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

[MediumTex]

If the Fed announced that it was going to stop buying all bonds, it would cause the stock market to crash because everyone would assume that the economy was being taken off of life support (which it has been on for going on five years).

When the money in risk assets began running for safety in response to such an action, where would it go?  Into the treasury market, of course, just like it did in late 2008, when rates were just as low as they have been since the Fed has been buying bonds on a large scale.

In other words, rates are going to stay low either way.

Look at credit levels and demographics and that really tells you all you need to know about what is likely to happen with interest rates in the U.S., with or without the Fed monkeying around in the bond market, and Bernanke knows this.

[moda0306]

If the fed winding down QE would increase rates, why have rates done most of their increasing during QE, and decreasing after it's over?

If interest rates are so unnaturally low, how has gold gone from $1,900 to $1,200?

If interest rates are so unnatually low, why don't we have rampant inflation as demand for credit-fuelled consumption and investment overtakes our productive capacity?

What is the "natural" rate of interest for a currency issuer to borrow the money they issue?  Seems to me it's either 0% (kind of like the "natural score" of a referee or umpire), or whatever rate produces full employment and price stability in the market.  Both are below current rates.

Since demand for new loans is so low, and supply (either constrained (willing depositors x reserve multiplier)) or unconstrained (no true reserve req't)) is so high, with low current inflation (as measured even by the BPP) and low projected future inflation (spread between inflation and non-inflation-protected t-bonds), why is the "natural rate" anything but super low right now?

If the fed came out and raised t-bill rates to 7% (or whatever Austrians think they deserve on risk-free assets), this would be the subsidy of a lifetime, and would absolutely tank the economy, resulting in deflation, making 7% t-bills even more of a ridiculous subsidy.

The fed may be able to control the floor on the price of money, but they can't control the movements of the entire economy... The market is showing very, very few signs that these are grossly unnaturally low rates.

This idea that we've seen some asinine increase in the money supply is astoundingly misleading.  The fed trades fiat nominal "liabilities" for fiat nominal liabilities" of equal value.  If the government came out tomorrow and signed a bill making T-bills legal tender, open market operations would do NOTHING to the money supply on a chart going forward.  However, all the PP'ers holding T-bills wouldn't just shit the bed in fear and start spending their T-bills because the "money supply" exploded and their dollar-denominated confetti is about to collapse.

It's much better to look at there being a spectrum of "moneyness," much of which is made up by financial assets, some of which generate in the private sector (a share of stock or private bond) and are a direct claim (likely) to some non-financial assets (factory, home, business, car), or they are generated by the government to be used to clear private transactions (dollars/t-bills) and help control interest rates.  Most actual transactions don't use shares of the S&P 500 or a T-Bond or a muni bond as legal tender, but they very well could in our modern economy.  The problem isn't there being too much money on our balance sheets, it's that there's not enough money and other financial assets on our domestic balance sheets to keep our economy running at full capacity.

[happyspec]

Also, if rates rise, we have 25% of our money in an short-term bonds--an asset type that quickly adjusts to rising rates and will give us nice fat interest payments. Almost as if it was all planned out that way… 

in this discussion the arguments that have the most value in my humble opinion are those of Pointedstick. The headaches people get from thinking about future possible are nothing else than the result from trying to outsmart the markets. As I understand it the Permanent Portfolio has been constructed to relieve investors from the need to predict things.

[happyspec]

I'm not sure I follow your logic, Libertarian666. Are you saying that without Fed interference, interest rates would be much higher?

Yes, of course. They are the only purchasers of T-Bonds. What happens when the only purchasers of anything stop purchasing? The price will go... down. This isn't rocket surgery!

Haven't you been buying T-Bonds too? at least you should have been

[frommi]

Also, if rates rise, we have 25% of our money in an short-term bonds--an asset type that quickly adjusts to rising rates and will give us nice fat interest payments. Almost as if it was all planned out that way… 

in this discussion the arguments that have the most value in my humble opinion are those of Pointedstick. The headaches people get from thinking about future possible are nothing else than the result from trying to outsmart the markets. As I understand it the Permanent Portfolio has been constructed to relieve investors from the need to predict things.

There is no reward without risk. Even the PP has a risk, its rising interest rates without inflation. If you think you can get above inflation returns without risk, than stop investing a penny and rethink about what you are doing. I was naive enough to do it and i now have to pay the bill for it. Read about Markowitz portfolio theory, The Intelligent Investor and Security Analysis from Graham and perhaps than you are better prepared .

[Pointedstick]

Nobody sensible thinks the PP is a riskless investment portfolio. Without presuming to speak for others, what I can say attracts me to the PP is the history of inflation-beating returns, the shallowness and short duration of portfolio drawdowns (I mean c'mon, we're talking about intra-year -7% or so here), and the mental peace of mind provided by being broadly diversified across multiple major asset classes. So far the PP is having a lousy year. That doesn't invalidate it as a portfolio concept any more than 50/50 stocks and short-to-intermediate-duration bonds would be invalidated by a stock market crash. That's an awfully popular portfolio that can experience much, much deeper drawdowns.

You just need to know what you're getting into. If I wanted zero nominal downside volatility, I'd choose something else. If I wanted stable tax-free income, I'd choose something else. What is being stress-tested here is not the PP itself, but extremely conservative PP investors who did not realize that the portfolio could experience moderate levels of downside volatility in the short term.

[Tortoise]

What is being stress-tested here is not the PP itself, but extremely conservative PP investors who did not realize that the portfolio could experience moderate levels of downside volatility in the short term.

Yes, that's certainly a big part of what's going on here. But based on what some of the dissatisfied PP investors have been saying recently, it sounds like another source of their frustration is some of the perhaps oversimplistic statements about the PP that have been repeated over the years. And oversimplification often leads to misunderstandings.

A few examples:

• "The rising asset(s) in the PP tend to more than compensate for the falling asset(s). I.e., the rising asset(s) tend to buoy the portfolio."
  (This is usually the case but is not always the case.)
• "...smooth, steady returns..."
  (This is a relative statement. The returns are smooth and steady relative to a far more volatile stock-and-bond portfolio, but not relative to cash or short-term bonds.)
• "The PP is for the money you can't afford to lose."
  (In this context, "lose" is defined over an investment period of at least a few years--not over mere weeks or months.)

[Ad Orientem]

A few examples:

• "The rising asset(s) in the PP tend to more than compensate for the falling asset(s). I.e., the rising asset(s) tend to buoy the portfolio."
  (This is usually the case but is not always the case.)
• "...smooth, steady returns..."
  (This is a relative statement. The returns are smooth and steady relative to a far more volatile stock-and-bond portfolio, but not relative to cash or short-term bonds.)
• "The PP is for the money you can't afford to lose."
  (In this context, "lose" is defined over an investment period of at least a few years--not over mere weeks or months.)

That should be put up in a flashing neon sign on the front page of the forum.

[Libertarian666]

I'm not sure I follow your logic, Libertarian666. Are you saying that without Fed interference, interest rates would be much higher?

Yes, of course. They are the only purchasers of T-Bonds. What happens when the only purchasers of anything stop purchasing? The price will go... down. This isn't rocket surgery!

Haven't you been buying T-Bonds too? at least you should have been

No. I don't use the PP.
As for T-Bonds/T-Bills: I am rather heavily short dollars. In a way that can't result in a margin call, of course; I'm not suicidal!

[Pointedstick]

No. I don't use the PP.
As for T-Bonds/T-Bills: I am rather heavily short dollars. In a way that can't result in a margin call, of course; I'm not suicidal!

Long gold and short dollars? Oof. How are you holding up these days?

[Libertarian666]

No. I don't use the PP.
As for T-Bonds/T-Bills: I am rather heavily short dollars. In a way that can't result in a margin call, of course; I'm not suicidal!

Long gold and short dollars? Oof. How are you holding up these days?

It hasn't been too much fun doing my weekly spreadsheet recently.
But I'm pretty sure part of 2008 wasn't much more fun than this, and I managed to survive.
My "short dollar" position is a non-recourse mortgage on my primary residence at a ridiculously low fixed rate, so that doesn't pose any hazard. My gold is also fully paid for.

Luckily, I'm working, so I don't have to draw down my portfolio. Now that would be painful.

[Gumby]

No. I don't use the PP.
As for T-Bonds/T-Bills: I am rather heavily short dollars. In a way that can't result in a margin call, of course; I'm not suicidal!

Long gold and short dollars? Oof. How are you holding up these days?

It hasn't been too much fun doing my weekly spreadsheet recently.
But I'm pretty sure part of 2008 wasn't much more fun than this, and I managed to survive.
My "short dollar" position is a non-recourse mortgage on my primary residence at a ridiculously low fixed rate, so that doesn't pose any hazard. My gold is also fully paid for.

Luckily, I'm working, so I don't have to draw down my portfolio. Now that would be painful.

Sounds like you let your political views guide your investment decisions. Would you disagree?

[Libertarian666]

Long gold and short dollars? Oof. How are you holding up these days?

It hasn't been too much fun doing my weekly spreadsheet recently.
But I'm pretty sure part of 2008 wasn't much more fun than this, and I managed to survive.
My "short dollar" position is a non-recourse mortgage on my primary residence at a ridiculously low fixed rate, so that doesn't pose any hazard. My gold is also fully paid for.

Luckily, I'm working, so I don't have to draw down my portfolio. Now that would be painful.

Sounds like you let your political views guide your investment decisions. Would you disagree?

Yes, I disagree. My economic analysis indicates that the risk in stocks, bonds and the dollar is too great for me to tolerate, which has nothing to do with my political views. Of course, I could be wrong, but that is true of all analysis on any basis.

[asherah]

• "The rising asset(s) in the PP tend to more than compensate for the falling asset(s). I.e., the rising asset(s) tend to buoy the portfolio."
  (This is usually the case but is not always the case.)
• "...smooth, steady returns..."
  (This is a relative statement. The returns are smooth and steady relative to a far more volatile stock-and-bond portfolio, but not relative to cash or short-term bonds.)
• "The PP is for the money you can't afford to lose."
  (In this context, "lose" is defined over an investment period of at least a few years--not over mere weeks or months.)

As my first post in this forum I would like to give my +1^n to this. I have read a lot about the PP and these quotes always raised my eyebrows. I know that HB himself made these statements in his radio shows but a newbe can be misguided by these general remarks. They really have to be corrected or to be set in the general frame of the PP.

Besides this: Many thanks for all your posts! My asset allocation is now 50 % German PP with EMU stocks and 50 % playground with international stocks and bonds. Looking forward to the gold crash. My bet: 950 USD within weeks.

[Gumby]

Yes, I disagree. My economic analysis indicates that the risk in stocks, bonds and the dollar is too great for me to tolerate, which has nothing to do with my political views. Of course, I could be wrong, but that is true of all analysis on any basis.

Can you explain how a politically agnostic economic analysis comes to the conclusion that stocks, bonds and Dollars are all too risky? It sounds like you are predicting the demise of the US dollar and economy — which is a politically biased conclusion (i.e. "government headed in the wrong direction" or something of that nature).

[WhiteDesert]

• "The rising asset(s) in the PP tend to more than compensate for the falling asset(s). I.e., the rising asset(s) tend to buoy the portfolio."
  (This is usually the case but is not always the case.)

This statement was one that I found compelling when I was doing my initial research, prior to implementing a 4X25PP. It's hard to recall, but it might well have been one of the things that inspired me to research the strategy in the first place. Interestingly, however, even saying that the statement is usually accurate might be overstating things some.

My 4X25PP is fully contained within my Roth, and consists of allocations to VTI, IAU, SHY, and TLT. I started it on 1 July 2011 and have tracked it since. I try to record its performance daily, but I have missed some days due to off-the-grid travel, and I don't track its performance on days that I add money to it (or to my variable, since I track them both as a single portfolio where the PP acts as part of the "anchor"). This leaves me with some 380 observations of performance.

For kicks, I just went in to my tracking spreadsheet and did some quick back-of-the-envelope figuring. The results surprised me, so I thought I'd share them. I assumed that "falling asset(s)" equals at least one of the four components dropping by at least 1%, and I assumed that "buoying the portfolio" means that the overall 4X25PP does not drop more than .25%. I also assumed that "by not more than" means that if the overall portfolio drops exactly .25%, then it counts as a buoyed day (this happened three times). I studied the performance since 1 July 2011 and selected days where at least one asset had dropped by 1% or more from its close on the previous day. This gave me 152 relevant observations. I then scored each of those 152 days as a 0 or a 1. The day earned a zero if the whole portfolio dropped by more than .25%. The day scored a one if the portfolio lost less than .25%.

So, of 152 relevant days, 79 days scored a one and 73 days scored a zero. Using this dataset, and with the assumptions that I had chosen, the portfolio was buoyed by rising assets on just over half of the days that at least one of the funds dropped by 1% or more. The rising assets failed to buoy the portfolio 48% of the time. Additionally, of the days that the portfolio lost more than .25%, it dropped by more than .50% 42 times and more than 1% 10 times. Of the days that the portfolio was buoyed by rising assets, the overall portfolio was positive at the end of the day 40 times and lost value 39 times.

Anyway, this was just some quick figuring and wasn't particularly rigorous. And obviously, changing the initial assumptions will change the results. But I thought folks might find it interesting.

[moda0306]

Yes, I disagree. My economic analysis indicates that the risk in stocks, bonds and the dollar is too great for me to tolerate, which has nothing to do with my political views. Of course, I could be wrong, but that is true of all analysis on any basis.

Can you explain how a politically agnostic economic analysis comes to the conclusion that stocks, bonds and Dollars are all too risky? It sounds like you are predicting the demise of the US dollar and economy — which is a politically biased conclusion (i.e. "government headed in the wrong direction" or something of that nature).

+1

The PP, and investing in a macro-diversified manner in general, carries so much political weight that it's probably pretty pointless to try to completely separate the two. Harry Browne did it about as much as humanly possible.

If you truly think our currency is going to collapse, to say that you've completely removed your political opinions from that is probably impossible... All we can hope for ourselves is that we're making sure that we are seeking to understand economics first, and only later deciding what our political beliefs are, and not letting it go the other way around. 

[Libertarian666]

Yes, I disagree. My economic analysis indicates that the risk in stocks, bonds and the dollar is too great for me to tolerate, which has nothing to do with my political views. Of course, I could be wrong, but that is true of all analysis on any basis.

Can you explain how a politically agnostic economic analysis comes to the conclusion that stocks, bonds and Dollars are all too risky? It sounds like you are predicting the demise of the US dollar and economy — which is a politically biased conclusion (i.e. "government headed in the wrong direction" or something of that nature).

Austrian analysis indicates that there are two and only two possible endings of a gigantic inflation* such as we are seeing today:

1. The central bank stops printing money; or
2. The central bank keeps printing money until they destroy the currency.

Either of these would cause disastrous losses for stock and bond holders; thus my conclusion that those two investments are too risky.

Why would either of these cause disastrous losses?

1. Interest rates for the federal government (and all other debtors who borrow in dollars) head for the moon due to lack of actual end demand for their debt, causing the stock and bond markets to collapse.
2. All instruments denominated in fixed numbers of dollars are destroyed in this case. The stock market may survive, but the social chaos makes it difficult for firms to be profitable.

Now it is true that if the central bank chooses ending 1, the dollar could go up a great deal in purchasing power. However, I am of the opinion that they will not do that because of their sensitivity to the stock and bond market crashes that (as we can see from recent events) would start immediately upon their announcement of their new policy. Is this a political opinion? Maybe; the rest is standard Austrian economic analysis.

*By inflation I mean an increase in the money supply, not that general increase in prices that follows from the increase in the money supply.

[buddtholomew]

*By inflation I mean an increase in the money supply, not that general increase in prices that follows from the increase in the money supply.

Is it an increase in the money supply or the circulation of that supply to the masses (velocity)? We haven't witnessed a rise in inflation even with the increase in money supply as banks continue to hold more in their reserves.

[Libertarian666]

*By inflation I mean an increase in the money supply, not that general increase in prices that follows from the increase in the money supply.

Is it an increase in the money supply or the circulation of that supply to the masses (velocity)? We haven't witnessed a rise in inflation even with the increase in money supply as banks continue to hold more in their reserves.

"Velocity" is a meaningless concept in economics. Every unit of money is at all times in someone's cash balance. Even if "the check is in the mail", the money it represents is in one account or another at any given time.

You guys should really read Von Mises' Human Action, which destroys the myths of the so-called "mathematical economists" as well as explaining what economics really is and really can do.

Note that I don't agree with his erroneous assumption that government is necessary to the free market. But other than that he's pretty much spot on.

[Pointedstick]

You guys should really read Von Mises' Human Action, which destroys the myths of the so-called "mathematical economists" as well as explaining what economics really is and really can do.

How do you know we haven't? I have. Austrian economics is attractive because it is logical and internally consistent, but it has been my experience that attempting to apply it to the economies of the last 50 years results in problems because the Austrian explanation for what should come to pass often stubbornly resist manifesting itself in the real world. IMHO it doesn't do a very good job of modeling the world of freely-exchangeable unpegged floating fiat currencies, which has oddly enough avoided collapse thus far and which people mysteriously seem to accept despite the fact that it's all backed by smoke, mirrors, and promises by untrustworthy entities.

Its supporters (myself formerly included) can have difficulty letting go of it because of how darn logical it is and how self-evident are its fundamental axioms. But if it don't work, ya gotta start looking elsewhere.

[Libertarian666]

You guys should really read Von Mises' Human Action, which destroys the myths of the so-called "mathematical economists" as well as explaining what economics really is and really can do.

How do you know we haven't? I have. Austrian economics is attractive because it is logical and internally consistent, but it has been my experience that attempting to apply it to the economies of the last 50 years results in problems because the Austrian explanation for what should come to pass often stubbornly resist manifesting itself in the real world. IMHO it doesn't do a very good job of modeling the world of freely-exchangeable unpegged floating fiat currencies, which has oddly enough avoided collapse thus far and which people mysteriously seem to accept despite the fact that it's all backed by smoke, mirrors, and promises by untrustworthy entities.

Its supporters (myself formerly included) can have difficulty letting go of it because of how darn logical it is and how self-evident are its fundamental axioms. But if it don't work, ya gotta start looking elsewhere.

Yes, the collapse has not arrived yet, but that doesn't mean it isn't coming. I don't recall any claim by Von Mises that the timing of the end was predictable. In fact I would be very surprised at any such claim, considering the basic fact that economics is not a mathematical science.

And as I still have not seen any explanation of how there can be another ending besides the two I outlined, I will maintain my position that one of those two will happen eventually.

[Xan]

I will maintain my position that one of those two will happen eventually.

I won't quote Keynes's old saw, but "eventually" can be a VERY long time indeed.  Why not stick 25% of your savings into stocks, 25% into bonds, set some rebalance bands, and capture the gains while they last?

Eventually, the stock market will no longer exist.  Eventually the sun will go nova.  Eventually I will die.  But in the meantime, I'd like to buy stocks and bonds low and sell them high.  :-)

[Libertarian666]

I will maintain my position that one of those two will happen eventually.

I won't quote Keynes's old saw, but "eventually" can be a VERY long time indeed.  Why not stick 25% of your savings into stocks, 25% into bonds, set some rebalance bands, and capture the gains while they last?

Eventually, the stock market will no longer exist.  Eventually the sun will go nova.  Eventually I will die.  But in the meantime, I'd like to buy stocks and bonds low and sell them high.  :-)

Because I don't like the risk/reward ratio.

[moda0306]

What if "printing money" is really just exchanging slow money for fast money?  A bond that is a promise to pay a fiat dollar from the entity that issues those dollars is fundamentally not all that much different from the dollar itself.

Please explain how printing dollars and exchanging them for t-bills changes the nominal purchasing power of the economy.

Pleeeeeease.

And the natural rate of interest to receive for loaning your currency to the issuer of said currency is 0%. We're in a deleveraging crisis with lots of unused productive capacity. Why in gods name should there be a high interest rate floor?

The referee of a hockey game doesn't wear ice skates so he can score a goal. He wears them so be can do his job of holding the players accountable more easily.  The players know this, and don't treat him like they treat other players.  The issuance of bonds by the federal government isn't much different.  There's no natural need for a currency issuer to issue bonds, just like refs don't need equipment to help them score goals.  However, giving them those tools doesn't all of a sudden make them like everyone else.  We just now know that the government is in the business of setting an interest rate floor and the ref wants to see things better.

Ill give one more example...

Imagine if instead of "printing money" and exchanging it for tbills, the government gave every US citizen treasury bonds of varying duration worth a total of $100,000.

The money supply, according to common measurements, has not increased. However, we have a nominally risk-free financial asset to the tune of $100k on our balance sheets that wasn't there before.  THIS would be inflationary. This would repair all our balance sheets and then some.

This would cause a lot of inflation. However, in an under-capacity, low investment environment, lowering an interest rate floor to 0-3.6% is NOT a crazy market manipulation, and that's essentially what "printing money" is.