Not Even Harry Browne Thought It Was Going To Be This Bad

[moda0306]

Lastly, it is already established that you do not believe in any scenarios other than the PP maintaining it's past performance, so I do not think there is much to gain by further raising and dismissing specific scenarios.

I don't think MT ever said that.

[MediumTex]

Lastly, it is already established that you do not believe in any scenarios other than the PP maintaining it's past performance, so I do not think there is much to gain by further raising and dismissing specific scenarios.

I don't think MT ever said that.

I'm just waiting for someone to tell me about a scenario in which the U.S. economy is neither expanding nor contracting and the price level is neither rising nor falling.

I don't think there are any options outside of the ones above.  I don't care what interest rates in some other country are doing because they are not relevant to the principles on which the PP is based.  Regardless of what is happening anywhere else in the world, the U.S. economy will either be expanding or contracting and the U.S. price level will either be increasing or declining.

[moda0306]

It can be converted into something of value... until it can't. See "Zimbabwe dollar", Weimar mark, and hundreds of other examples.

Zimbabwe's hyperinflation resulted from racially motivated theft of private property that resulted in dramatic capital flight from the country.  This scenario has no applicability to the U.S.

Weimar Germany's hyperinflation was the result of war reparations following its loss in WWI.  This scenario has no applicability to the U.S.

I understand your concern about the U.S. dollar, but it seems to me that there are countless currencies that will collapse long before the U.S. dollar, in part because the U.S. is a vastly more productive economy and has a more stable government than you see in almost any other part of the world.

Yes.  Cullen Roche has responded at great lengths about these hyperinflation events, and we've posted them on here.  Of course the US dollar would collapse in the face of gross corruption or an alien invasion.  If we all of a sudden owed Saudi Arabia 80 trillion dollars worth of gold, and tried to print our way out of it, and Saudi Arabia captured our northeast corridor to help repay them, we'd see hyperinflation. 

It would be one thing if we weren't posting responses to all this. 

Tech, it seems like you don't even want to think outside a certain framework.  Please read what we're posting. 

[MediumTex]

I don't need MR to know about that risk; it is implicit in the Austrian model as well.

But isn't the Austrian model based upon a currency that is convertible into gold?

It seems to me that the current system is outside of the Austrian model, and thus Austrian predictions and prescriptions may not work as well as they would under a gold standard (and they may not work at all).

[Libertarian666]

I don't need MR to know about that risk; it is implicit in the Austrian model as well.

But isn't the Austrian model based upon a currency that is convertible into gold?

It seems to me that the current system is outside of the Austrian model, and thus Austrian predictions and prescriptions may not work as well as they would under a gold standard (and they may not work at all).

No, the Austrian model is NOT based on a currency that is convertible into gold. It includes analysis of pure fiat currencies as well as those convertible into gold.

[MediumTex]

I don't need MR to know about that risk; it is implicit in the Austrian model as well.

But isn't the Austrian model based upon a currency that is convertible into gold?

It seems to me that the current system is outside of the Austrian model, and thus Austrian predictions and prescriptions may not work as well as they would under a gold standard (and they may not work at all).

No, the Austrian model is NOT based on a currency that is convertible into gold. It includes analysis of pure fiat currencies as well as those convertible into gold.

Would it have predicted the 30 years of explosive economic growth with relatively low inflation for most of the 30 year period following the end of gold convertibility in the U.S.?

See the long term real U.S. economic output chart to see what I mean.  It looks like the U.S. economy performed better after the end of gold convertibility on an inflation-adjusted basis than it did while still on a quasi-gold standard.

What is the Austrian economics explanation for this apparently favorable post-gold standard outcome?

[systemskeptic]

MediumTex,

I do not think you addressed the point about price level vs. real rates inside the US.  Right now we have zero/negative real rates and a "rebounding" economy.  So it's not much of a stretch to imagine a situation where the real rates stay low and the economy stops showing significant returns.  It's not the price level that matters it's the real return on a bond barbell...

Also, why do you think Gold will necessarily protect you in the event that another region has a period of economy prosperity relative to the US?

[MediumTex]

MediumTex,

I do not think you addressed the point about price level vs. real rates inside the US.  Right now we have zero/negative real rates and a "rebounding" economy.  So it's not much of a stretch to imagine a situation where the real rates stay low and the economy stops showing significant returns.  It's not the price level that matters it's the real return on a bond barbell...

I didn't address price level vs. real rates because real rates are not one of the variables on which the PP is based.  All I need to know is whether the economy is expanding or contracting and whether prices are rising or falling.

Do you understand why these are the only variables that the PP cares about?

Also, why do you think Gold will necessarily protect you in the event that another region has a period of economy prosperity relative to the US?

Did I say that gold would protect you in that situation?  If I did, I didn't mean to.  What I should have said was that outperformance of another region would be irrelevant to the PP's performance in the U.S.  All we would need to know would be whether the U.S. economy was expanding or contracting and whether U.S. prices were rising or falling.

I wish it wasn't so simple because we tend to like complicated explanations to complicated problems, but those two variables are really all that matter, especially for a U.S. investor who is investing in the largest bond market in the world and investing in the stock market tracking the largest economy in the world.

[systemskeptic]

I didn't address price level vs. real rates because real rates are not one of the variables on which the PP is based.  All I need to know is whether the economy is expanding or contracting and whether prices are rising or falling.

Do you understand why these are the only variables that the PP cares about?

I guess I don't understand because you aren't invested in price levels nor are you invested in the "economy" you are invested in bonds and holding a stock fund. 

What does the price level of steak (CPI) have to do with real returns on TLT/SHY?  What does the US economy have to do with the world economy?  How does the economy of Europe affect the flow of money into and out of VTI?  Are these items synonymous? 

[MediumTex]

I didn't address price level vs. real rates because real rates are not one of the variables on which the PP is based.  All I need to know is whether the economy is expanding or contracting and whether prices are rising or falling.

Do you understand why these are the only variables that the PP cares about?

I guess I don't understand because you aren't invested in price levels nor are you invested in the "economy" you are invested in bonds and holding a stock fund. 

What does the price level of steak (CPI) have to do with real returns on TLT/SHY?  What does the US economy have to do with the world economy?  How does the economy of Europe affect the flow of money into and out of VTI?  Are these items synonymous?

The PP owns proxies for each combination of economic conditions I described.

If the economy is expanding with low inflation, stocks will do well.

If the price level is rising with little economic expansion, gold will do well.

If the price level is falling and the economy is contracting, bonds will do well.

...and so on. 

There is a PP asset or combination of assets for every economic condition based upon the expansion or contraction of the economy and the rise or fall in price levels.

Craig and I cover this concept in a lot more detail in the PP book.

[Libertarian666]

It can be converted into something of value... until it can't. See "Zimbabwe dollar", Weimar mark, and hundreds of other examples.

Zimbabwe's hyperinflation resulted from racially motivated theft of private property that resulted in dramatic capital flight from the country.  This scenario has no applicability to the U.S.

Weimar Germany's hyperinflation was the result of war reparations following its loss in WWI.  This scenario has no applicability to the U.S.

I understand your concern about the U.S. dollar, but it seems to me that there are countless currencies that will collapse long before the U.S. dollar, in part because the U.S. is a vastly more productive economy and has a more stable government than you see in almost any other part of the world.

Yes.  Cullen Roche has responded at great lengths about these hyperinflation events, and we've posted them on here.  Of course the US dollar would collapse in the face of gross corruption or an alien invasion.  If we all of a sudden owed Saudi Arabia 80 trillion dollars worth of gold, and tried to print our way out of it, and Saudi Arabia captured our northeast corridor to help repay them, we'd see hyperinflation. 

It would be one thing if we weren't posting responses to all this. 

Tech, it seems like you don't even want to think outside a certain framework.  Please read what we're posting.

You're right; I don't want to think outside a certain framework.
So what are your thoughts on phrenology?

[systemskeptic]

The PP owns proxies for each combination of economic conditions I described.

If the economy is expanding with low inflation, stocks will do well.

If the price level is rising with little economic expansion, gold will do well.

If the price level is falling and the economy is contracting, bonds will do well.

...and so on. 

There is a PP asset or combination of assets for every economic condition based upon the expansion or contraction of the economy and the rise or fall in price levels.

Craig and I cover this concept in a lot more detail in the PP book.

I understand the concept, my question is: are those assertions really true or are you being mislead because you are looking only the performance of those items in a region with a strong / strengthening presence.

Put another way, I agree with the economic cycles you are describing.  The question is not about those cycles, but about the state of the region... those same cycles occur in both strong and weak regions.  Probably the difference is in the magnitude of returns (positive, zero, or negative). 

You seem pretty confident that the sum of those cycles always occurs "above water" , as it were.

[MediumTex]

You're right; I don't want to think outside a certain framework.

Why not?

So what are your thoughts on phrenology?

It's interesting that you bring that up because "figurative phrenology" might be an interest thing to study--i.e., the way thinking within different frameworks alters the shape of the mind and by extension the figurative shape of the skull.

[MediumTex]

The PP owns proxies for each combination of economic conditions I described.

If the economy is expanding with low inflation, stocks will do well.

If the price level is rising with little economic expansion, gold will do well.

If the price level is falling and the economy is contracting, bonds will do well.

...and so on. 

There is a PP asset or combination of assets for every economic condition based upon the expansion or contraction of the economy and the rise or fall in price levels.

Craig and I cover this concept in a lot more detail in the PP book.

I understand the concept, my question is: are those assertions really true or are you being mislead because you are looking only the performance of those items in a region with a strong / strengthening presence.

If you are saying that a Zimbabwe, Lebanon or Cuba PP might not work as well as a U.S. PP, I completely agree with you, but for a U.S. investor why would this matter?

If you are saying that the U.S. is going to be the next Zimbabwe, Lebanon or Cuba, are you also saying that this will occur overnight, because if it doesn't happen overnight it seems like there would be plenty of time to re-evaluate your investment strategy in light of deteriorating conditions.

When people have backtested the PP in situation involving a small economy experiencing catastrophic economic conditions such as Iceland in 2008, the PP would have still provided pretty good protection, and far better protection than almost any other diversified investment strategy.

I would also like to add that in a lot of these discussions where the PP is held to a higher and higher standard of perfection, remember that we all must invest in something, so it's reasonable to point out that if the PP is doing poorly most other strategies are probably going to be doing very poorly.

Are you suggesting that the PP doesn't hold enough gold or is there something else about it that you think it lacks?  I would really like to hear your thoughts on this topic.

[glennds]

The PP is premised upon the following assumptions:

1. At a given point in time, the economy can only be on an expansion trajectory or a contraction trajectory.  It's possible for the economy to be neither expanding nor contracting, but such a condition rarely lasts for very long.

MT,

Is it really such a simple  binary proposition - we're either expanding or we're contracting? Could it be that the effect on the portfolio also depends on the type of expansion or the nature of contraction? Not to beat the "this time it's different" drum but I really do wonder if the four states of economy concept is simplified to the point of being potentially deceptive. Could it be that under two different scenarios where economic expansion has occurred but in each in a different manner,  the portfolio might behave differently because the correlations between the asset classes might behave differently?  Thanks for your thoughts on this nuanced question.

[MediumTex]

The PP is premised upon the following assumptions:

1. At a given point in time, the economy can only be on an expansion trajectory or a contraction trajectory.  It's possible for the economy to be neither expanding nor contracting, but such a condition rarely lasts for very long.

MT,

Is it really such a simple  binary proposition - we're either expanding or we're contracting? Could it be that the effect on the portfolio also depends on the type of expansion or the nature of contraction? Not to beat the "this time it's different" drum but I really do wonder if the four states of economy concept is simplified to the point of being potentially deceptive. Could it be that under two different scenarios where economic expansion has occurred but in each in a different manner,  the portfolio might behave differently because the correlations between the asset classes might behave differently?  Thanks for your thoughts on this nuanced question.

Over the last 40 years it has been that simple.

Are you suggesting that the stock market might respond to one type of economic expansion differently than it would another?  Why would it?  If corporate profits are increasing, do we care why?  We may care a lot, I just thought I would ask the question.

In my mind, if the economy is expanding in real terms I don't feel the need to look beneath the numbers.  I simply take the expansion at face value.

Will it be that simple going forward?  I don't know.

[Libertarian666]

You're right; I don't want to think outside a certain framework.

Why not?

So what are your thoughts on phrenology?

It's interesting that you bring that up because "figurative phrenology" might be an interest thing to study--i.e., the way thinking within different frameworks alters the shape of the mind and by extension the figurative shape of the skull.

Why don't I want to study the Klingon language?
Why does the patent office require a working model of a perpetual motion machine submitted for patent protection?
Why doesn't a chemist want to study alchemy? Why doesn't an astronomer want to study astrology?

The answer to all of those is very similar to the answer for your question: we know enough about the supposed object of study to be able to dismiss it as valueless to us, so why should we waste any additional energy on it?

[MediumTex]

You're right; I don't want to think outside a certain framework.

Why not?

So what are your thoughts on phrenology?

It's interesting that you bring that up because "figurative phrenology" might be an interest thing to study--i.e., the way thinking within different frameworks alters the shape of the mind and by extension the figurative shape of the skull.

Why don't I want to study the Klingon language?
Why does the patent office require a working model of a perpetual motion machine submitted for patent protection?
Why doesn't a chemist want to study alchemy? Why doesn't an astronomer want to study astrology?

The answer to all of those is very similar to the answer for your question: we know enough about the supposed object of study to be able to dismiss it as valueless to us, so why should we waste any additional energy on it?

So you don't think that MR accurately describes the way our current monetary system works and helps to explain why no significant inflation has occurred over the last five years?

Do you think that all people who find MR to be a helpful explanation of how the current system works are simply mistaken, in the same way that an alchemist is mistaken about the nature of the elements?

[Libertarian666]

Why not?
It's interesting that you bring that up because "figurative phrenology" might be an interest thing to study--i.e., the way thinking within different frameworks alters the shape of the mind and by extension the figurative shape of the skull.

Why don't I want to study the Klingon language?
Why does the patent office require a working model of a perpetual motion machine submitted for patent protection?
Why doesn't a chemist want to study alchemy? Why doesn't an astronomer want to study astrology?

The answer to all of those is very similar to the answer for your question: we know enough about the supposed object of study to be able to dismiss it as valueless to us, so why should we waste any additional energy on it?

So you don't think that MR accurately describes the way our current monetary system works and helps to explain why no significant inflation has occurred over the last five years?

Do you think that all people who find MR to be a helpful explanation of how the current system works are simply mistaken, in the same way that an alchemist is mistaken about the nature of the elements?

Correct.

[MediumTex]

So you don't think that MR accurately describes the way our current monetary system works and helps to explain why no significant inflation has occurred over the last five years?

Correct.

Which part of MR do you think fails to explain the current monetary system?  If you read any of the pieces that moda and Gumby linked to, what was the largest error(s) you felt that the authors made in their analyses?

Although I think that our post-gold standard monetary system is kind of goofy, I have found MR to be a useful tool in understanding the mechanics of how it actually works, including the role of deficit spending, the effects of interest rates on debt that is being rolled over, what the Fed's QE policies actually do, and how bond auctions work.

I hate to hear that my understanding of all of these things as scene through an MR lens may be wrong, but I suppose it's possible.

I assume that you are also saying that there is no data, analysis or new information that could change your conclusions about MR as a tool to help understand how the monetary system works.  You do now (and will always) view MR in the same way that you view astrology and FSM.  Is that correct?

[Libertarian666]

So you don't think that MR accurately describes the way our current monetary system works and helps to explain why no significant inflation has occurred over the last five years?

Correct.

Which part of MR do you think fails to explain the current monetary system?  If you read any of the pieces that moda and Gumby linked to, what was the largest error(s) you felt that the authors made in their analyses?

Although I think that our post-gold standard monetary system is kind of goofy, I have found MR to be a useful tool in understanding the mechanics of how it actually works, including the role of deficit spending, the effects of interest rates on debt that is being rolled over, what the Fed's QE policies actually do, and how bond auctions work.

I hate to hear that my understanding of all of these things as scene through an MR lens may be wrong, but I suppose it's possible.

I assume that you are also saying that there is no data, analysis or new information that could change your conclusions about MR as a tool to help understand how the monetary system works.  You do now (and will always) view MR in the same way that you view astrology and FSM.  Is that correct?

Any system that comes to the following conclusions is clearly incorrect:
1. That the Fed's buying virtually all the newly issued T-Bonds is insignificant, and that therefore if the Fed stopped buying them, that would have no effect on interest rates. Yes, I know they buy them from the primary dealers, but the primary dealers are merely front-running the Fed and get their commissions without any risk.
2. That the number of dollars borrowed and spent by the Treasury is irrelevant because of the great productive capacity of the USA. That includes at least two obvious logical errors: that the productive capacity of the USA belongs to the government and it can take as much as it wishes without causing a financial calamity; and that people will indefinitely continue to use money that is purposely being devalued.
3. That the fact that the dollar has not collapsed is due to some miraculous property of the USA, which makes it different from every other government in history that has run gigantic deficits with no credible plans to solve such a problem. It is a matter of time. How much time is not predictable because timing of collapse is a matter of mass psychology, not of economics, and anyone who says otherwise is deluded. Confidence must be lost, and it will be lost if nothing is done.

I'm sure there are more, but that should do for now.

If you can resolve these issues, let me know and I'll re-examine your theory.

[glennds]

Over the last 40 years it has been that simple.

Are you suggesting that the stock market might respond to one type of economic expansion differently than it would another?  Why would it?  If corporate profits are increasing, do we care why?  We may care a lot, I just thought I would ask the question.

In my mind, if the economy is expanding in real terms I don't feel the need to look beneath the numbers.  I simply take the expansion at face value.

Will it be that simple going forward?  I don't know.

MT,
I wasn't really suggesting anything, just raising the question (to which I don't claim to know the answer myself). I'm interested in your thoughts on this - do you feel the economy at present is expanding or contracting, and are price levels increasing or decreasing?

[Pointedstick]

Any system that comes to the following conclusions is clearly incorrect:

Speaking of logical errors, you are assuming the conclusion to invalidate the data.

Again, nobody is suggesting that any of this stuff is good. Very few of us like the current crony capitalist system with a rigged banking sector that's pressed into service and requires huge, morally hazardous bailouts every once in a while. But that's what we've got.

[MediumTex]

Any system that comes to the following conclusions is clearly incorrect:
1. That the Fed's buying virtually all the newly issued T-Bonds is insignificant, and that therefore if the Fed stopped buying them, that would have no effect on interest rates. Yes, I know they buy them from the primary dealers, but the primary dealers are merely front-running the Fed and get their commissions without any risk.

I don't think anyone said it wouldn't have any effect on interest rates.  I think that it would, though it wouldn't be as dramatic as many imagine, but that's just my opinion.

2. That the number of dollars borrowed and spent by the Treasury is irrelevant because of the great productive capacity of the USA. That includes at least two obvious logical errors: that the productive capacity of the USA belongs to the government and it can take as much as it wishes without causing a financial calamity; and that people will indefinitely continue to use money that is purposely being devalued.

Inflation is always a constraint, and everyone has been saying this throughout the discussion.

3. That the fact that the dollar has not collapsed is due to some miraculous property of the USA, which makes it different from every other government in history that has run gigantic deficits with no credible plans to solve such a problem. It is a matter of time. How much time is not predictable because timing of collapse is a matter of mass psychology, not of economics, and anyone who says otherwise is deluded. Confidence must be lost, and it will be lost if nothing is done.

I would say that confidence might be lost, but it might not.  It's really hard to say.  I would say that confidence is much better today than it was five years ago, even though the country's finances are in much worse shape (as the finances of many other countries are as well).

In general, what would you say the problem is with large government deficits if they are not translating into inflation?

If you can resolve these issues, let me know and I'll re-examine your theory.

I don't know if it resolves any of them, but hopefully the responses above are helpful.  And BTW, it's not my theory.  It just happens to make sense to me in the same way that an explanation for the appeal of Britney Spears' music might mke sense to me, even if I don't care for her music myself.

[MediumTex]

MT,
I wasn't really suggesting anything, just raising the question (to which I don't claim to know the answer myself). I'm interested in your thoughts on this - do you feel the economy at present is expanding or contracting, and are price levels increasing or decreasing?

I think that the economy is clearly expanding at a sluggish rate, with mixed expectations about the future, though the stock market seems pretty giddy.

Price levels are currently rising at a modest rate, with mixed future expectations there as well.  As we saw in early 2008, inflationary expectations based upon current inflation levels can be deeply misleading.  The price of gold seems to suggest that people are suspicious of sustained future price inflation as well.

Overall, I think that we are still in a secular deflationary trend that is being driven by a number of factors.  The Fed is trying to walk a tightrope of arresting these deflationary forces without triggering undesirable inflation. 

Any time you have short term rates at zero for almost five years, I would say that deflation is probably the threat that the central bank is trying to counter.  I'm not saying "deflation" as in "prices are deflating", but rather deflation as in there are strong forces favoring private sector credit contraction and reduced overall economic output as a result of demographic shifts in the U.S. (which is also deflationary because it can lead to a contraction of the entire economy as aggregate demand becomes softer and softer).

I think that the key to understanding what is going on right now is to be able to distinguish between secular and cyclical trends.  We are currently in a cyclical bear market for gold in the midst of a strong secular bull market.  We are currently in a strong cyclical bull market for stocks in the midst of a secular bear market.  We are currently in a cyclical bear market for long term treasury bonds in the midst of a secular bull market.

I always like to keep an eye on the secular market trend and ignore cyclical markets as much as I can (though sometimes it's hard because cyclical moves in the opposite direction of the secular trend can be so powerful).

What all that comes down to is that I see modest economic expansion that stocks have benefited from, though the stock market is probably way ahead of the actual economy.  Gold and long term bonds have gone down recently because the Fed has made noises about raising rates, which would presumably help to dampen inflation and bring us closer to emerging from the negative real interest rate situation we have been in for a long time.  I think, however, that the Fed is way premature in its suggestion about raising rates, and I would think that gold and long term bonds would return to the secular trend at some point, and stocks will also return to their long term trend as people realize that the economy is still very wobbly.

The expectation I have right now regarding the future is that the economy will contract in real terms and prices will rise.  Of course, I have no idea what will happen and that could all be wrong.

I'm comfortable with the PP in light of everything I described above.  IMHO, gold is the most appealing PP asset right now, based primarily on the illusory sense that many people have that a full recovery from the 2008 financial crisis has occurred, even though current Fed polices should make it clear to an impartial observer that this is far from the case.

Part of the key to understanding the inter-relationship of PP assets is that a lot of it is based upon future expectations, as opposed to the reality today.  Right now, future expectations regarding all future economic scenarios seem a little murky to me, and thus it isn't surprising that the PP has stumbled a little of late.