Monday, February 28, 2011

Should You Listen to Dave Ramsey and Suze Orman?

Although this blog is mostly about economics and investments from a libertarian standpoint, it is also about general advice on money.  I have written before on Dave Ramsey and Suze Orman, but I think it is worth repeating.  Although the two of them may have some differences, they are also similar in a lot of ways and I am going to lump them together for the sake of this discussion.

For people with spending problems, I would highly recommend listening to these two.  Give each of them a chance and see which one motivates you more.  If you are in debt (other than maybe a reasonable mortgage and car payment), then you should seek advice.  You should work extra hard and save extra hard to pay off your debt, especially if it is on a high interest credit card.  As Dave Ramsey says, eat "rice and beans".

I heard Suze Orman once say that she is not in favor of budgets.  I agree with her on this, although I think exceptions can be made.  She said that budgets are like diets.  If you want to be healthy physically, you shouldn't diet.  This implies that it is temporary.  You should eat healthy as a way of life.  The same is with spending.  You shouldn't buy something or not buy something because it is or isn't in your budget.  You should be disciplined to spend only on things you need or, if it is a want, it should be something that you will use and something that truly is worth what you are paying for it.  In other words, your spending should be based on a reasonably frugal lifestyle, not on a budget.  It doesn't mean that you never treat yourself; it just means that you prioritize.  Part of prioritizing is paying yourself first.

I have heard both of them offer good advice in other areas.  I have heard Suze Orman say several times that she is in favor of term life insurance and not whole life insurance.  I have heard both offer advice that goes way beyond money.  Sometimes it is more like listening to Dr. Phil.  Now I'm not saying they are always right, but certainly their advice is worth listening to and considering.

With all of that said, there is one area that I would recommend you not listen to both of them.  Neither one of them understands Austrian economics.  They do not understand the workings of the central bank.  They don't understand the dangers of a fiat currency.  They don't understand the boom-bust cycle and how it is caused by central banks creating money out of thin air and artificially lowering interest rates.

This is why they tell you to invest in mutual funds.  They tell you to buy and hold and that the market will provide good solid returns over the long run.  They do not understand the benefits of having gold and other metals and commodities in your portfolio.  They don't understand that gold is a much better hedge against inflation than stocks.

If you are looking for advice on investing, read Fail Safe Investing by Harry Browne.  Follow the advice on the permanent portfolio.  For other advice on money, I think Dave Ramsey and Suze Orman are worth listening to.

Saturday, February 26, 2011

Price Inflation Getting More Headlines

Frank Shostak has written a piece for the Mises Institute on price inflation.  He is predicting that price inflation will pick up this year.  He makes the assertion that "it takes about 36 months before changes in the money supply generate a visible effect on the prices of goods in general."  This would mean that the Fed's more than doubling of the monetary base in late 2008 and 2009 would only begin to show up this year.

Whether you agree with this or not, there are certainly a lot of arguments in favor of higher price inflation in the somewhat near future.  The monetary base has gone up like never before and even though much of this new money is sitting at the banks as excess reserves, there is that looming threat that it will be released and massive price inflation will hit.

The most fascinating thing right now is that price inflation is making a lot of headline news, even in the mainstream media.  CNBC has had several segments talking about inflation in the little bit of time I have watched it.  I have also seen stories on popular financial websites talking about inflation.  I will also see the occasional opinion article saying that deflation is actually our biggest threat, but even this is insinuating that most people are viewing inflation as the bigger threat (despite what Bernanke says).

Normally I would be a contrarian and believe the opposite of what the mainstream media is saying, but in this case my contrarian view is that even though many are predicting an uptick in price inflation, I don't think they understand just how bad it could get.

If the banks start to loan out those excess reserves, prices could move higher very quickly.  In addition, the velocity of money or the speed at which money changes hands will play a big role.  Velocity has been low as Americans are fearful of the future and have been trying to save more and spend less.  If people start to perceive that prices will continue to move much higher in the near future, then it gives an incentive to buy "things" right away before losing purchasing power.  This drives prices even higher and can be a bad cycle.

At that point, the Fed will have to slam on the monetary brakes or risk hyperinflation.  I am reasonably sure that the Fed will stop creating money and allow interest rates to rise (a lot).  Then we will experience a very harsh depression and DC will be forced to cut back severely (which won't be depressing at all).

Get your investment ducks in a row now.  Make sure that you are ready for high price inflation.  Make sure that if price inflation hits 20%, that your investments will do well enough to keep pace.  This means that you must have some investments (such as energy and precious metals) that will do really well in a time of double digit price inflation.  And do not count on wages keeping pace with inflation, at least in the near term.

Thursday, February 24, 2011

Do Higher Oil Prices Cause Inflation?

The short answer is no.  And it doesn't matter how we define inflation.  In Austrian economics, inflation is an increase in the money supply.  Obviously higher oil prices can't cause an increase in the money supply.

The definition of inflation used commonly today refers to an increase in the general price level.  While there can be a correlation between higher oil prices and price inflation, oil prices do not cause a general increase in the price level.

Higher oil prices can cause certain prices to go up.  One obvious example is gasoline.  Even though consumers ultimately determine prices, higher oil prices do increase the cost of gasoline, which is generally passed on to the consumer.  Higher oil prices could cause other certain things to rise.  If a certain item costs a lot to be shipped, perhaps the increase in transportation costs could affect the price of the item.

But we are talking about a general rise in prices.  If anything, higher oil prices would have the opposite effect.  Let's say that you have a family budget of $2,000 per month.  Part of that budget is gasoline and you have $100 per month budgeted just for that.  Now let's say that gas prices double.  Most of your driving is necessary (commuting, going to the store) and you can't cut down on it.  Therefore, you now have to budget $200 per month.  This means you will have to cut $100 from somewhere else.  Perhaps it would be eating out at restaurants or some other form of entertainment.  No matter what, you will be spending $100 per month less on something else and this will actually drive other prices down.

The only way for you not to cut spending somewhere else is for your budget to increase.  For this to happen, you need an increase in the amount of money you have.

Now take this example and translate it to the entire economy.  If oil (and hence gasoline) prices go up, most Americans will cut somewhere else, thus driving other prices down.  The only way that all or most prices can go up with oil and gas is if you have more money in the system to bid up prices.  Therefore, we would need monetary inflation to drive up the overall general price level along with the price of oil.  This is ignoring the short-term effects in changes of velocity or the speed at which money changes hands.

Therefore, if oil prices go up without an increase in the money supply, it is likely that some other prices will fall.  This is a classic case of why the definition of inflation has changed over time.  If inflation was defined as an increase in the money supply, then everyone would know to blame the Fed for higher prices.  Instead, when inflation is defined as higher prices, we get to hear hacks blame everyone but the Fed and government.  They will blame China, greedy businessmen, or whoever else is convenient at the time.  Of course, they will also blame higher oil prices, which is obviously ridiculous based on what is written above.

Oil prices do not cause inflation.  Inflation (an increase in the money supply) causes higher oil prices.  Other things can cause higher oil prices like supply and demand or the perception of a coming change in the supply and demand.  If we see higher oil prices and a general rise in other prices, we can be sure to blame the money creators at the Federal Reserve.

Wednesday, February 23, 2011

Is it Decision Time for the Federal Reserve?

There is a lot going on right now.  The protests are spreading in the Middle East.  The latest big news with protests is coming from Libya, where the thug dictator is not going down easily.  This in turn has caused the price of oil to spike.

Silver is hitting 30-year highs and gold is near all-time highs.  Food prices are going up just about everywhere.  Meanwhile, there have been a couple of bad days for Wall Street.  In addition, housing prices are hitting new lows (although this is good news for buyers) as more and more people are underwater with their mortgages.

Today there was news of Charles Plosser, president of the Federal Reserve Bank of Philadelphia, saying that he may push for an early end to QE2 (money creation).  Whether or not QE2 ends early does not matter much in the long-term.  Eventually the Fed will be faced with a choice and that choice may have to be made sooner than expected.

Although Bernanke gets a lot of attention as the Fed chairman, he really is just one man.  His views may not matter quite as much as some think.  The Fed is part of the establishment.  But they are their own sector.  It is a group of elitist bankers.  The establishment matters more than one man (Bernanke).  In the same way, the presidency is part of the establishment.  The president doesn't really matter all that much, as long as he plays the game.  The last one who didn't play the game was Kennedy and we know how that ended.

So basically, it is not just Bernanke's decision on what happens.  It is really up to the banking establishment.  This is why I don't think we will have hyperinflation.  We may have massive price inflation, well into double digits, but I don't think the bankers are going to go Zimbabwe style on us and risk their own fortunes.

The Fed will face a decision when price inflation gets higher and there is pressure from foreign nations.  Paul Volcker is not some wizard, but the Fed pulled back when he was chairman.  This saved the dollar and the economy.  There was some short-term pain in the recession of 1981/1982.  I think the same thing will happen again (with a much bigger recession), regardless of Bernanke.

The Fed will be under pressure by Congress, and maybe the president, to monetize debt.  The Fed will only play the game for so long.  If there is a high risk of hyperinflation and a total collapse of the dollar, the Fed and the bankers will save themselves.  They will not risk a total breakdown of civilization.  They have too much invested.  In addition, there will be much pressure from other countries, blaming global problems on the U.S. central bank.

The Fed will stick it to Congress.  The problem and decisions will then be forced on the federal government.  They will have decisions to make as to what will be cut.  I think the empire will be the first major thing to go.  Americans would rather choose Medicare and Social Security than Iraq and Afghanistan.  If it is really bad, there might not be a choice as everything would get cut.

The biggest bubble has not been tech stocks or real estate.  The biggest bubble is government at all levels.  The bust is coming.  It will hit state and local governments first.  Then it will be the federal government's turn to go bust.

Tuesday, February 22, 2011

Wisconsin Union Protests

The union protests in Wisconsin are an interesting sight to see.  While the eventual result of what happens in Wisconsin has little effect on our daily lives, it is symbolic of what is to come.  There are a lot of states in financial trouble and government pensions are near the top of the list of expenses.

First, it is important to point out the libertarian position in all of this.  Libertarians believe in the separation of school and state.  People should not be forced to go to school or send their kids to school.  In addition, people should not be forced to fund schools, whether they have kids or not.

As far as unions, libertarians believe that people should be free to associate with others.  If a bunch of employees want to get together to negotiate with their employer, that should be their right to do so.  At the same time, it should be the employer's right to fire anyone they want.

So basically, in a libertarian world, while unions would not be outlawed, they probably wouldn't exist without the support of government.  In addition, while I am not against a bunch of people pooling their money together and running "government schools", in a libertarian world, government schools probably wouldn't exist because money would have to be collected voluntarily.

For this debate, let's accept the fact that there are government schools and teachers.  If the government is going to provide pensions for government school teachers, it should be a defined contribution plan.  In other words, they should have the equivalent of a 401k.  If you are going to force taxpayers to pay for teacher pensions, then it should at least be limited to current taxpayers.  Governments should not be making promises based on the ability of future taxpayers.

This whole thing in Wisconsin will be repeated in states all over.  During the boom times, taxpayers did not fight the government pensions and salaries.  Now that the middle class is struggling, people are getting tired of the parasites.  Government salaries and benefits are now far higher on average than other workers.  People are starting to revolt and this is just the beginning.

There will continue to be fights all over the place.  The government workers and unions will win some fights, but I think they will lose in the long-run.  The average Joe outnumbers the government employees and the average Joe is starting to wake up.

Eventually this will move to a federal level.  Most of this will happen in local and state governments first because they can not run huge deficits.  They are more limited in their spending, whereas the federal government has the Federal Reserve to buy its debt (print money).  Even this is limited by the threat of hyperinflation, but Washington DC can kick the can down the road for a bit longer.

Monday, February 21, 2011

Oil Prices and Protests

Oil prices were up huge today.  The price of crude went up about $8.  This is a major jump when the price isn't even at $100 yet.  The main reason for the big jump was because of continuing protests in the Middle East, particularly in Libya this time.

There are reports now that long-time dictator, Gaddafi (there are about a million ways to spell this guy's name), has fled Libya.  This has spooked the oil markets due to fears of an interruption in supplies.

From a liberty standpoint, these protests are a good thing.  They won't produce some libertarian paradise overnight for sure.  And we know that democracy can be just as bad as dictatorships at times.  But despite what you might hear from hacks like Sean Hannity, these protests are not mainly about religion or ethnicity.  They are mostly about oppressed people seeking some freedom.  And they are not like the protests out of Greece or Wisconsin with people demanding more government handouts.  There may be some of that in these Arab states, but it is mostly about people wanting the grip on them loosened.

Russia is a corrupt place in many ways and there are certainly more desirable places to do business.  But not many people would deny that Russia is a better place to live than 25 years ago when it was the Soviet Union.  Freedom does not usually come all at once.  Just like socialism progresses with baby steps, sometimes it is the same for freedom.  So overall, these protests are a good thing as people seek a taste of freedom that they've never had, but maybe heard about.

With all of that said, these protests could be a short-term disruption for business.  Along with oil prices, gold and silver prices went up significantly today too.  This is not to say that they couldn't all fall back down tomorrow, but we can't ignore these huge moves.  Libya produces some oil, but it is no Saudi Arabia.  If protests start to flare up against the Saudi dictators, then the oil market could really get spooked. We could see the price of oil go to $150 or even $200 in a very short period of time.  Gas prices will not be far behind.

It might not be a bad insurance policy right now to have a few oil plays in your investment portfolio.  Just the price of gas alone will get expensive if something major happens.  There are ETFs, individual stocks, and mutual funds that can be bought to get exposure to the price of oil.  If you buy individual stocks, I would recommend that you stick with the big companies.

The other interesting thing we will watch in the future is how this may affect velocity.  The velocity (the speed at which money changes hands) has been low in the U.S. since the fall of 2008.  If velocity picks up because of these events (or any other reason, like QE2), then high price inflation could be closer than people think.

Saturday, February 19, 2011

Silver Prices Hit 30-Year High

The price of silver is at a 30-year high.  One ounce of silver is now trading over $32.  The only reason it is not at an all-time high is because of its brief rise to almost $50 back in 1980.  That brief explosion in silver prices occurred when the Hunt brothers tried to corner the silver market.  It also happened during a time of high inflation and right about the time that Paul Volcker slammed on the monetary brakes.

I am a fan of silver related investments only up to a point.  As we can see from 1980, the price of silver can go down just as quickly as it can go up.  Silver is far more volatile than gold.  For this reason, I suggest that you invest a far higher proportion of your money into gold related investments than silver.

Silver may have a place in your portfolio, but it should be a small place.  I wouldn't recommend more than 5%, or maybe 10% if you are really aggressive.  It is a good speculation because there is such a high upside potential.  If gold goes to $2,000 per ounce in the next year or two, silver could easily go to $75 per ounce or more.  This is not a prediction, but just an observation that silver is a higher risk and reward play than gold.

If you are good at timing the market (almost nobody is), then silver is a stronger play.  If you invest in it as a speculation, try to be disciplined and take some profits if and when the price goes up.  You will never know exactly when it will reach its top, just like any other investment.  It is important not to get too greedy and to take profits on the way up.  It doesn't mean you have to sell all of it at once.  Actually, it is a good idea if you don't.

Again, I am talking about silver and silver related investments here as a speculation.  It should not be part of your permanent portfolio.  For Harry Browne's permanent portfolio, the gold portion will be your protection against inflation and a crashing dollar.  Gold is far more stable than silver and I expect it to continue that way.

Thursday, February 17, 2011

Monetary Base on Fire

The adjusted monetary base is on fire.  A couple of months ago, I was starting to doubt whether QE2 was actually happening as it wasn't showing up in the monetary base.  Well, the February 17, 2011 update of the monetary base shows a line straight up since the beginning of the year.  It is obvious now that the Fed is actually doing what it said it would do.  QE2, otherwise known as the Fed buying government bonds, otherwise known as money creation, is happening.

You can view the chart here:
http://research.stlouisfed.org/publications/usfd/page3.pdf

We will closely follow the excess reserves held by commercial banks over the next few months.  We want to see if this increase in the monetary base is at least somewhat sterilized by an increase in excess reserves.  Bernanke claimed that the Fed was not increasing the money supply in circulation.  Either he expects all of this new money to go into excess reserves or he is lying.

If even part of this new money gets into circulation through the banks, then price inflation should be close at hand.  I think prices could explode at any time.  It is hard to say what will lead the way.  Commodities and precious metals could be the leaders.  Stocks might keep doing well, but that is harder to say.  When consumer prices start going up at a good clip, you can count on food prices to rise significantly.

We may be coming up on one of those rare investment opportunities.  Although high inflation won't really be good for anyone, we can at least try to profit from some of it, or at least protect what we have.  If the excess reserves don't keep pace with QE2, I think all of our speculative investments belong in hard assets.  The dollar will get crushed and price inflation will take off.  Hard assets like gold, silver, platinum, oil, food, and maybe even real estate will do well.  You can't make these things on a printing press.

Wednesday, February 16, 2011

The Money Supply Measures

For anyone that studies the money supply, it can be quite confusing.  There are different measures of the money supply and you can read or listen to three different people come to completely different conclusions, based on different measures of the money supply.

Robert Murphy has written a piece that gives a good summary of what makes up some of these different money supply measurements.  It certainly can be confusing on what measurements you use and what you should use them for.

First, a big reason for looking at the money supply in the first place is because we want to predict price inflation.  The only problem is, there are so many variables.  There are different measures of the money supply, but there are other factors too.  There are excess reserves held by banks, there are loans, and there is the velocity of money or the speed at which money is changing hands.  These all have an effect on prices.  In addition, an inflation in the money supply may show up in asset prices like stocks or commodities while not showing up in consumer prices.

With that said, we still want to have a useful measure of the money supply.  My personal favorite is the monetary base.  The reason I focus on this measure is because it is the measure that is most directly controlled by the Fed.  For example, with QE2, you will see the Fed's buying of bonds show up in the monetary base.  The Fed can buy or sell assets and change the monetary base.

Now that banks are piling up excess reserves, we have to pay attention to this too.  But overall, the monetary base tells us what the Fed is doing.  It can't tell us with any certainty what is going to happen with price inflation or the stock market or commodities, but neither can any of the other measurements.  At least the monetary base can accurately tell us what the Fed is doing and can at least provide us with that little piece of the puzzle.  Right now, it is telling us to watch out for rough waters ahead and to buy gold.

Tuesday, February 15, 2011

Gold ETF For Your Investments

I am subscriber to Harry Browne's permanent portfolio.  With all of the uncertainty in the world, it is good to have some of your investments safe and sound, or at least as safe as possible.  The permanent portfolio is set up to weather any type of financial storm and it has done its job well.

With that said, I think it is ok to speculate with a portion of your money, as long as you can afford to lose it.  Right now, I think the best speculations (in my opinion) are in non-dollar assets.  The federal government (along with state and local governments) is piled high in debt with no end in sight.  The only solution coming out of DC is more money creation.  This is bearish for the U.S. dollar.

For your permanent portfolio, your gold portion should be in assets that correlate directly to the price of gold.  You can actually buy the metal in coin form, you can buy certificates that are redeemable in gold, and you can buy an ETF (symbol: GLD).  However, for your speculative investments, gold stocks are a more interesting play.  There is more leverage and more risk.  But the rewards can also be far greater.

An interesting exchange traded fund (ETF) that you might want to look at is GDXJ.  It is made up of junior mining stocks.  It is a good way to get some exposure to this sector.  It is a risky sector as many junior mining companies never really get off the ground and make a profit.  But they can also be very profitable.  This ETF is a way to get exposure to junior mining stocks while also spreading your risk around.

This is an investment that could easily go down 50% or more in a stock market or gold market downturn.  On the other hand, if gold goes up 20%, you could easily see this ETF more than double.  The good thing about it as a speculation is that you can liquidate it quickly.  It trades just like a stock and you can buy it with almost any online brokerage account.  When you are ready to take profits, you can sell it in minutes or less.

Again, you should not mix this with your permanent portfolio.  This is a speculative investment as a play against the U.S. dollar and for gold.  You can review GDXJ here.

Monday, February 14, 2011

Budget Battles

There are budget battles going on in Washington DC.  Republicans in the House have proposed up to $100 billion in cuts.  Obama has proposed cutting $1.1 trillion from the deficit.  This would be decent if it weren't for the fact that the $1.1 trillion in cuts would be over 10 years.  This calculates out to just over $100 billion per year.

The Republican cuts are a real joke.  They are playing games with the numbers, counting things as cuts from future spending increases.  Even if these were real cuts, they are still a joke.  The deficit for this year alone is expected to top $1.5 trillion.  Therefore, a cut of $100 billion isn't even 10% of this amount.  And don't forget that this is just the deficit.

So even if Obama and the Republicans came up with $100 billion in cuts, it means we might have a deficit of $1.4 trillion next year.  This means another $1.4 trillion added to the national debt, which is already sky high.

The Republicans could propose cuts in all sorts of programs.  They could scrap the Education Department. They could get rid of all subsidies to farmers.  They could end all foreign aid.  These would be easy things.  In fact, they don't just have to propose cuts, they can actually do it.  They hold control of the purse strings.  The president can only sign what is put on his desk.  If the Republicans never pass a budget with these things, then they will automatically be gone.  The same goes for Obamacare.

Aside from the easy things that won't even happen, the only way to balance the budget is to look at military spending and so-called entitlement spending (Medicare, Medicaid and Social Security are the big ones).  There is no will to touch any of these things.

So what does this whole thing mean for the big picture?  It means the federal government is heading over a cliff at a high speed.  Maybe they can stop the car from accelerating.  Maybe they can even slow it down by one M.P.H.  But unless they slam on the brakes right now, this car is going off the cliff.  This means some kind of default.  It will mean painful defaults for people that will be counting on Medicare and Social Security.  It will mean high inflation.  It may mean an outright default on bonds.

All of your speculative investments should be counting on a weaker U.S. dollar for the long-term.  The politicians in DC are guaranteeing this outcome.  The Fed will go along until it faces hyperinflation.

Saturday, February 12, 2011

Is Price Inflation Coming?

Robert Murphy has written an article, published on the Mises Institute website, on the subject of price inflation.  Murphy is one who has predicted stagflation.  The recession part of it has been correct, especially with unemployment so high.  But Murphy admits that there has been little vindication yet when it comes to price inflation.

Some libertarians would argue that we have price inflation.  We can look at health insurance, grocery prices, college tuition, and the stock market.  For the stock market, this is an asset class that is not a good qualification for consumer goods.  While monetary inflation certainly causes asset bubbles, it is hard to put this into the category of price inflation, only because it is not seen as a bad thing by the general population.

It is hard to count college tuition and healthcare costs because the government is so heavily involved.  All of the regulations raise prices for us and it doesn't matter whether there is inflation or not.

For grocery prices, this is certainly a consumer good and it affects everyone.  The only problem is, while prices have been going up a little, it is not significant enough to grab people's attention.  People can live with a 5% rise in grocery prices for a year.  It may not even be that high.

So while we certainly have monetary inflation, we do not have high price inflation.  I know many libertarians don't like the CPI, but it is still a good measurement of the trend and it is showing that price inflation is still low.

In his article, Murphy shows a long-term chart of the adjusted monetary base.  You can see where it more than doubled, starting in late 2008.  We have never seen anything like this.  We also haven't seen excess reserves increase like they have.  We are in a unique situation in modern day America.

While Bernanke seems to like the current situation where all of the monetary inflation has gone into excess reserves, I don't think it can last forever.  Even if it did last forever, there will be a shakeout eventually.  There was a lot of malinvestment from the Fed's loose monetary policy of the 1990's and 2000's.  A lot of resources were diverted into unsustainable things like real estate.  These resources need to adjust back to their proper place according to consumers.  This can take time and it will take a lot more time when the government is interfering with the correction process.

Whether the banks start to lend or not, Bernanke and the Fed will be faced with a choice sooner or later. They will have to choose between massive price inflation and depression.  I still think they will choose price inflation to begin with, if it is just to kick the can down the road.  Ultimately, the Fed will have to tighten up its monetary stance to avoid hyperinflation.  This will cause a massive depression that most people have never seen.

Thursday, February 10, 2011

Collecting Nickels

I have seen more stories on nickels lately, for some reason.  Here is one piece (via LRC).  It is a good time to review the subject of collecting nickels.  Nickels are a unique investment right now.  It is the only investment I can think of that is a hedge against inflation and deflation at the same time.

It is obvious why a nickel would be a good hedge against deflation.  It is money.  It is cash.  In a deflation, your money will gain purchasing power.  If you have a whole bunch of nickels, you can use them as cash. You can trade your rolls with the bank for bills.  Holding cash is good in a deflationary environment.

Now to the inflation side of things.  A nickel is made up of 75% copper and 25% nickel.  If you take the monetary value of the metal in a nickel, it is actually worth more than 5 cents.  Right now, it is worth a little more than 7 cents.  So a nickel is actually worth 40% more than 5 cents if you take the value of the metal.

It is inevitable that the U.S. Mint will stop producing these.  It does not make sense to produce coins at a loss when it is a fiat currency.  Of course, the government does a lot of things that don't make sense, but this will come to an end eventually.  Now, it is illegal to melt pennies and nickels.  It may or may not continue to be illegal when the government changes the content in a nickel and penny.  But this does not really matter.  If you go to a coin dealer, they will actually pay you more money for older pennies.  You will get the silver value of pre 1965 quarters.  The same goes for silver dimes.  People don't melt them down anyway.  They use the recognizability of the coin and store it or trade it for the metal content.

Of course the hard part of this whole thing is that a nickel is only worth 5 cents (or 7 cents if you judge it by the metal content).  You have to collect a lot of nickels to make it worth it.  A penny actually has metal value too, but it is just too small a value and too burdensome to consider collecting pennies.

Even though you have to collect a lot of nickels, why not start now?  At the very least, don't spend your nickels.  Put them in a separate jar.  Don't trade them in to the bank.  The worst case scenario is that I'm totally wrong on this and you will one day roll your nickels and trade them in for cash.  But the more likely scenario is that Gresham's law will take hold and the money will be driven out of circulation.  As the Fed continues to inflate and money becomes worth less and less, the metal content of a nickel will be worth a lot more than 5 cents or 7 cents.

You can certainly try hard to collect them.  You can ask for a roll of nickels at a store.  You can ask for some rolls at a bank.  I would not tell them your true purpose.  At the very least, stop spending your nickels.  Save them in a jar somewhere.  Keep them for a rainy day.  If you end up saving up a few hundred dollars worth of nickels, it may turn out to be a good investment.

Wednesday, February 9, 2011

Hyperinflation and the Money Supply

The question of the day is:
Can you have hyperinflation without a significant increase in the money supply?

First, to answer this question, we must define hyperinflation.  Austrian economists usually define inflation as an increase in the money supply.  By this definition, the only way you can have inflation (or hyperinflation) is if the money supply is increasing.

But let's debate the question using the now commonly used definition of inflation.  For the sake of this discussion, let's say that inflation is the equivalent of price inflation.  For the definition of hyperinflation, let's say that this means very significant price inflation.  This means that prices are rising very rapidly, probably over 100% per year.  This means that prices may be going up every day, but at the very least, once a month or more.

So can we have massive increases in prices without a significant increase in the money supply?  While the probability is low, it is not impossible.  When we look at the overall price level, there are two sides to the equation.  There is the money supply on one side and there is the demand for money on the other.  They may or may not correlate.

Right now, there is actually a fairly high demand for money.  This means that velocity is low.  It means that money is not changing hands as frequently.  This is actually the equivalent of a decrease in the money supply.  People are frightened of the economy.  There is a lot of uncertainty.  People are paying down debts and saving money (if they can) for a rainy day, at least more than they were doing before.

Velocity occurs based on how people are thinking.  If people are scared and feel the need to hold some cash, velocity will be low.  If times are good, people may be willing to spend more and velocity will be higher.  But there is also a scenario where times are not necessarily good and yet velocity is high.  If people fear that their money will not buy as much tomorrow as it does today, they may go ahead and spend it and get rid of it before it loses more value.  People will buy "stuff", because at least the "stuff" will hold its value better.

This last scenario is most typical in an environment of big increases in the money supply.  This is what happens in countries that experience hyperinflation.  It is a bad cycle.  This is what happened in 1920's Germany.  It came to a point where prices were going up much faster than the money supply.  This was due to extremely high velocity.  People did not want to hold cash.  They wanted to spend it immediately.  People would get their paycheck and immediately run to the store to buy food with it before the food prices went up again.

Usually in a high velocity environment, people are expecting the money supply to continue to increase.  But it is technically possible to have high velocity without an increasing money supply.  People may just expect it to increase or they may lose faith in the currency for some other reason.  It is technically possible that the majority of Americans will wake up tomorrow and start reading the Mises Institute website and become Austrian economists.  Based on public opinion, especially if legal tender laws were repealed, people could all of a sudden reject the fiat currency and turn to gold or some other money.  It would even be possible for the market to turn away from gold because it found something better.

So to answer the above question, because of the velocity of money (how quickly money changes hands), it is possible to have runaway price inflation without a dramatic increase in the money supply.

Tuesday, February 8, 2011

A Society of Free Money

Because we live in a world of fiat money, it is hard to imagine a society that functions with free money and free markets.  Many people, libertarians included, forget that so much of what we are accustomed to only takes place because of fiat money.

Let's imagine a society with a truly free market.  If this society had any government, the only thing the government would do would be to protect people and their property and enforce contracts.  This means there would be no or minimal taxes and no or minimal government regulations (the market would have regulations).  It also means there would be no legal tender laws and no central bank creating money out of thin air.

Now let's say that the free market in this society chooses to use gold or silver (or perhaps both) as money.  People would be free to use whatever they want, but most likely one or two things would win out and become money for society.  People would obtain gold or silver so that they could save, invest, and buy other things.

For the sake of discussion, let's say that banks did not participate in fractional reserve banking.  I would argue that even in a free banking system, banks would keep close to 100% reserves anyway, but either way, let's say for this discussion that all banks kept 100% reserves.  Now, this is not realistic, but for discussion sake, let's also say that the amount of money (gold or silver) does not change.  There is no new mining and the money stays within this society.

Now, that is a lot of assumptions, but what would this society look like?  Besides the fact that it would flourish, there would be a lot of differences with what we have in current day America.  For example, we are accustomed to wages going up (at least before a couple of years ago).  This would not really happen any longer as a whole, at least not in nominal terms.

Over time, we usually see stock prices go up.  We usually see housing prices go up.  We usually see the prices of consumer products go up.  But this would all go away.  Housing might actually get cheaper over time.  While stocks would still go up and down, the overall stock market would not likely go up.  This is hard to fathom.  So why would anyone buy stocks?  Well, any one particular stock can go up, but you could still buy index funds because they would pay dividends (especially with no tax on dividends).

This is really tough for people to grasp.  Wages would not go up.  You would have the same money supply, so how could they go up?  Where would the money come from?  But this is all ok.

Many people think that as the number of goods and services in society increases, that the money supply must increase to accommodate this.  But it just isn't true.  What happens is that your money becomes worth more.  With the same amount of gold or silver, you can buy more today than you could yesterday.  We would live in a world like the electronics industry.  Things would get better and cheaper as time goes on.  You wouldn't see a rise in nominal wages, but your standard of living would shoot up as your wages could buy so much more.

This is what actually happened in much of 19th century America.  Prices actually fell gradually.  But it wasn't some scary deflation.  It was an increase in purchasing power due to increased investment, technology, and productivity.  This is the way it should be.  We should expect more for our dollar tomorrow, but instead we get less.  We have been brainwashed by fiat money.

Monday, February 7, 2011

Inflation and Hedonics

Gary North has written an interesting and insightful piece (as usual).  He basically points out that some things have gotten cheaper and that we should factor in the quality of products when we are looking at the price.

I can give my own example.  More than ten years ago, I bought a 27 inch television for about $400.  I would not be able to buy the same television today, unless I pick it up used on Ebay or somewhere like that.  If I spent $400 on a television today, I would get something bigger (screen size), but it would be lighter and it would only be a few inches thick.  It would have more features with a higher quality.  This is definitely a reduction in price.

I first read Gary North's article on his website and I was wondering if Lew Rockwell would publish it.  This could actually be a controversial piece amongst some libertarians.  There are a lot of libertarians who, to say it politely, don't think much of the Bureau of Labor Statistics and the Consumer Price Index (CPI).  There are a lot of free market thinkers who believe that the CPI is manipulated to understate price inflation and thus make us think we are better off than we really are.  I happen to agree with Gary North on this subject (I believe Harry Browne had a similar opinion) and think that the CPI is useful for measuring trends.  Of course it will never be totally accurate.  That is impossible.  But it would be just as impossible to come up with a totally accurate number if it were done by a non-government group.  It is impossible because of hedonics.

Now, I would not be one to take Gary North at task on an article relating to anything monetary, and I don't think I'll start here, but I do have an extra point to make.  Yes, some things, particularly those in the technology sector, are getting cheaper.  Yes, this is due to increased investment and productivity over time. Yes, a computer that costs one thousand dollars today that is twice as fast as a one thousand dollar computer a year ago is a price reduction for what you are getting.  With all of that said, this just shows us one thing.  In sectors where prices are dropping, productivity is outpacing monetary inflation, but we have absolutely no idea how much we have of each.

If there is no increase in technology or productivity and prices stay flat, then price inflation really is zero.  If productivity and technology are increasing rapidly and prices stay flat, then price inflation due to monetary policy is actually high.  It is just being offset by the productivity.

I think this is why the CPI is so annoying to so many libertarians.  While the CPI is supposed to measure the price index, libertarians equate it to monetary policy.  And while there is certainly a correlation, the CPI is really measuring two things that are opposing forces.  The CPI is measuring price inflation due to monetary policy and price deflation due to gains in productivity.  It is possible to have them go the other way, but not likely, especially in today's world of central banking.  Of course, you can also see prices in things like education and healthcare go up faster because of interference by government.

Because of hedonics, it is impossible to know how much of an effect monetary policy has vs. the effect of productivity and technology.  It is obvious with televisions, computers, cell phones, digital information, and most other things technology, that we have seen rapid gains and they show no signs of slowing down.  This has allowed prices to go down and quality to go up, in spite of continued monetary inflation by the Federal Reserve.

The CPI really is a contest in many ways between the free market (productivity) and monetary policy (money debasement).

Friday, February 4, 2011

Rich Man, Poor Man

There was an article the other day published on LRC (via Dow Theory Letters) by Richard Russell.  He says this is the most popular piece he's published in 40 years.  It is a short read and I think worth it if you haven't seen it already.

His second rule of not losing money sounds so ridiculous, but it really is true.  This isn't to say that you shouldn't take some risk, but you should manage your risk and limit your losses.

The first rule is about compounding interest.  I think this is a very important lesson to teach kids.  I'm not sure what age is best as it probably varies depending on maturity.  But certainly by high school, it is a good lesson to teach.  If you look at the subject beyond an individual investor, it also explains the wealth of nations.  When a nation is grounded in freedom and property rights, the economy will flourish.  While the gains in overall wealth are hard to see over a short period of time, the growth compounds.  You will get to a point where you can save and invest more, while also consuming more.  Again, this goes for individuals or for the general wealth of a nation or area.

There is one thing in this piece that I have to take exception with.  He gives an example of the power of compounding interest and he uses an interest rate of 10%.  Now I understand that he is using a nice clean number and I'm not sure when this was originally written, but it certainly doesn't apply to our times today.

The biggest problem is that the real rate of return right now (adjusting for inflation) is negative, particularly if you are investing in short-term bonds or money market funds.  If you take your money and stick it in a savings account right now, you are losing money.  While this idea of compounding interest is important, it's not going to happen in today's environment with the investments he recommends.

While this is a good educational piece, I would make sure to pair it with some writing on the Permanent Portfolio as described by Harry Browne.  His strategy is to divide up your investments into 4 equal parts.  The 4 parts are stocks, long-term government bonds, gold, and cash (or near cash equivalent).  Anyone who has used this strategy has seen nice and steady returns through the years with very few bumps.  This is a strategy that will protect you against a collapsing dollar, something that isn't addressed in this article.

Wednesday, February 2, 2011

Mubarak to Step Down

Hosni Mubarak, who has been president (dictator) of Egypt for almost 30 years, says he will step down and hold elections.  This could be several months away, but it is not all that likely that he will make it through the weekend.  Protesters are demanding that he step down now.  Mubarak, of course, is claiming that he was going to step down anyway (yeah, right).

This blog is usually about the economy and investments, but it also has a libertarian theme.  The situation in Egypt is too important to ignore right now and it will likely have an impact on our investments too.  We are seeing a revolution take place, much like the demise of the Soviet Empire in the last 80's and early 90's.

This situation is not just in Egypt.  It started in Tunisia where the dictator of 23 years there was ousted.  We are seeing protests in Jordan and Yemen.  All of the Arab states, particularly those with U.S. government backed dictators, are in jeopardy.  Courageousness can spread quickly.

The biggest news would be if Saudi Arabia started stirring.  Just like Egypt, Saudi Arabia receives billions of dollars in U.S. welfare and most of it goes to support the totalitarian government.  Considering how much U.S. politicians like to talk about spreading democracy, they sure do support a lot of dictators.

If the House of Saud were to topple, it will have a lot implications on the rest of the world.  Overall, it would be a good thing, especially if it moves the people towards liberty.  It might drive the price of oil to the sky in the short-term because of uncertainty.  In fact, I think a small speculation on an ETF or stock that is correlated to the price of oil would not be a bad bet right now.  I could certainly be wrong, but there seems to be a lot more reward potential than risk right now.

Unless there is an all-out war, I don't think the oil supplies will be interrupted for long.  For whoever is in control of the oil supplies, it is in their best interest to sell it.  So if you do speculate on an oil play, it would also be wise to take some profits if they come.  Oil and gold both went up big last Friday, but by Monday morning they had settled down.  Once people get more comfortable with the situation (like in Egypt), the market tends to settle down.  The same could happen in Saudi Arabia if there end up being protests there.

This is an historic time we live in.  This all shows that there is hope for liberty in our future.  Technology is getting the truth out like never before.  We should embrace this technology and encourage others to do so.  We should spread the word of liberty.  We should help others see how much better their lives would be with more liberty and less government.  This goes for everywhere.

Tuesday, February 1, 2011

The Internet and the Future for Liberty

Gary North has written an excellent article describing the revolution that has taken place in the last month.  The internet has enabled people to communicate as never before and it is what allowed the people of Tunisia to topple their government.  This has encouraged others to attempt the same, most notably right now in Egypt, but also in Yemen, Jordan and others.  All of the Arab states may be on the brink of revolution.

There is a competition going on in the world.  It is government vs. technology.  The real fight is between government and the people at large, but it is technology that is allowing people to fight back.  Technology has meant more information and communication than ever before.  It is information that cannot be controlled by governments.  This is the biggest enemy to government.

Governments can only exist when they have some kind of consent from the populace.  As this consent is withdrawn, governments weaken and will eventually fall.  Revolution does not require violence.  It requires education and changing the hearts and minds of people.  When enough people realize that the government is not only not helping them, but is actually hurting them far more, then the government cannot stand for long.

As Gary North indicates in this and other writings, technology cannot be stopped.  The increases in speed and new technology is like nothing we've seen before.  If you buy a computer today, it is faster than almost anything that existed just a few years ago.  The technology gets better and cheaper and it is at an exponential rate.

It is actually very difficult to understand the times that we are in.  I cannot fathom it.  We really don't know what our world will look like in 20 years.  Government is the only thing that can stop technology from continuing its dramatic increases (except for maybe a giant meteor or some other unknown).  But technology is what is allowing people to communicate and organize and thus de-legitemize government.  It is a race of big government and technology and technology is winning hands down.

I am pessimistic for the short-term prospects of the American economy.  All of the fiat money and government bureaucracy is bad for business.  It will have to correct at some point.  But the long-term outlook is actually quite good.  We cannot begin to understand just how much we will have in a couple of decades.  The internet revolution has been unbelievable in less than 20 years.  I remember I got my first email account in 1993.  There was no YouTube, Google, Wikipedia, Facebook, and millions of others.  In fact, most of these didn't event exist 10 years ago.

If you are ever feeling down about the prospects for liberty, just think of the electronics that exist today.  We are in a digital revolution, but most people fail to acknowledge the significance or that we are even in one.