Monday, January 31, 2011

Adjusted Monetary Base Finally Shows QE2

For the last couple of months, we haven't really seen the adjusted monetary base shoot up.  Bernanke announced, in early November, the Fed's plan to buy an additional $75 billion in U.S. bonds each month for 8 months.  What he said did not seem to be coinciding with the chart of the adjusted monetary base, which is the monetary measure that the Fed directly controls.

Finally, we can see that the Fed has done some major buying.  The monetary base shot up in one week as reported last Thursday.  The updates come out each week, usually on Thursday.



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

Now look at the one-year chart for excess reserves held by commercial banks:


fredgraph.png


Just as the monetary base turned up, so did the excess reserves held by banks.  this means that, at least so far, most of the money being created by the Fed is going into the banks and not being lent out.  This means it could take longer for price inflation to show up.  This new money is not being injected into the economy and the fractional reserve process is not multiplying the effects.

We will continue to watch these charts and see if there are any reversals.  For right now, it seems that QE2 is finally showing up in the monetary base and it seems that it is going into excess reserves.  Stay tuned.

Saturday, January 29, 2011

Revolution in Egypt

There is something very significant happening in the world right now.  At this moment, it is appearing in Egypt.  For several days, there have been massive protests in Egypt, and it seems to be directly aimed at the Egyptian government.

Like most conflicts that happen in this world, it is not necessarily a black and white case of good vs. evil.  I'm sure there are different people protesting for different reasons.  Some of it may be a mob mentality.  Some may be demanding more government handouts.  But there is a real sense that a good portion of the mentality is that people are fed up with their brutal government.  This all came about in Egypt right on the heels of similar protests in Tunisia.

Overall, this could be a good thing for our future.  Of course, any violence that occurs from either side is wrong, unless it is purely in self defense.  It is hard to see how anyone on the side of the Egyptian government can claim self defense.  The biggest significance of what is happening in Egypt is that the mentality seems to be spreading.

There is an article on CNN (via Drudge) that says the Saudi king is slamming protesters in Egypt who seek to destabilize their country.  Of course, the Saudi government would say this because they are in the same position as Mubarak.  Hosni Mubarak has been the Egyptian president (really dictator) for nearly three decades and the only way he has been able to maintain power for so long is by backing from the U.S. government.  The same can be said for the Saudi family.

Courage is like a virus that can spread easily.  If the people in Saudi Arabia see a toppling of the government in Egypt, they might think it is more possible to topple their own.  Despite what you might hear from Sean Hannity, this is mostly not about radical Islam.  This is about oppressed people throwing off their brutal rulers.

It is hard to say what it would take in the U.S. for something like this to happen.  We have already seen the Tea Party in action, but things tend to be far less violent here, which is a very good thing.  Perhaps when people stop receiving their Social Security checks you will see millions of demonstrators in the streets.

This whole event is quite significant, not just because of Egypt, but because of the precedent it may be setting.  If we see something similar happen to Saudi Arabia, it will impact our economy and investments in a big way.  The situation in Egypt already, at least seemingly, caused gold and oil to spike on Friday.  If something starts happening in Saudi Arabia, watch for oil to shoot by $100 per barrel and way beyond.  Just the fear of a disruption in the oil supply will send prices soaring.

This whole thing could end up being a major part of history.  Just like the falling of the Berlin Wall was a precursor to the falling of the Soviet Union, this event in Egypt could lead to a toppling of a lot of thug dictators in the Middle East and elsewhere.  The U.S. government is in panic mode right now, even if the politicians are trying not to show it.  The U.S. government props up dictators all around the world (and we wonder why there is blowback in the form of terrorism) so that the dictators can bow to U.S. politicians.  These bribes (at U.S. taxpayer expense) may be coming to an end faster than we could have thought.

Let's pray for peace in Egypt and elsewhere, but let's also hope that the people can shrug off their rulers. Let's also hope that the people there turn towards liberty and not towards another thug dictator.  Just as bad would be for them to think that democracy is the answer to their problems so that they can elect a thug as president.  They should seek decentralization and individual liberty.

Thursday, January 27, 2011

State Bankruptcies

There is more open talk about U.S. states filing for bankruptcy.  Although I don't see the Republicans in the House of Representatives doing any great things, it does seem that a Republican majority in the House makes it less likely that state governments will get a bailout from Washington DC.

The states that are the worst off financially are blue states (perhaps not coincidentally).  Some of the states that are in real trouble are Illinois, California, New York, and New Jersey.  Why would the Republicans help in a bailout for states that usually vote Democratic?

It is hard to say which state is the worst.  New Jersey has a Republican governor now and he is actually somewhat fiscally conservative, at least compared to others that we hear the term used for.  New York, while in trouble, did not get as big of a bust in the housing market.  New York City is still a place where a lot of people want to live and work and there isn't much land there.

I think the two leading contenders for bankruptcy are California and Illinois.  Both state governments are in massive debt and they have almost kicked the can down the road as far as they can.  They are in severe debt.  They are both in a situation similar to Greece or Ireland.  State governments cannot print money to hold off the problem.

This is why state bankruptcies will be a precursor to any implosion in DC.  The federal government can continue to kick the can down the road until it faces massive inflation or hyperinflation.  It can continue to run massive deficits because of the Fed's monopoly on the money we use.  The states do not have this privilege.  The states will truly run out of money and will be unable to pay the bills.  The only choice will eventually be bankruptcy and dramatic cuts in spending.  Overall, while it will be painful for many, it will be a good thing for the long-term.

If you own any municipal bonds, get out.  If you are dependent on a state or city pension, start saving more money and be prepared for this money to be cut.  If you are in a college pre-paid fund for your child, you might want to consider pulling the money if you can, especially if your child is years away from going to college.

All of this talk of states filing for bankruptcy would have been unheard of just a few years ago.  It just tells us how dire of a situation things are in.

Wednesday, January 26, 2011

SOTU Speech and Your Investments

Last night, Obama delivered his state of the union speech.  You can read a full transcript here:
http://www.nytimes.com/2011/01/26/us/politics/26obama-text.html?pagewanted=1&_r=1

Bottom line, I don't seen anything new here.  It was a typical speech given by a typical Keynesian president.  The conclusion you can reach from the whole thing is that he will try to maintain the status quo of big government, big spending, and continued war.

Obama said that he is proposing a freeze on annual domestic spending (whatever that means) for the next five years.  I'm not sure if that includes Social Security or Medicare, but I doubt it.  There is little chance that his proposal will come to fruition.  He is speaking meaningless words.  But even if it did happen, he says that it will reduce the deficit by more than $400 billion over the next decade.

Let's make sure we understand the difference between deficit and debt.  The national debt is about $14 trillion.  The annual deficit right now is about $1.5 trillion.  That means we are adding $1.5 trillion every year to the national debt.  So if we reduce the deficit by $400 billion, then that means we will get an annual deficit of $1.1 trillion in a decade.  In other words, we will continue to add more than a trillion dollars a year to the national debt every year for the next decade.  Do the terms "massive inflation" and "default" mean anything now?

Obama also talked about innovation.  He did cite some past innovations that were done with little or no government.  But then he talks about innovations as if the government has to somehow help.  He talked about electric vehicles and high speed rail.  Of course, his plan is to subsidize these things with taxpayer money (or perhaps printed money).

Obama is a Keynesian.  He is a believer in big government, just as Bush before him.  Obama believes that the government has to help innovate.  He does not understand that if something is worth doing, then it shouldn't have to be subsidized.  As Austrian economists, we talk about malinvestment as it relates to the Fed printing money.  But there is almost always malinvestment when the government spends any money at all.  If consumers want high speed rail, it should be profitable for a business to provide the service without government subsidies.

Obama also mentioned regulations and said that he ordered a review of government regulations.  He said that when we find rules that put an unnecessary burden on businesses, we will fix them.  Um, can you say "Obamacare"?

In conclusion, this speech was nothing new.  The federal government is heading over a cliff.  Maybe it will speed up or slow down a little before reaching the edge, but there is no stopping it.  Prepare accordingly.

Tuesday, January 25, 2011

A Harry Browne Classic

Harry Browne, the two-time presidential candidate for the Libertarian Party, wrote some brilliant pieces.  He was well-versed in all things libertarian and also contributed greatly in investing.  He even wrote a self-help book.  Today, I want to focus on an article he wrote back in 1992 dealing with economic fallacies.

One of the great things about Harry Browne is that, although he passed away almost 5 years ago, you can read his material today and most of it still seems relevant.  Even things that were written 40 years ago seem relevant today.  This article from 1992 is no exception.

If you listen to much economic analysis (if that's what you want to call it) from the mainstream media, you are likely to hear that we need more manufacturing in our country.  Of course, when I hear that, the commentator who says it doesn't usually offer up a specific solution.  Does he want to force people to do certain jobs?  Does he want protectionist tariffs?  Does he want us to be forced to buy certain products made in the U.S.A.?

This topic is brought up more frequently now because of China.  For some reason, some people in the U.S. think that the Chinese are a threat.  Does it really matter that we buy a lot of "stuff" from the Chinese?  Does having an imaginary line between two countries (called a border) somehow make trade wrong?  If the Chinese have a comparative advantage in manufacturing things, while Americans sell services, so what?

If there is less manufacturing in the U.S. because of government and central bank policies causing malinvestment, then that is certainly a problem.  But that is not what a lot of people are talking about.  If that is the case, then of course the solution is to get the government and central bank out of the way and let the free market prosper.  The market will allocate resources the most efficiently and if that means more or less manufacturing for Americans, then I don't really care.

Harry Browne's arguments from almost 20 years ago are as relevant today as they were then.  We would be wise to listen.

Monday, January 24, 2011

Hyperinflation vs. Deflation

Last week, there was an article on Mises.org by Vijay Boyapati.  He says that there are two classes of people that operate the state: the political class and the banking class.  He says that the banking class (which includes the Federal Reserve) is in charge of monetary policy in the U.S.

He makes a case that hyperinflation will not happen in the U.S.  He says that the banking class will not let this happen because doing so would be destroying their own system.  I generally agree with this assessment.  At the very least, I don't think that the Fed will intentionally cause hyperinflation.

The author of this article goes further.  Not only does he not see hyperinflation in our future, but he actually sees a controlled deflation.  He makes an interesting point near the end of his piece that it doesn't matter what Bernanke says.  He says that the Fed's institutional structure is more significant.  In many ways, I agree, although I don't think Bernanke's personal views are irrelevant.

Boyapati's prediction of a controlled deflation is contrary to what a lot of other Austrian economists believe.  I tend to be more in the camp of Gary North on this one.  I think we will see high price inflation, certainly in double digits.  We may even see massive price inflation of 20 to 30 percent.  But I think that the Fed will pull back eventually and take a depression over hyperinflation.

Articles like these are very good to consider.  It gives us a different viewpoint from an Austrian perspective.  We need to ask ourselves: what if he is right?  He makes a decent case.  What will this do to our investment portfolio?  This is why I am an advocate of the permanent portfolio that was promoted by Harry Browne.  Although I think high inflation is more likely in the near future, I don't want to bet everything on this scenario.  Boyapati makes a good case for a scenario more like Japan.  While I don't think it is the most likely scenario, it certainly is a possible scenario, and we should be prepared for it.

Saturday, January 22, 2011

Interest Rates, Housing Prices, Rents

The housing market is obviously depressed and has been for a few years.  It is not depressing for someone looking to buy a house, but it is obviously tough for those who own a house, particularly for those who bought at the height of the boom in 2005/2006.  But where will housing prices in the U.S. go from here?

First, housing prices vary considerably depending on the region.  Prices are higher in some areas and prices will go up or down faster in some areas.  With that said, this analysis is just based on the overall trend.

There are some conflicting arguments in regards to housing, especially for the medium to longer term.  In the short term, housing prices seem like they will continue to go down.  There are a lot of short sales and foreclosures and there are also people waiting to sell until prices move back up.  This is all bearish for housing prices.

Interest rates, while they have moved up a little in the last few months, are still at near historical lows.  You can still get a 30 year fixed rate mortgage for around 5 percent if you have decent credit and a decent down payment.  When you compare this to the double digit rates of the 1970's, they are very low.  But housing prices have stayed down in spite of these low rates.  If interest rates go up, this could depress housing prices even more.

If interest rates (and mortgage rates) rise, it will make payments more expensive.  This will probably lower housing prices.  But if you own a piece of property that you rent to someone else, the rent amount may not fall.

But you could also look at rising rates another way.  It may depend on why rates are rising.  If it is because the market views a greater risk of default, then housing prices probably will go down.  But the more likely scenario is that interest rates go up because the market fears inflation.  Interest rates go up with fears of inflation to compensate the lender, since he will be paid back in money that is worth less than before.  But if inflation is raging, then this could have a counter-effect and cause housing prices to go up or at least go down slower.  Real estate is a hard asset and that is what you want to own in a high inflationary environment.

My overall take on housing is as follows:

If you are planning to live in the same location for a while, and if you currently don't own a house or are willing to rent out your current property, and if you have a decent down payment and good credit, and if you can buy a house where your payments will be comfortable for you (that's a lot of "ifs"), then you should consider shopping for a house.  You can find some good deals out there if you are patient.  If you can lock in a low fixed interest rate for 30 years and you keep the house for that long, your last payment will probably be the cost of a nice lunch.

Friday, January 21, 2011

The Measures of the Money Supply

There is an article by Michael Pollaro saying that the money supply is firing on all cylinders.  It is an interesting article to read.  He talks about TMS or the True Money Supply which is a measure of the money supply developed by Austrian economists.

I have my own opinions on the money supply.  First, although a lot of libertarians didn't like it when M3 was no longer published, I think M3 is overrated.  I usually follow the adjusted monetary base because it is the money supply that the Fed directly controls.  It is also important to follow the excess reserves held by commercial banks.  This was not an important statistic in the past, but it has become important in the last couple of years with bank reserves increasing in great amounts (over $1 trillion).

The charts for these two things are here:

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

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

Looking at money supply charts still cannot accurately forecast future price inflation.  They can help us take a good guess, but there are other variables.  First, price inflation does not happen uniformly.  Five years ago, we saw massive price inflation in housing.  Over ten years ago, we saw massive price inflation in the stock market, particularly in technology stocks.  The next thing we see go up may be gasoline, food, gold, or maybe all of them.  The point is that prices do not move up uniformly.  New money finds certain sectors and causes bubbles.

Another reason we can't completely rely on money supply charts is because it is only one side of the equation.  The other side of the equation is the demand for money (also called velocity).  It is how quickly money is changing hands.  It is surprising that more Austro-libertarians do not talk about velocity.  If money is changing hands very slowly, then we can say that there is a high demand for money.  This means people are not spending as much.  This has the same effect as a deflation in the money supply.  It can offset monetary inflation and keep prices from rising.  I think this has played a big role in keeping prices down in Japan over the last two decades.

In the U.S., it seems that the demand for money has been higher since the fall of 2008.  People are trying to pay down debts and save money.  They are being more conservative with their money because of the uncertainty in the economy.  This has helped to keep price inflation in check, along with the massive excess reserves accumulated by the big banks.

If banks start to lend and the velocity picks up at the same time, we could see some massive price inflation.  We are not there yet, but it is something to keep an eye on.  It is probably the biggest financial threat that we face.

Wednesday, January 19, 2011

Japan and Debt

There is an article via Drudge saying that Japan has hit a critical point on state debt.  Japan's debt-to-GDP ratio is around 200%.  This is higher than the U.S., Ireland, and even Greece.  It is amazing that interest rates have stayed so low for so long in Japan.

The Japanese central bank has not created money out of thin air to the same extent that the Fed has.  This has kept inflation relatively low there.  Still, with a debt so high, there have to be a significant number of buyers in the bond market.  Since foreign governments are not buying Japanese debt the way they buy U.S. government debt, I assume that the biggest bond buyers are Japanese citizens.  It has been a decent investment so far, just as real estate was a good investment in the U.S. up until 2006.

This kind of debt cannot be sustained forever.  Something will eventually have to give.  Either the Japanese government will cut spending or interest rates will rise and the debt will become unmanageable.  Then we will see the Japanese central bank in action or we will see a government default.  This is why I don't see the yen taking over as the world's reserve currency.

If this whole story proves one thing, it is that we shouldn't underestimate how long an insolvent government can kick the can down the road.  With a central bank and gullible investors, the day of reckoning can be delayed for longer than we might think.

Tuesday, January 18, 2011

Foreign Policy and Your Investments

U.S. foreign policy plays a big role in the investment world.  It may not seem so, at least directly, but there is more to war and occupation than the lost and broken lives.  The cost of war and the cost of running an empire around the world places a heavy burden on the debt and the dollar.

Richard Maybury, who writes the Early Warning Report, is the best I've seen at tying foreign policy and investments together.  He has a great understanding of the world around him and the effects that it has.  Paraphrasing him, it is usually a safe bet that governments will be corrupt and incompetent and continue to do the wrong things.

The occupations  and wars of Afghanistan and Iraq will play a big role in destroying the dollar.  In turn, the economic troubles will eventually cause these wars and occupations to end.  How soon, will depend on how long the Fed can keep things from collapsing.

We can safely bet that the U.S. empire will continue until the money runs out.  When the dollar is severely weakened and the Fed has to raise rates to save the dollar, the economy will come crashing down.  When congress is forced to cut spending, the American people will choose Social Security and domestic programs over war.  The politicians in DC will finally be forced to support a withdrawal of troops.

In the meantime, defense stocks could easily outperform the broader stock market.  If you are going to speculate in stocks, this might be a sector worth looking at.  In addition, the massive expenditures overseas will continue to take their toll on the American economy.  You can count on the dollar to continue its weakening, but I don't know that I'd place a big bet on any other fiat currencies either.  Commodities will do well, just as they did in the 1970's.

Investments in real assets will be the winners.  Investments in dollars, bonds, and other fiat currencies will eventually be the losers.  Unless the wars and occupations come to an unexpected end, you can count on a weak currency in the future.

Monday, January 17, 2011

Chinese President Hu Jintao on the Dollar

Chinese President Hu Jintao has stated that the U.S. dollar-denominated currency system is a "product of the past".  The article is here.  Chinese politicians have been more critical of the Federal Reserve lately due to low interest rates and the second round of quantitative easing (money creation), also known as QE2.

These statements by the Chinese president remind me of American politicians criticizing the other party.  I don't disagree with a lot of what he said, but have you looked in the mirror lately?  China has had monetary inflation above 20% per year.  This has fueled a speculative boom in real estate, similar to the one experienced in the U.S.  The bust is coming in China and it is all because of the same or similar policies.

It is true that the U.S. dollar is slowly losing its status of being the reserve currency of the world.  It is not because of China or any other country.  It is simply the incompetence and corruption of the U.S. government that has caused this.  The big spending and money creation has led to a decline in confidence in the U.S. dollar.  I hate to break the news to the Chinese politicians, but the yuan will not be taking the place of the dollar as the reserve currency any time soon.

China is still referred to as a communist country.  In some ways it is, but in some ways it is freer than the U.S. and other western countries.  China does not have the American for Disabilities Act.  It does not have as much red tape in many areas.  China has come a long way in the last 3 decades.  It has liberalized its markets in a lot of ways, but it also has a long way to go.  They have loosened their grip on the yuan, but it is still not a freely traded currency like the dollar, euro or yen.

I see a crash coming in China.  It will be painful for a country that has never had a big boom-bust cycle before.  When you are always in a state of bust, as China was, you are not used to a bust after a boom.  I see the growth in China over the last 30 years in two ways - part of it is illusory (artificial boom) and part of it is real.  The real part of it has actually contributed to an increase in the standard of living of tens of millions of Chinese people (maybe hundreds of millions).

China's president is right to criticize the Fed.  His government is going to get stiffed by all of the U.S. bonds that it owns.  The problem is that China is still a mercantilist country.  At least it seems to be heading in the right direction.

Saturday, January 15, 2011

Shorting Bonds in Your Portfolio

I try to practice what I preach or maybe it is more like preach what I practice.  My investment advice is no different except for the fact that each individual's situation is different.  I remember reading an article by Michael Rozeff talking about how he didn't always follow the same advice that he wrote in articles (or something to that effect) when it came to investing.

It is hard to give investment advice to everyone because each person's situation really is different.  Each individual is a different age, with a different net worth, with a different personality, with a different risk tolerance, etc.  That is why I like to recommend things, but at the same time provide a disclaimer of being a speculation, particularly with the higher risk moves.

With that said, let's talk about shorting the bond market.  Currently, I do not have any short positions in the bond market, or at least not directly.  I am a big advocate of Harry Browne's permanent portfolio, which happens to consist of 25% long-term government bonds.  I think for people who are less knowledgeable about investments and also less risk tolerant, they should just consider putting all of their investments in a permanent portfolio setup.  Then they can forget about it and sleep better at night.  Even many experienced investors would be better served by using the permanent portfolio.

Now, I have no idea what will happen with bonds tomorrow or one year from now.  If I had to guess, I would say that bonds will most likely move lower in the next several years.  It is not up to me to decide.  It is up to the market and the decisions of millions of people, along with the non-free market forces of politicians and the Federal Reserve.  But again, if I had to guess, I think that interest rates will eventually rise and will lower the price of bonds.

Since I am an advocate of the permanent portfolio, but I also want to speculate that interest rates will eventually go up, I have lightened up on bonds.  I see no point in directly shorting bonds, because I'm not confident enough at this point, particularly with the Fed buying them.  Instead, I have chosen to carry less than 25% of my investments in bonds.

There is nothing wrong with shorting bonds, even if you do have bonds elsewhere in your portfolio.  It is really up to you on how you want to go about it.  Again, I think there are heavy risks in shorting bonds right now, especially with QE2 (money creation) going on.  It is a risky play, but it is also a play that could pay off well if you are right.  So my recommendation is to lighten up on bonds from your permanent portfolio, but only for speculation purposes.  If you don't want to speculate (although everything carries some risk), then just put your investments in the permanent portfolio fund and forget about it.  For a mutual fund that somewhat mimics this, see symbol PRPFX.

Thursday, January 13, 2011

America vs. China

The lead article today on LewRockwell.com is by Fred Reed.  If you've read much of his stuff, he is very witty and certainly puts things in an interesting perspective.  I agree with much of what he says in this article today, but I would like to focus on a few things where I disagree.

First, he says that "if a country does not manufacture things, it does not have an economy, and manufacturing has fled American shores."  This really isn't true on several levels.  Manufacturing perhaps has declined in the U.S., but it is not like it has vanished.  But even if it had completely vanished, this doesn't mean that there isn't an economy and that there isn't wealth.  We often make this mistake of drawing these artificial lines around countries as if they matter.  If what he says is true of a country, would it also not be true of a state or a city?  New York City has very little in the way of manufacturing and I wouldn't say that NYC has no economy.

He speaks highly of China, but Hong Kong is far richer than mainland China (per capita) and Hong Kong is not a big manufacturing country.  These are the benefits of free trade and comparative advantage.  You don't have to make all of the food you eat.  In fact, you really don't have to make any of it.  You don't have to make the car you drive and the car doesn't have to be made in your country of residence.  There is nothing wrong with providing services.  There is nothing wrong with having doctors, therapists, hair stylists, salesmen, financial planners, athletes, singers, etc.  This is a sign that we are a rich society.  We only need a small fraction of people to produce food now because of capital investment and technology.  We don't all have to work on a farm because it is not necessary.  We don't all have to work in a car factory because other places can do it cheaper or at least in comparison to other things.

The CEO of McDonald's might be the best burger flipper there is, but does it mean he should be in the kitchen flipping burgers all day?  This is comparative advantage.  He is better off doing more important things and letting other people flip burgers, even if they aren't quite as good at it.

The second thing in the article that I don't agree with is his view of competition with China.  He seems to imply that a gain in wealth for the Chinese is detrimental to America.  He does not directly say this, but it is implied.  We certainly don't want China to overtake the U.S. in wealth because the U.S. gets poorer.  But if China simply becomes wealthier, this is not a loss to the U.S.  It benefits everyone for China to open its markets and become wealthier.

There is one more thing to point out in this article.  He says that "America is the world's greatest debtor nation, China the greatest creditor."  I agree and the national debt is a serious concern.  But the one thing I would like to point out is that the Chinese people are subsidizing Americans because of this.  The game will not last forever, but the Chinese are going to get stiffed on all of the U.S. bonds that are held.  As Reed says, "we must either default or inflate."

Fred Reed is a great writer and I don't mean to nitpick his work.  I just want to make sure that people understand some basic fallacies that are out there.  America has a lot of problems, but it has little to do with manufacturing or China.

Wednesday, January 12, 2011

Price Inflation in 2011

Robert Wenzel, who blogs at EconomicPolicyJournal.com, has a piece today on price inflation.  He goes through seven things, identified by AOL, that will cost more in 2011.  The seven things listed by AOL as likely to rise are food, gas, medical care, clothing, college, raising kids, and bank fees.

Medical care and education may go up without high price inflation, just because government is so highly entrenched in these things.  Bank fees are too small to worry about and raising kids is too general.  For the other three things, food, gas and clothing, I agree.  There is no guarantee these things will go up in price in 2011, but it is likely, and if it doesn't happen this year, it will most likely happen shortly after.

If your net worth is less than 6 figures, I think the best way to hedge against inflation is to buy things now that will likely go up in price later.  You can't really store a lot of gasoline, or at least you shouldn't.  It is hard to hedge against rising gas prices unless you play options/ futures.  It is even hard to find stocks and ETFs that correlate to the price of gas.

For clothing, you should consider buying clothes now that you might need in the future.  This is a tough one though because there might be a tendency to buy what you want instead of what you will need.  If you are disciplined, go ahead and buy some new clothes now and put them away for when your current clothes are worn out.  Just make sure not to gain or lose too much weight if you do this.

For food, it is hard to buy a lot of things in advance.  You can't buy milk, but you can buy canned foods and some other items that last for a while.  Just make sure you follow the FIFO method - first in first out.

There are other things you can buy in advance.  You can buy paper towels, toilet paper, soap, razor blades, kleenex, shaving cream, toothpaste, makeup, shampoo, laundry detergent, and a whole host of other things.  Again, you should use the FIFO method so that things don't get too old.  If you don't have a lot of storage space, look in closets to see if you can put any shelving up high for more storage.  You should look for sales when you go to stores like Target or Walmart.  I hope you aren't buying these things at the grocery store unless they are on sale or you are rich.  You can usually find them elsewhere cheaper.    When you see a sale, load up on the item (within reason).  It is an investment that you can't really lose on.  What are the chances that prices will be lower this time next year?

If you are a millionaire, ignore this, unless you think there is going to be a total collapse in the division of labor.  If you are a millionaire, you are better off focusing on the big picture and taking care of the money  and assets that you have.  Anyone with any significant amount of wealth should be finding ways to hedge against inflation, whether it is real estate, gold, silver, or certain stocks.  I think inflation is the biggest threat to our standard of living right now.

Tuesday, January 11, 2011

Efficient-Market Hypothesis and Austrian Economics

Robert Murphy has written an article related to the efficient-markets hypothesis or EMH.  It is certainly worth a read, as most of Murphy's work is interesting and accurate.

EMH is an interesting, yet wrong, hypothesis.  It is true that markets adjust according to what is known.  Prices also adjust in the present based on what is probably going to happen in the future.  If Apple announces that it has the latest and greatest gadget that will exceed all expectations, then there is a good chance the stock price will go up.  Apple does not have to have any sales of the new product and you may not even know specifically what it is, but just the expectation of future sales, and hence profit, will drive up the price of the stock.

At the same time, this doesn't mean that everything is known equally.  It doesn't mean the price is rational, other than the fact that the price is what it is.  The market has set the price, so who am I to argue on what is rational or irrational?  As I often mention in this blog, it doesn't matter what the fundamentals are or what you think the price of something should be.  It matters what the billions of people in the world think.

EMH reminds me of a joke (I wish I could give credit where credit is due).  There are two guys walking down the street and one of them is an economist.  The other guy says to the economist, "hey, look, there's a twenty dollar bill on the street."  The economist doesn't even look down and keeps walking.  He says, "That's impossible.  If there were a twenty dollar bill on the street, somebody would have already picked it up."

Austrian economics does not allow us to predict the future with certainty or accuracy.  Again, you can't predict anything with certainty that involves the thinking of millions or billions of people.  But we can make some good assessments using Austrian free market economics and see where the market does not seem to correlate with the fundamentals.

The housing market is a good example of all of this.  It seems obvious now that there was a housing bubble, but it was not obvious at the time.  But it is certainly conceivable that if someone gave some serious thought to the whole thing, they could have seen that the exuberance in the market would wear off when more people started struggling to make their payments.  There were some Austrian economists that did predict a crash in the housing market.  They were aware of the boom-bust cycle.  They realized that housing prices were going up much faster than other prices.  They could have been wrong, but it was a reasonable prediction to make.

Let's look at gold now.  Some say it may be in a bubble of its own.  We may very well see a sell-off in the near future on profit taking.  But we can also look at the fundamentals and see that the Fed has created massive amounts of new money and says that it will continue to do so.  If this new money gets out of the banks and into the economy, prices will rise drastically.  Commodities will most likely explode.  Gold has the potential to double or triple in price in a short time frame.  Again, this is not to say that this will happen, but only that it is a good possibility based on what we know.

There are many people that don't analyze this.  There are many people that don't understand this.  They are missing opportunities.  Perhaps the people that know little believe in the EMH because they really do have no chance of beating the market.  These people don't understand monetary policy and inflation and do not understand that gold might rise significantly due to the policies of the Fed.  There is a twenty dollar bill on the street.  Will you look down to pick it up?

Monday, January 10, 2011

The U.S. Government and Insolvency

Michael Rozeff has the lead article on LewRockwell.com today.  He says that the U.S. is insolvent.  I'm not sure if this is technically true or not, but it certainly will be if it is not now.  It really depends on whether you count the unfunded liabilities of Medicare and Social Security.

If the U.S. government severely cut spending, including Medicare, Social Security, pensions, and the military, then the government could make good on its promises in regards to treasuries.  Of course, this is a major "if" that will not happen.  It will only happen when Congress is forced to because of the threat of hyperinflation and/or default.

If the government cut every single program other than the military, Medicare, and Social Security, it most likely would still not be able to fulfill its promises.  As time goes on, the hole just gets deeper and deeper.

At the end of his article, Rozeff says, "it is prudent to take measures to make oneself as independent of government as one possibly can."  This is really the key point.  There is really nothing you can do about the train wreck that is about to occur.  The only thing you can do is prepare yourself and those you care about (if they'll listen).  The best way to do that is to try your best not to rely on government.

There is one other thing you can do too.  You can help in the education process.  You can inform people of what is to come (again, if they're willing to listen) and you can let them know that, in the words of Reagan, government is not the solution, it is the problem.  The more people that realize this, the better chance we have of being in a state of liberty after the U.S. government comes crashing down from all of its promises and debt.

The train wreck coming will be quite a sight to see.  For those paying attention, it is easy to see it coming.  Others will continue to keep their eyes closed to the obvious.  These people think that there is such a thing as a free lunch.

Saturday, January 8, 2011

Can the Fed Become Insolvent?

Terry Coxon has written an article called "How the Fed Could Become Insolvent".  If you haven't seen it, it is certainly worth a read.  He basically points out that if interest rates rise, there will be a certain point where the Federal Reserve is operating at a loss.

I don't think this means that the Fed becomes insolvent and he even acknowledges this.  His conclusions are similar to mine in that the Fed will have more limited choices as rates rise.  I think the Fed will eventually have to choose between hyperinflation and depression and I think and hope it will choose the latter.

I generally agree with what he says and I think interest rates will play a key role when we start to see things unravel.  But in the grand scheme of things, a loss to the Fed is not that big.  The bigger issue is the national debt, which is now over $14 trillion.  The Congress will have to pay interest on this debt and when it has to rollover debt or issue new debt, it will be at higher rates when rates do in fact rise.  The Congress will either have to spend less, tax more, or get the Fed to create more money out of thin air.  The first two options are limited.  Congress could certainly spend a whole lot less, but even if it cut the budget by one-third, there would still be a yearly deficit right now.  The problem is that the politicians are unwilling, at least at this time, to make any substantial cuts to the military or "entitlement" programs.

Raising taxes won't really help either.  It will just stifle the economy that much more and it may even lead to less taxes collected by the government (we'll give Art Laffer, a non-Austrian economist, a little bit of credit here).

So basically, that leaves the Fed to create more money.  More inflation will lead to even higher interest rates down the road, just as Coxon has written in his article.

The Fed will eventually have to slam on the brakes to avoid hyperinflation and I think it will.  The ultimate solution will be for government to be dramatically cut, including the military, Social Security, Medicare, and pensions.  The other thing that will probably happen is a default.  It will happen first through inflation and then there will be some kind of outright default.  You don't want to own a lot of government bonds when that happens.

Thursday, January 6, 2011

The National Debt Ceiling

The national debt has been in the news lately.  It just went over $14 trillion.  You can view it here:
http://www.brillig.com/debt_clock/

You can view more details here:
http://www.usdebtclock.org/

The sites differ a little bit, but they are both an estimate.  They may differ by a few billion dollars, but that isn't much in this context.  There is a debt ceiling that is fast approaching.  The Congress has to vote to raise the debt ceiling.  This has always happened in the past.  It is usually the party in the majority that votes in favor of raising it.  It is a political ploy by the party in the minority, but the debt ceiling always gets raised.

This time will be no different except that there might be more political posturing.  Some Republicans are threatening to vote no on raising the limit.  The establishment says this is impossible.  They say that it will have to be raised.  They say it has to be raised because otherwise the government would default on some of its debt and that is just impossible in their world view.

The Republicans could refuse to raise the debt limit.  They could, but they won't.  They will cut a deal with Obama.  Perhaps they will tell Obama they want some token spending cuts.  Perhaps they will ask for a reduction in corporate taxes of a few percentage points.  But in the end, they will vote to raise the debt limit.

When it comes to the national debt, I think repudiation of the debt is an option that, while seems to be ridiculous to most, is actually a good idea from a libertarian standpoint.  I have written on this before.

But even if you don't think repudiation (defaulting) on the national debt is a good idea, there is still another option.  Congress could actually cut spending.  Now, it would have to cut it significantly.  It would have to cut about 1.5 trillion dollars out of the annual federal budget.  But we have to get rid of this idea of non-discretionary spending.  Everything is discretionary, whether it is Social Security, Medicare, pensions, or the military.

The problem is that Congress does not want to make these hard choices.  They do not want to cut spending.  Even most of the new politicians who helped get elected by the Tea Party do not want to make tough cuts in spending.  They talk in generalities, not in specifics.

There may be a few that follow Congressman Ron Paul.  Most will not.  They will keep spending, even if it means at a slightly slower pace.  The national debt ceiling is a joke.  It might provide some good entertainment in the near future, but it will not put a limit on the debt.  The only thing that will eventually limit the national debt is the destruction of the dollar.

Tuesday, January 4, 2011

Is A Bond Crisis Inevitable?

Is a bond crisis inevitable?  That is the question that Pat Buchanan is asking.  Buchanan is not a libertarian, but he certainly has libertarian leanings.  I tend to agree with him on foreign policy more and economics a little less.  He does not understand the benefits of free trade and that is the main area where I part ways with him.

With this article on the national debt and bonds, he understands what he is talking about.  His last sentence says it all: "We may be closer to the falls than we imagine."

Europe has already seen a lot of problems and they have a lot more to come.  The state and city governments in the U.S. are struggling.  Illinois is on the verge of default and California is not far behind.  It will be amusing to watch politicians, particularly Democratic politicians, having to cut money from their main constituents - union and government "workers".

The big trouble will hit the states and cities before it hits Washington DC.  The reason is the central bank.  The Fed can keep creating money out of thin air.  The Fed can temporarily drive down interest rates and keep bonds attractive.  This allows the deficit spending to go on.  But the day of reckoning is coming for DC too.  The Fed will eventually have to choose between funding the debt and hyperinflation.  I think the Fed will eventually tell Congress to figure it out.  Hyperinflation would wreck their own game and would cause massive upheaval.

It will be an interesting day when the checks from DC bounce.  They will either have to default on the debt or massively cut spending.  Actually, they will probably have to do both.  It has been a long time coming and the moment is almost here.  Even if it takes another 10 years, it will be unbelievable to watch when it happens.  The vote buying politicians will be walking on thin ice if they aren't already.  Let us hope that the American people (along with people everywhere else) finally turn their backs on government and withdraw their consent.

Monday, January 3, 2011

The Monetary Base Does Not Correlate With QE2

If you want an updated chart of the adjusted monetary base, go here:
http://research.stlouisfed.org/publications/usfd/page3.pdf

This is what the chart looks like through 12/30/2010.



This chart does not correlate to QE2 (Bernanke's money creation).  It was announced at the beginning of November and the Fed is supposed to buy $75 billion in assets each month (not counting rollovers) that will total up to $600 billion by the end of June (8 months times 75 = 600).  This new money should appear in the monetary base.  Meanwhile, it has barely moved since QE2 was announced.  It looked like it was finally going up, but then made a move back down in the last week.

What is going on here?  Is it possible that Bernanke would announce one thing and do another?  It certainly is possible, but I just can't imagine how he would get away with it, particularly in today's world of the internet.

I can't explain what is happening right now other than the fact that it looks like the Fed has not expanded the monetary base like it said it would.  We will continue to monitor this chart weekly and look for a move upwards.  If the chart continues to stay flat or near flat, we might have to revise our outlook.  All signs point to price inflation and higher commodity prices in the future.  If Bernanke is lying and the Fed doesn't go through with QE2 and the banks continue to keep their excess reserves high, we might have to plan for a depression sooner than we originally thought.

Saturday, January 1, 2011

Gary North on Capitalism

Gary North has written an excellent article on capitalism.  His article is titled "In Defense of Shopping Malls".

This is the beginning of a new year and it is good to step back once in a while and appreciate all that is around you.  Our lives are so incredibly easy in so many ways compared to the rich of 100 years ago.  It's not to say that we don't have difficulties and tragedies.  It is just to say that, on average, our standard of living is amazingly higher than people of just a few generations ago.  There are still people all over the world who are on the verge of starvation.  But we are also at a point where we can safely say that over half of the earth's population is not on the verge of starvation.  For Americans and other people of first world countries, our standard of living is in luxury mode.

It really makes you realize how bad the government is, how much better our lives would be with much smaller government, and how much we still have in spite of the government.  The things that the government is highly involved in (healthcare, education) are the things that we struggle with in terms of quality and cost.  When it comes to things where government interference is more minimal, things thrive.  Electronics is the obvious example that comes to mind.  You can buy a big screen television that is less than 2 inches thick for $1,000.  This is truly amazing.  This technology did not exist 20 years ago and not only is it available now, it is available to the middle class.  Quality goes up, while prices go down and this is in spite of the Fed's monetary inflation.

Yesterday, I bought a $5 bottle of champagne at the grocery store just so that we would have something to celebrate with on New Year's Eve.  For 5 bucks, it wasn't bad.  It might have been bad to some people, but I am not an expert champagne drinker.  Not only that, but the plastic cork screwed off and you could screw it back on easily to put the bottle back in the fridge.  It is just one small example of our wonderful division of labor.  Most people could not make a glass bottle, let alone actually making champagne.

Walmart and other retailers have been incredible in making things affordable for the little guy.  You don't even have to shop there and you have still benefited by the increased price competition.  It is the same way that the internet is forcing retailers to lower prices.  Our standard of living really is incredible.  It is unimaginable to think what we would have if the government at all levels did not regulate and tax us so onerously.

I think this is why liberty will eventually prevail.  Our standard of living will go down in the near future, but Americans and other westerners will only tolerate so much.  The wars overseas will end when Americans realize that it is hurting their standard of living.  Welfare at home will be curtailed greatly when Americans realize that it is hurting their standard of living.  Americans like their big screen televisions, their cell phones, and all of their other gadgets.  They will not easily give them up.