he is wrong, then we should expect high price inflation to follow the high monetary inflation and we could see gold skyrocket more than it already has.

Saturday, December 4, 2010

The Fed and Foreign Firms

Shockingly, it has been revealed that in 2008 and 2009, the Federal Reserve (Fed) not only bailed out U.S. banks, but it also supported many non-banks and many foreign banks.  It is not shocking that it happened (for anyone paying attention), but it is shocking that it was actually revealed.

Of course, during the time, we heard cries from Bush, Paulson, and all of the other establishment figures in DC, telling us that we had to have a bailout or we could see the whole system collapse.  Due to the threat of a run on banks, there was a slight element of truth to what was being said.  After all, a run on the banks could have collapsed the banking system (because of the severe fractional reserve lending and the bad loans that had been made by banks) and then it would have been left to the FDIC to pay the bill.  Since the FDIC wouldn't have been able to cover 1% of the total deposits necessary, then it would have been bailed out by the Fed.  From a libertarian standpoint, we will address this issue at a later time, but I am just pointing out that there was a slight element of truth of what was being said by the establishment.  They weren't specifically talking about bank runs very much, but that really was a threat.

With all of that said, most of the bailout was a total fraud.  It was obvious then for anyone who knows how the government operates, but this latest story reveals just what a fraud it was.  The Fed was bailing out companies like Verizon, Harley Davidson, and Toyota.  We already knew that it bailed out GM and Chrysler.  These bailouts have almost nothing to do with the banking system and a possible financial collapse.  It is simple favoritism.  It is corporatism.  It is fascism.  It is almost everything but capitalism.

By propping up these companies, the government is wasting resources.  Whether it is through loans or straight subsidies, the government is taking private money (whether through taxes or inflation) and it is directing this money to failure.  It is misallocating resources on a grand scale.  This money could have been used towards profitable companies or towards savings and investment.  This money should have been allocated by the billions of individuals that owned it.  Every person and entity that has U.S. dollars in their possession was ripped off by this.

Not only is this a waste of resources and will mean a lower standard of living because of a decrease in savings and investment, it will also have to be corrected.  The Fed has delayed the correction process.  In the future, these resources will have to be directed by the free market to their proper place.  They will shift from failed companies to profitable ones.  This will take time and pain, but the correction is necessary.

The government and the Fed keep making things worse.  They are delaying the inevitable and the correction will be worse for it.  Be prepared for interesting times ahead.

Thursday, December 2, 2010

Tax Rates and the Stock Market

There is an article (via Drudge Report) that says a failure to extend tax cuts, especially the capital gains rate, could lead to a stock market crash.  Basically, people would look to lock in gains at the lower capital gains tax rate.

This makes sense in a lot of ways.  If you sell a stock for a loss to try to claim the loss on your tax return and then you buy back the same stock, you could be subject to the wash-sale rule if you bought it back within a certain time frame.  I know of no such rule for selling winners.  That is because the government usually wants you to pay your tax and would rather you pay it now than later.  You almost have to wonder if congress comes up with some kind of penalty for selling a winning stock and then buying it back within a short time frame.

If I had a winning stock, I would sell it before the end of the year.  Why not pay the lower capital gains tax rate now than pay a higher one later?  And if you still want to own the stock, you could always sell it and buy it back.

This scenario is a real possibility.  The only question is how many people own winning stocks right now.  The market is about even over the last decade.  But still, there have been enough wild swings that there are definitely more than a handful of people that own winners right now.  There might be people who bought shares in March of 2009.  There might be people who bought 15 years ago that never sold.  There also might be people who bought individual stocks that have been winners (for example, Apple).

This could signal trouble for stocks that have had a big run lately.  A hike in the capital gains tax rate would give shareholders an incentive to sell before the end of the year.

While nothing is a guarantee (and that is always the case in investing), it might be an interesting time to speculate in shorting the market.  Before anything, I would lighten the load on stocks if you own any.  But you could also try speculating with a short ETF.  There are short ETFs for the major markets.  There are also double and even triple shorts for leverage.  Again, this would be a speculative play, but it might be worth a gamble with a small percentage of your money.

Wednesday, December 1, 2010

U.S. Ready to Bail Out EU

This is the latest news.  Nothing is really a surprise anymore.  The report says that the U.S. would be ready to commit extra money to the International Monetary Fund (IMF) which ultimately would be seemingly used to bail out failing European governments and banks.

How significant is this development?  By itself, it is not that significant.  But it is just another sign that the governments of this world are out of control and the U.S. is in as much trouble as any other government.  The U.S. government has been able to prolong its out of control spending and debt because the U.S. dollar is the reserve currency of the world.  But this too will come to an end eventually.

Greece, and now Portugal and Ireland among others, have felt the pinch because they are more like state governments in the U.S.  For example, Greece is more like California than the U.S. government.  Why?  The reason is because Greece does not have direct control over the euro, which is the currency that is used in the country.  California also does not control the U.S. dollar.  That is up to the Fed.  In Greece's case, it is the European Central Bank and the other governments of Europe that can bail out Greece.  Greece cannot simply print money to buy its own bonds the way that the Fed does.

But every game like this must come to an end.  The game of the U.S. government and the Federal Reserve will come to an end eventually.  We can know this by studying Austrian free market economics.  The Fed will eventually have to make a choice.  It will face hyperinflation and it will have to choose.  It can either completely destroy the dollar or it can save it.  I think the Fed will try to save it, but hopefully before it is not too late.  To save the dollar, the Fed will have to refuse to buy more government bonds.  This will drive rates sky high.  The congress and president will then have to choose.  They will have to cut back severely (including Medicare, Social Security, and the empire overseas) or it will have to default on its debt.  It may have to do some combination of both.

Either way, the day of reckoning is coming.  Be prepared with your family and your investments.  Try to educate others on why this is happening.  Try to educate others that liberty is the answer to our problems and not more government.  Then when the dollar and DC come crashing down, we will be there to pick up the pieces and instead of continuing with more big government, we can move forward with peace and freedom.