Gyroscopic Investing

moda0306 wrote: craigr,
I think your description of the success of Japanese people to remain prosperous and the problems of South America would exist no matter what the price level factors.  We're talking cultural and corruption factors here that override what their money did or didn't do for them.  Give Japan a helecopter drop of yen or put South America on the Gold Standard and you'll see the same societies emerge. 

moda Germany was a total mess in Weimar times but it was still Germans there. I agree that it was a problem of distribution (ie everything in the entire country was owed to the WWI victors) but it still shows that a dire economic mess can make "good" people barbaric.

As I keep wittering on, I don't agree that nominal monetary deflation need be damaging so long as distributional issues are addressed. Personally I'm not sure that gold needs to be taken note of in order to have a non-expanding currency. Perhaps a sane fiat system would be one where gold happened to stay the same price from one century to the next without anyone taking note of it.

I was meaning the scenario just as you described where the assets just zigged and zagged around taking turns to rise and fall with no long term trend for any of them. That is what stocks have done for the past decade and perhaps is what they "normally" do if you exclude the freak event of the 1982-1999  bull market. Perhaps eventually the gold bull market will run its course and then gold will do the same.
If the zigs and zags are large enough then the portfolio gains needn't be slight. Imagine if the assets alternately halved and doubled in price. Look at what a rebalanced 50% EDV: 50% silver portfolio does at times even if you just go between time points where silver has traced back to where it was at the start.

Stone, I backtested silver vs zeros from 1952-2011. The performance of a portfolio of half silver/half zeros rebalanced annually couldn't even beat inflation from 1952-1971 despite the assets having a roughly -0.326 correlation over this time period. For that matter, the performance of say $1,000 put into both (half into each so $500 into silver and $500 into zeros) didn't really provide much of a different result from 1952-1971 than putting $500 into each in 1952, not rebalancing at all, and checking at the end of 1971 to see what you had (which would have been a sum of money-roughly $1150 whether rebalanced or not-that was higher in nominal terms but lower in absolute terms than what you'd started with).

From 1972-2011 the results were rather more impressive for a rebalanced vs non-rebalanced mix of 50/50 silver and zeros. The non-rebalanced portfolio ($500 apiece put into each in January 1972 and never rebalanced but checked again on December 31st 2011) left you with roughly $26,000 ($7,500 in silver and $18,500 in zeros). The annually rebalanced portfolio left you with almost $84,000 despite the fact that silver and zeros during the period 1972-2011 had a negative correlation of only -0.137. I would note that the non-rebalanced portfolio had you ahead for several years starting in 1979 but by 1982 the advantage reverted back to the rebalanced portfolio (needless to say both portfolios suffered staggering losses-upwards of 30% per year in nominal terms and 40% per year in real terms-in 1980 and 1981).

In any event, silver (or gold) and LT zeros may both be getting ready to fall together. If that happens in the coming years (and I'm not saying it will but it might) then look out below....

The only thing I'm certain of is that nothing exponential is sustainable unless it is entirely imaginary.

True that...what was it Ken Boulding said? "Anyone who believes that infinite exponential growth is possible in a finite system is either a madman or an economist." Of course this means that any investment strategy, PP or not, will eventually (unless we can research new and better non-depleting energy sources and find better ways to recycle our wastes...or unless we expand into space) bump up against the hard limits of resource constraints in a finite world.

If inflation/deflation equally affected all types of prices and debts then it could be said to be entirely imaginary. But it doesn't so it isn't. I suspect that eventually we will have to face up to the reality that we can’t sustainably use nominal smoke and mirrors effects such as inflation to manage the economy. Instead mild deflation to keep up with improving technology is what reality is and what a non-distorting monetary system has to reflect. Something like moving tax to being an asset tax IMO is a much better approach than trying to aim for 2% inflation and failing dismally instead getting wage deflation and escalating asset price/commodity volatility. Currently it is tax advantaged to hoard money rather than training staff or building machines etc. If that wasn't the case, then deflation wouldn't screw up the economy in the way it would with our current tax system IMO.

Correct in that if you don't have an asset tax-since you don't have inflation to act as one-or something like it, in a continuously deflationary economy people would be rewarded each year with a larger share of goods and services the economy produced for simply stuffing money under a mattress. They didn't even have to loan that money out or make investments with it (or even deposit it in a bank to be loaned out to others). They were rewarded for doing nothing. AN asset tax would put the kibosh on that (although a 7 or 8% asset tax would be a big incentive to hide any non-interest earning physical cash money and not report it IMO).

Inflation sucks. And I think it probably is worse in just about every case than deflation.

Craig, do you really think people were worse off under the high inflation from say 1972-1980 than they were under the deflation from 1929-1933? Look at per capita income growth, industrial production, inflation-adjusted year-over-year GDP growth, poverty rates, unemployment rates, etc and tell me how you think people (at least average working Americans and not those few wealthy who owned enough AAA corporate bonds or Treasuries to live off the interest) were worse off during the 1970s than during the Great Depression. For that matter, how have all of the above (per capita income growth, industrial production, inflation-adjusted year over year GDP growth, poverty rates, unemployment rate) been for Japan from the early 90s (deflationary) vs Japan from say 1950-1971 (they had about 4.4% average inflation during those years)? Neither was especially bad for the average Japanese but I think deflation affected most Japanese less than it would most Americans for two reasons:

One, as already mentioned by Moda, the high Japanese savings rate meant that job loss wasn't as devastating financially to most Japanese as it probably would be to most Americans. I'm also not sure what kind of social safety net Japan has as regards UI, welfare, universal healthcare, housing benefits, etc but if they had a more generous one than America it could also be another reason the higher unemployment , slower growth, and deflation (from 1990-2011 vs from 1950-1989) didn't hurt them as badly as it might have hurt the average American.

I also would ask you to consider that deflation probably didn't hurt the average Japanese as much as it might have his American equivalent due to Japan's corporate culture and society. Japanese firms didn't fire workers as readily as American firms would have when the economy turned soft; executives and stockholders were expected to share in the economic pain. Japanese executive pay is maybe 15-20 times average worker pay, Japanese corporate leaders don't typically get rewarded with bonuses even if the business fails or for laying off half a company's workforce, and stockholders have for the better part of two decades now had to accept 4% or less ROE on average and stock prices below book value in Japan, whereas in America it's "maximize shareholder value and damn the consequences" and executives are often paid several hundred times (in some cases several thousand times) what most employees make and can still collect huge bonuses even if the company fails, stockholders don't make any money over many years, or the corporation is run so poorly they end up having to fire much of their workforce. You can't compare Japan and America (or Japan and second or third world countries) and say that deflation would affect us the same here....in the US some groups would feel more pain under deflation than in Japan.

I get upset when I read about economists saying they want inflation. They have not looked at other places where the "dream" came true. Or if they have they didn't understand what really happened by talking to people that went through it. I was speaking last year with someone from Argentina that lives in the states now about what happened in 2001. I mentioned how economists thought it was a good thing what happened. But for her she would get red-faced angry and go into many stories about people losing everything. I just have to take her word for it that losing 2/3rds of your life savings almost overnight is not good. Great for exports and foreigners, true. But really bad for the people living there.

Yeah, well, it sucks to be her (although if there weren't laws forbidding buying gold, commodities, or foreign currency, she must shoulder some of the blame herself IMO because she could have prepared and did not) but I don't see this as much different than someone keeping their savings in wheat or oil or gold and then losing maybe half of it or more in years like 1981-2000 (for gold) or 2008 (for commodities).

Besides, what was the alternative for Argentina? If it had abandoned the dollar peg and defaulted on its debt but NOT deliberately devalued and/or inflated, do you really think the market wouldn't have given its currency a massive haircut (and thus chopped its citizens purchasing power by a good chunk anyway) anyhow? Or should Argentina just have tried to repay foreign (USD IIRC) denominated debt that had become huge relative to its GDP and had its citizens suffer under austerity and high taxes to repay said debt (look at Ireland or Greece to see what happens when you have too high of debt to GDP and it's denominated in a currency you don't control)? For that matter, what would have happened to Iceland (and its citizens) if they had had to repay their debt (which wasn't their national debt but their bankers'...but it could have been if their government had assumed it like Ireland's did) that was almost six times the size of their GDP instead of repudiating the debt, devaluing the currency, and imposing capital controls? Has there ever been a historical example in the last 70 or 80 years where a country got out of debt by defaulting on its obligations (or alternatively, when the country didn't default but there was an asset bubble followed by huge financial crisis and its large banks/lenders/corporations did default) but then there was deflation and the deflation helped the country recover? It seems the opposite is typically true, you either have a sovereign default (Argentina 2001, Russia 1998) or large scale financial corporation default (Iceland 2008, Malaysia 1997-98, Thailand 1997-98, Sweden 1990) followed by inflation and/or devaluation (either by your own government or by the market deciding that if you aren't going to pay your debts maybe your currency isn't worth as much as they thought), followed by recovery as the debt burden was lifted by partial or full default and (to the extent it was paid back) by being paid back in devalued currency. For that matter, didn't the inflation of the late 1940s wipe away about 1/4 of the US and UK's war debt and allow more of their citizens' money to be spent or invested rather than being used for debt service?

I'm not saying that inflation or devaluation is good, per se (it isn't)...I'm just saying that sometimes the alternative (years of debt slavery in Argentina's case) might well be a whole lot worse for the country overall and many of its citizens.

Lastly, I think it's a mathematical impossibility that gold could continue to provide a growing economy with a stable medium of exchange once it's been mostly mined.  If inflation is "too much money chasing too few goods," and deflation is the opposite, then the supply of gold would have to continue to grow with the economy to be a stable medium of exchange.  Fiat currencies can much more closely grow to economic output capacity than gold can in the modern economy.  You say deflation is bad for business just like inflation is... well it's a mathmatical certainty that gold as a common medium of exchange in a growing economy would result in either severe deflation, or no growth.  There's really no other way around it.

Moda, you could allow the money supply to grow by either letting banks issue their own notes (or today, by doing the electronic equivalent) based on a certain amount of gold held in reserve...if you wanted to let the money supply grow you'd reduce the reserve requirement from say one ounce of gold for every ten notes to maybe one ounce of gold for every eleven notes. This was (roughly) what we had before 1857 and it worked OK most of the time (although I'm not sure I'd recommend it as there were various panics and crashes along the way as banks sometimes issued too many notes and people tried to redeem them and couldn't; waves of bank failures were the result). But you are right that in a pure 100% reserve requirement gold standard there will be deflation if the economy grows faster than the gold supply.

moda Germany was a total mess in Weimar times but it was still Germans there. I agree that it was a problem of distribution (ie everything in the entire country was owed to the WWI victors) but it still shows that a dire economic mess can make "good" people barbaric.

Stone, wasn't the "economic mess" that helped bring Hitler to power the Depression and not hyperinflation? The inflation was in 1922-1923 and the Nazis didn't gain real power until the 1930s (the Beer Hall Putsch in 1923 failed miserably). I know they did blame Germany's woes on the Versailles treaty reparations and (unfairly, since it was the government's fault) pinned the blame for the 1920s hyperinflation on "Jewish bankers and speculators" but do you really think the Nazis would have been able to take power if it wasn't for the Great Depression?

One tweak that was proposed to guard against a simultaneous steep correction in LT bonds and gold was to switch the barbell approach to a traditional five year treasury ladder. I did this when LT bonds hit about 3.8% and gave up a considerable amount of gains in the last months.  Embarrassed

Short of getting into emerging market debt or other exotic securities I don't see any safe options to park money right now other than treasuries....

Yes, two assets getting hammered would probably result in a loss, but what assets out there could be used as a substitute right now to prevent a scenario like this from occuring?

doodle, I don't know of any "tweaks" right off hand that would fix it. Tweaking the PP by tilting it (more cash, less LTTs, stocks, and gold but more volatile versions of each....maybe zeros, SCV and aggressive large growth, and gold mining stocks and 2X gold) helped some but still couldn't give a consistent 4-5% or so real return in the 1950s and 1960s. Tweaking the PP by switching to a 3x33 (the opposite of tilting...getting RID of all the cash) didn't help much either from 1952-1967 (or any a hypothetical future environment where stocks rise but LT bonds and gold fall) because the greater punch of the stocks was mostly counteracted by the falling gold and LTTs. Maybe (perish the thought and I hope I don't get banned for the heresy of saying this) the PP simply doesn't work in an environment of rising rates and falling gold prices when starting from a base of low interest rates. Simple "tweaks" to the basic PP 4x25% framework might not fix this any more than simple tweaks would fix something else (say, an Earth-centric solar system theory...tweaking it by moving Jupiter and the sun closer or farther from Earth won't fix it because the whole basic premise doesn't take into account what actually happens and actually exists) that had a fatal flaw in it from the get-go.

What the PP really needs to fix this IMO is for cash to become as volatile (on the upside....when rates rise) as LT bonds in a deflation or declining rate environment, stocks in prosperity, or gold in inflation or negative real rates. In other words, you'd be willing to take a loss on your cash in times of falling rates in order to get a bigger gain in times of rising rates. There are several ways to do this (swaps, options, etc) if you are interested but they do kind of violate HB's principles of "no counterparty risk" and of keeping cash as "dry powder for rebalancing" that can't lose money.

D1984 wrote:Craig, do you really think people were worse off under the high inflation from say 1972-1980 than they were under the deflation from 1929-1933?

I wasn't clear:

Deflation was not the cause of misery of the Great Depression. It was the government policies put in place to "fix" things that made it so bad. Deflation was a symptom.

Many bad economies are directly linked to government polices. Not vice versa. FDR implemented price and production controls in the 1930s that made things worse. It wasn't deflation that signed those laws. Etc.

So again I am saying that government response to economic emergencies is a much more unpredictable problem. Inflation in the 1970s was made worse by government policy as well. When looking at deflation, inflation, etc. we have to remember that they are the result of these actions.

And yes, culture matters. I've said this in the past. But economists that make blanket statements about monetary policy "fixing" things assume that the culture of a place in Latin America is the same as Japan. Etc. Each society has their own mores on saving, investing, work ethic, etc. and those play a much bigger role in how they deal with economic problems. Printing or not printing money is far down on the list of priorities.

Besides, what was the alternative for Argentina? If it had abandoned the dollar peg and defaulted on its debt but NOT deliberately devalued and/or inflated, do you really think the market wouldn't have given its currency a massive haircut (and thus chopped its citizens purchasing power by a good chunk anyway) anyhow?

The problems in Argentina at this point are that they think the socialist policies of Peron are a good way to do things. IMO. At least that's my takeaway having looked at the country and speaking to people I know that grew up there. So they will simultaneously blame the government for blowing up the currency, but not make the link that the spending it does is a contributing factor. I have met one Argentinian resident though that hates the socialist policies and politics of Argentina and knows full well they put them in this cycle of destruction. But people like him seem to be in the minority in my experience. Maybe if someone from Argentina is ever reading this forum they can say differently. But this is just my observation to date.

What the PP really needs to fix this IMO is for cash to become as volatile (on the upside....when rates rise) as LT bonds in a deflation or declining rate environment, stocks in prosperity, or gold in inflation or negative real rates. In other words, you'd be willing to take a loss on your cash in times of falling rates in order to get a bigger gain in times of rising rates. There are several ways to do this (swaps, options, etc) if you are interested but they do kind of violate HB's principles of "no counterparty risk" and of keeping cash as "dry powder for rebalancing" that can't lose money.

Something that I think many people ignore in the portfolio is that the variety of assets provides an investor with options to deal with extremes. It ma be that in 5 years the whole thing goes to pot. But I feel more comfortable owning the variety of assets because I know that out of them, I will have at least one I can work with to adapt to an emergency if I have to.

Then again, these doomsday scenarios we create rarely come true either. I just kind of roll with it and not focus too much on any one possibility.

Adam A,

The inflation/deflation debate is a morbidly fascinating one that shows just how unknowable the future is.  

With as much leveraged debt as there is right now it seems inevitable that we will eventually be forced to take one route or the other, neither pleasant.

Agreed, but if humans in the United States are anything like these humans in Romania it seems that governments will be unable to maintain deflationary austerity measures for very long: http://www.cnbc.com/id/46006120

doodle wrote: Adam A,

The inflation/deflation debate is a morbidly fascinating one that shows just how unknowable the future is.  

With as much leveraged debt as there is right now it seems inevitable that we will eventually be forced to take one route or the other, neither pleasant.

Agreed, but if humans in the United States are anything like these humans in Romania it seems that governments will be unable to maintain deflationary austerity measures for very long: http://www.cnbc.com/id/46006120

People do not like having things given to them taken away. This is always the way it is.

The EU will fall apart. I didn't give it 20 years back in 2001 when I was there. This may be the year it all goes down. There is simply no way all those countries are going to remain under the same currency. It may get ugly.

craigr,

Take a look at this short article, and more specifically, the graph showing economic output after countries dropped off the gold standard.  Are you sure it was price controls that sustained the depression, and that monetary/fiscal policy couldn't have played a large roll? 

http://fabiusmaximus.wordpress.com/2009/04/01/fetters/

Even Milton Friedman thought proper monetary policy could have significantly shortened and softened the suffering of the depression.

Price controls probably didn't help, but I highly doubt they were a major contributor to a decade-plus-long economic slump.

moda0306 wrote: craigr,

Take a look at this short article, and more specifically, the graph showing economic output after countries dropped off the gold standard.  Are you sure it was price controls that sustained the depression, and that monetary/fiscal policy couldn't have played a large roll?  

http://fabiusmaximus.wordpress.com/2009/04/01/fetters/

Even Milton Friedman thought proper monetary policy could have significantly shortened and softened the suffering of the depression.

Price controls probably didn't help, but I highly doubt they were a major contributor to a decade-plus-long economic slump.

That chart is nonsense, frankly. It completely ignores all historical context of what was going on.

I knew a woman in her 90s that lived through the Great Depression. She was in a rural area where there were farms all around. At the time there were policies dictating how much could be grown, what could be grown, when it could be sold and how much it could be sold for. She would explain how her uncle would come over and secretly give them excess crops that he was ordered to destroy. They used them to barter with neighbors. If they would have been caught doing that there was threat of fines and prison.

So now someone says "It's gold's fault that there were shortages and misery! Clearly this yellow metal had everything to do with it."

And I say BS.

It's BS because people like FDR and New Dealers were ordering people like farmers to destroy perfectly good crops and keep prices high. It was the New Dealers that told farmers to retrain mules to run over crop rows and turn over crops that were deemed "in excess" and cause deliberate shortages. It was New Dealers that ordered pigs be slaughtered to be kept off the market. Etc.

http://onlinelibrary.wiley.com/doi/10.1 ... x/abstract

It was those kinds of stupid policies that caused shortages and misery. Not gold. Monetary policy was not out there doing these things. It was the government.

Free markets can deal with shortages of money. People just aren't that dense. But what they can't deal with is jerking around money value all over the place with no predictability and arbitrary price and production controls. That gets business owners really nervous. These things are just blatantly obvious to anyone but an economist or Karl Marx.

Here's some light reading on the matter of the Agricultural Adjustment Act. Focus on what was going on in the early 1930s with "parity" controls. It's a disaster:

http://www.ers.usda.gov/publications/aib485/aib485.pdf

craigr,

How is the chart nonsense?  Is there nothing there of value to pull from it?  Seems a bit odd that recovery corresponded so closely to abandoning a gold standard.

I didn't say that it was gold's fault that there were shortages... shortages weren't the main problem during the depression... massive excess capacity of people looking for work was... they had skills, but since their peers were also unemployed and had bad balance-sheets, those skills weren't demanded.  It was that self-fulfilling problem that was the main problem of depression... not "shortages."

Price controls are wrong and counterproductive, but the main problem during the depression was massive unused productive capacity caused by the very unemployment and bad balance sheets that were self-fulfilling, not destroying production that farmers were being paid for.  Business owners were much more affected by lack of demand than price controls.  This was their true worry.

Social security may have been a bad idea too, but it likely didn't extend the depression.... just because something is burdonsome for some businesses doesn't mean it's the cause of mass unemployment and suffering.  When you try to keep a growing economy on an increasingly fixed (less gold to mine) amount of money you're severely limiting your economy's ability for stable growth.  It's simple math.  You need more currency for more economic activity to avoid deflation.  Eventually we run out of gold, but our productive capacity, ingenuity, etc charges forward... or at least it will try to against the friction of too-little medium of exchange.

moda0306 wrote: craigr,

How is the chart nonsense?  Is there nothing there of value to pull from it?  Seems a bit odd that recovery corresponded so closely to abandoning a gold standard.

It's nonsense because it ignores all history. Hitler came into power in the early 1930s. Maybe he caused the recovery?

Japan began expanding their empire. Maybe that did it?

Etc.

And that chart suspiciously stops at the late 1930s. Wonder why it didn't keep going through WWII? Probably because the war wrecked those economies gold standard or no.

So the chart is pointless because it assumes a line explains everything.

Price controls are wrong and counterproductive, but the main problem during the depression was massive unused productive capacity caused by the very unemployment and bad balance sheets that were self-fulfilling, not destroying production that farmers were being paid for.  Business owners were much more affected by lack of demand than price controls.  This was their true worry.

Well there are two ways to deal with problems in a business from my experience:

1) Acknowledge and get it over with and take the short-term pain.
2) Drag it out and let it fester so it becomes good and rotten.

If they had just done #1, as any good business owner would do, the Depression would have been over a lot faster. IMO. But they didn't. They choose option #2 just as they are doing today with the banks and real-estate. So you get the end result which is a dragged out problem economy.

Social security may have been a bad idea too, but it likely didn't extend the depression.... just because something is burdonsome for some businesses doesn't mean it's the cause of mass unemployment and suffering.  When you try to keep a growing economy on an increasingly fixed (less gold to mine) amount of money you're severely limiting your economy's ability for stable growth.  It's simple math.  You need more currency for more economic activity to avoid deflation.  Eventually we run out of gold, but our productive capacity, ingenuity, etc charges forward... or at least it will try to against the friction of too-little medium of exchange.

I can't argue the point any more. Gold in short supply doesn't matter. If gold was in short supply and people couldn't buy then the business owners would just lower their prices until things could be afforded with less gold. Anti-gold people make this way too complicated. A child selling lemonade for $10 a glass and makes no sales quickly realizes they need to lower prices and go back to their suppliers to demand the same. That's the best way to handle it. They shouldn't go to the govt. to demand price controls of lemonade and keep it unaffordable for everyone.

I have nothing more to say on the topic. It's going to go down the gold vs. fiat argument and my answer is the same: If gold is so bad then legalize it fully to compete against paper and we'll see who wins and what money people actually prefer.

The answer will not be a surprise to me. But probably will be very upsetting to people like Paul Krugman.

That's because Paul Krugman and the monetarists don't run businesses and probably have never bothered to ask a business owner what they value most in the money they hold. And I can tell you now it's not swinging around values and interest rates from under their feet.

If gold is so bad then legalize it fully to compete against paper and we'll see who wins and what money people actually prefer.

The answer will not be a surprise to me.

(emaphasis mine)

You so sure about that?  For someone who believes in the humility of the PP, you seem way too self-assured in macroeconomic cause/effect and the infallability of gold.  Even I question my assumptions on the cause of discussion... I don't LIKE government intrusion... I just don't think the evidence bears out that gold works as a currency for a growing economy.  Asking for the gov't to give gold an "even playing field" over and over doesn't accoplish anything... we can't prove either of us are right.  It's nice to think about, though, because it shines a light on exactly what the limitations on using gold as a hedge against debasement truly are.  The difference between us is I offer evidence as to why gold is WAY more volatile than the US dollar and you gloss over that evidence to justify a gold-based monetary system, ignoring the fact that for a 20 year period gold lost value consistently and was volatile all along the way.  Legalizing gold as currency doesn't prevent the government from paying positive vs negative real yields on treasury bonds... which seem to be the overriding factor of gold's performance.  Also, people may not be able to use gold as liquid money, but they can save in gold (even in a tax-free way), and can even denominate contracts to adjust to the price of gold... people often choose to do neither.

These are my observations, and it doesn't appear to me that there's much evidence that your experiment would yield much in at all in the way of gold being used as common currency.

Plus, Milton Friedman was a monetarist.... it's not just a bunch of evil Marxists trying to socially engineer society.  There's some actual legitimate thought there.

moda0306 wrote:Plus, Milton Friedman was a monetarist.... it's not just a bunch of evil Marxists trying to socially engineer society.  There's some actual legitimate thought there.

I'm aware of that. And even listening to his explanation of how he would like to see things work would be reasonable (having a computer precisely control the amount of money to put into the economy to balance supply/demand). Etc. That's fine.

But the real world doesn't work that way. Same reason why Marxism is a disaster. There are humans in charge and humans do things to manipulate situations for their own benefit. Nixon for instance was having the Fed goose the money supply to help him get re-elected. Then at the same time giving speeches acting like he was fighting inflation.

So Friedman's monetarism utopia is not possible. He might have even said as much in an interview I heard him give years ago but I don't recall where it was so don't quote me on that. But I'm hoping he was at least that insightful to recognize the shortcomings of what he was proposing. Friedman was right on many things, but not everything.

And again gold is not volatile. It's a piece of yellow metal. I am not going to post the charts of the first 130 years of the US showing the dollar basically flat with slight deflation again. It's around somewhere. It was not until the Fed came around that the dollar became volatile.

Looks like Friedman might have recanted if the online quotes are correct:

"The use of quantity of money as a target has not been a success. I'm not sure that I would as of today push it as hard as I once did." - Friedman in Financial Times UK June 2003

Humans can't be trusted with printing money. Always has been that way, always will be that way.

Craig,

I've seen the charts.

Gold being a yellow metal is irrelevent... the value of metals can be very volatile based on society's changing needs and fears of the future.  Charts of the 1800's are only partially relevant.  People view their savings' volatility in terms of the things that they save to buy.... groceries, rent, vacations, a car, etc... gold is way too volatile for people looking for a stable store of value.  This is simply math, Craig.  Gold fell over 30% in 1981, a year of 10%+ inflation on the general price level of goods that people tend to buy.  Even if it had existed as a free-to-use currency, that doesn't necessarily put any limits on interest rates, and its obvious that it's real interest rates, not general inflation, that drives gold's behavior.  This is helpful in the PP.  We absolutely don't want something that simply keeps a steady purchasing power of a basket of real goods & services... but only as one asset.. the whole PP is very handy as somethng that has a tendency to generate a real return as measured against the general price level of real goods and services.

If gold isn't volatile, then the overall PP is extremely volatile and we need to radically rethink our investment strategy.  At least that's what the simple math is showing me.

I'll admit that I don't like much of what monetarism tries to do, but I'm not going to dive into why, and the quantity theory of money in the short term is a very bad indicator.  Over the long-term, however, a larger stock of base money would appear to be a basic need of a growing economy.  We've discussed the reasons for this in other threads to a great degre... with disagreements to be sure, but it's still my general postion.  I just think there are plenty of things the savvy investor/business can do to protect both parties against debasement and lack of price certainty.  It's not a big mystery.  Use of the futures markets can give businesses much more price certainty.  And if people are crazy enough to accept what I see as crazy volatility, they could simply peg all of their contracts to the price of gold.

D1984 wrote: What the PP really needs to fix this IMO is for cash to become as volatile (on the upside....when rates rise) as LT bonds in a deflation or declining rate environment, stocks in prosperity, or gold in inflation or negative real rates.

I think this needs to be re-iterated.  I believe this will prove to be the Achilles heel of the PP if (when) rates rise.  Gold, stocks, and LTT are all capable of throwing out 30% gains in a year but cash simply cannot do this, at best it can gain a few % per year over it's current value.

Gold protects in times of uncertainty/crisis/SHTF, stock protects in times of prosperity, and LTT protect in times of falling rates.  Cash helps out in a recession when all three assets drop so you can buy lows, but in a period of rising rates there is nothing in the portfolio which will perform well enough to offset the losses in LTT.

Uncharted territory for sure, but I for one am much more concerned with inflation/stagflation and a period of rapidly rising rates.

BlackOmen (I think) has posted on here that he uses a leveraged "USD bull index" tracking etf as his "cash" because he believes that it is "volatile cash".

D1984 wrote: In conclusion: If we do experience a future period of rising rates, falling gold, and non-inflationary prosperity, the PP may provide rather poorer returns going forward than we are used to and that we've come to expect. Does this concern anyone else?

Welcome to my nightmare.  I've concluded the only effective way to deal is to engage in technofundamental market timing and avoid those regimes that are clearly unfavorable to be holding whatever asset.  That are various ways to do it and there's no need to debate this fact.  Either you have the skills (or can acquire them) or you're stuck being a passive investor.

However, I've got to question why you feel that 2% real returns per year is bad?  The point of the PP is to at least preserve your wealth, not necessarily grow it.  Thats the job of your career and/or VP.  I consider the bigger risks to be mitigating are the large nominal or real drawdowns that can be quite extended in duration.

But it occurs to me that what the "adolescent" PP really needs is to be redesigned around a strategic composite of the frequency of the various economic regimes and not a fuzzy wuzzy 25% each.  I am not quite sure interest rates are the most accurate proxy for detecting thus, but I did post average stock and bond returns under various nominal interest rate levels in another thread.

What the PP really needs to fix this IMO is for cash to become as volatile (on the upside....when rates rise) as LT bonds in a deflation or declining rate environment, stocks in prosperity, or gold in inflation or negative real rates. In other words, you'd be willing to take a loss on your cash in times of falling rates in order to get a bigger gain in times of rising rates. There are several ways to do this (swaps, options, etc) if you are interested but they do kind of violate HB's principles of "no counterparty risk" and of keeping cash as "dry powder for rebalancing" that can't lose money.

This is worth exploring as it might improve robustness.

MG

I think this needs to be re-iterated.  I believe this will prove to be the Achilles heel of the PP if (when) rates rise.  Gold, stocks, and LTT are all capable of throwing out 30% gains in a year but cash simply cannot do this, at best it can gain a few % per year over it's current value.

Gold protects in times of uncertainty/crisis/SHTF, stock protects in times of prosperity, and LTT protect in times of falling rates.  Cash helps out in a recession when all three assets drop so you can buy lows, but in a period of rising rates there is nothing in the portfolio which will perform well enough to offset the losses in LTT.

Uncharted territory for sure, but I for one am much more concerned with inflation/stagflation and a period of rapidly rising rates.

Systemskeptic, if we get rapidly rising rates but they are less than inflation (i.e. negative in the real but not nominal sense) then gold should continue to do OK. Alternately, if we get positive real rates but they are 3-4% above inflation like they generally were from 1982 to circa 2000 we should still be fine even if gold and LTTs fall together (so long as stocks do their job...I'm assuming here that rates rising are coincidental with prosperity and the economy showing signs of life again). The issue is if rates are positive enough (in a real inflation adjusted sense...say 1% or 1.5% real after inflation) to hurt gold and LTTs but not positive enough to provide a decent boost to the PP even with the help of stocks. This is what happened from the early 50s to the mid-late 60s. The other thing that concerns me is what you seem to be referring to-stagflation or tight money recession but still moderate to bad inflation with rising real rates where everything falls but cash. It would be like 1994 or 1981 occurring several times in row. If this happened no other "normal" or "risk parity" portfolio would probably do much if any better than the PP but that's scant consolation (you can't take "relative" returns to the bank, only absolute ones...if your portfolio is down 5% year after year it's cold comfort that everyone else's was down 10% or more when it comes time to buy food, pay rent, or fill up your gas tank with money from your now shrunken portfolio)in my opinion.

BlackOmen (I think) has posted on here that he uses a leveraged "USD bull index" tracking etf as his "cash" because he believes that it is "volatile cash".

stone, a 2x USD or 2x DollarBull ETF may provide more leverage over days or months but yearly it may not do much good. These ETFs typically use options, swaps, futures, etc to mimic 2X the daily USD index return. Three concerns come to mind:

One, there are costs to leverage in the form of options (which makes sense; there are no free lunches if markets are efficient and therefore over the long term leverage costs in the form of options should cost at least as much if not a little more than borrowing to buy the assets because options give one the right to buy the assets at their current value if they increase over the option period but walk away with only the loss of the option premium if the assets go south, whereas if you'd bought the asset on margin you'd still get the increase in value if things went well but would be stuck paying back your margin loan plus interest costs plus extra cash out of your own pocket if the asset value declined). The leverage costs embedded in option prices might not matter so much now when rates are low but in 1981 leverage was NOT cheap with rates approaching 20%; perhaps this was reflected in option prices.

Two, there are additional costs to options (and here they are greater on a relative basis the shorter the term...twelve monthly call options bought and rolled each month will cost more than one 12-month call option bought and held for a year) in the form of volatility premiums- "option premium" and time decay; the option has time premium and option premium when first bought but this decays rapidly as the exercise date draws near and only option premium remains; the issue is that if it was an-at-the money or out of the money option to begin with and the asset price has barely moved then there never was a lot of actual option premium (since the option was not in the money to start with) and the time premium will expire worthless since an option is no good after the exercise date. These costs will be probably greater for an ETF that tries to track daily movements than one that tries to track 2X the yearly average (if I was simply wanting a 2X yearly return and didn't care about tracking error during the year itself I might consider futures instead of options).

Three, while the leveraged US dollar bull ETFs might do well as a volatility capture form of cash in the short term (I seem to recall that it was mentioned on this forum that when all three assets-LTTs, gold, and stocks-were down for the day, check out the USD ETFs and see how they were positive) at going up when nothing else is, what do you do in a year like 1981 when the USD index was only up about 12% when it was needed most? Ordinary STTs gave more of a gain than that...plus you have years like 2008 when USD soared (as everyone fled everything except dollars and yen) but it wasn't needed because LTTs carried the PP that year, whereas USD fell in 2009-even though rates rose (a currency is supposed to become stronger as rates rise but this was probably offset by people going back to risk assets and away from safe dollar denominated instruments as the year wore on).

Welcome to my nightmare.  I've concluded the only effective way to deal is to engage in technofundamental market timing and avoid those regimes that are clearly unfavorable to be holding whatever asset.  That are various ways to do it and there's no need to debate this fact.  Either you have the skills (or can acquire them) or you're stuck being a passive investor.

MachineGhost, look at the returns from 1952-1967 and see your nightmare made real.

STTs (or cash in an S&L acct)

1952 = 2.69%
1953 = 2.81%
1954 = 2.87%
1955 = 2.93%
1956 = 3.02%
1957 = 3.26%
1958 = 3.37%
1959 = 3.53%
1960 = 3.85%
1961 = 3.91%
1962 = 4.06%
1963 = 4.16%
1964 = 4.17%
1965 = 4.21%
1966 = 4.34%
1967 = 5.00%

Stocks (S&P 500)

1952 = 18.15%
1953 = -1.21%
1954 = 52.56%
1955 = 32.60%
1956 = 7.44%
1957 = -10.46%
1958 = 43.72%
1959 = 12.06%
1960 = 0.34%
1961 = 26.64%
1962 = -8.81%
1963 = 22.61%
1964 = 16.42%
1965 = 12.40%
1966 = -9.97%
1967 = 23.80%

LTTs (20 yr rolled over each year-counting income plus capital gains/losses)....there is no data for 30-yr bonds that far back but 30-yr or 25-yr Treasuries or Treasury zeros would have done even worse.

1952 = 1.68%
1953 = 3.73%
1954 = 3.96%
1955 = -1.24%
1956 = -4.07%
1957 = 5.62%
1958 = -5.03%
1959 = -2.74%
1960 = 10.35%
1961 = 1.24%
1962 = 5.78%
1963 = -0.04%
1964 = 3.62%
1965 = -0.19%
1966 = 3.42%
1967 = -7.00%

Gold (no free market prices but assumed to lose about 4.5% nominal or 6% real since we're dealing with non-inflationary prosperity)

1952 = -4.50%
1953 = -4.50%
1954 = -4.50%
1955 = -4.50%
1956 = -4.50%
1957 = -4.50%
1958 = -4.50%
1959 = -4.50%
1960 = -4.50%
1961 = -4.50%
1962 = -4.50%
1963 = -4.50%
1964 = -4.50%
1965 = -4.50%
1966 = -4.50%
1967 = -4.50%

Even if you assume gold had some good and some bad years but overall went down by about 60% (like it did from the early 80s to 2000) volatility capture doesn't help much since you're still looking at a downward trending asset.

Put these all in a spreadsheet , rebalance annually, and figure inflation averaged about 1.55% (go to http://eh.net/hmit for an inflation calculator for this period) and you get a little over 2.10% real (inflation adjusted) per year.

However, I've got to question why you feel that 2% real returns per year is bad?  The point of the PP is to at least preserve your wealth, not necessarily grow it.  Thats the job of your career and/or VP.  I consider the bigger risks to be mitigating are the large nominal or real drawdowns that can be quite extended in duration.

It wouldn't be so bad if the preceding years (1937-1951) weren't also so dismal for the PP (and I even backtested 37-51 with silver, with platinum, with commodities, and even with hypothetical gold that gained 3.5X inflation during 1941, 1942, 1946, 1947, and 1948...it still didn't help much); that's 31 years with poor returns. The other concerns I have are:

One, this 2.1% real return happened when stocks were booming. 1949-1967 was a bull market on par with 1982-1999. Tracking error (the PP gaining 2% real when stocks were doing 15% real) and regret at lost opportunity (your friends and co-workers bragging about how much they made in the market while you are in the PP making much less; tracking error and regret could create the temptation to abandon the PP just as things were about to get good for it in the late 60s...especially given that the late 1960s were a bull run for high-flying tech stocks like Control Data, DEC, Texas Instruments, Sperry, Mohwak Computer, Burroughs, and Data General. These were the dotcoms of their time and crashed hard in 1969 and 1970...just in time for someone to say "screw this" and due to the abovementioned regret abandon the PP to buy them...right before they fell).

Two, craigr's historical returns chart said "the PP was always competitive" with stocks and a 50/50 stock/bond allocation. If the 1950s and 60s were anything to go by, it wasn't, at least not then. This wouldn't worry me so much since it's water under the bridge at this point (the 50s and 60s are ancient history now) but my concern is if somebody gets the idea that the PP can deliver 4-5% per year real (i.e. stock-like returns) returns we less than 1/3rd the volatility....and then we get a near-repeat of the 50s and 60s then the PP will not give a good account of itself vis-a-vis what they were expecting. To get a repeat of the 50s and 60s we'd need: stocks that have gone nowhere or down in real inflation adjusted returns for years (check), gold and commodities at highs like they would have been after the postwar inflation and Korean War inflation (check), and LTT bond yields low after the end of a multi-decade bull market (yields haven't been this low on a sustained basis since the late 40s/early 50s, so check). That's 3 out of 3. I don't KNOW that we will get another period of non-inflationary prosperity and am not predicting such, but even if history doesn't repeat it often rhymes, and if it rhymes the same tune it did in the 50s and 60s the PP will NOT be delivering what we expect of it IMO.

But it occurs to me that what the "adolescent" PP really needs is to be redesigned around a strategic composite of the frequency of the various economic regimes and not a fuzzy wuzzy 25% each.  I am not quite sure interest rates are the most accurate proxy for detecting thus, but I did post average stock and bond returns under various nominal interest rate levels in another thread.

Would the percentages start out static-say 29/26/25/20 just as an example-and then change as conditions dictated?

This is worth exploring as it might improve robustness.

Especially if you used fixed-for-floating 2X swaps (pay 2X LT rates but get 2X LIBOR or 2X Federal Funds Rate) or even fixed-for floating Turbo swaps (pay LT rates squared but get LIBOR or FFR squared...i.e. the rates times themselves...if LT rates were 3.5% you'd pay 12.25% and if LIBOR was 1.5% you'd get 2.25% but if LIBOR increased to 5% you'd still be paying 12.25% but receiving 25%..and if rates increased to Volcker levels your counterparty would cry....); these are-as you can plainly see-VERY leveraged to increases in rates.

D1984, back to your earlier point about the Nazis not being a response to the 1920's hyperinflation. I agree. When I said that the hyperinflation made people barbaric I wasn't thinking of the Nazis (though of course they took barbarism to another level) I was thinking about people in the 1920s going and slitting the udders of cows to steal milk and such like. I know that is trivial when compared to the Nazis but it still makes me wonder when you see just how civilized Germans are today. I totally agree with your point that Japan copes with deflation well because they have equality. I'm just wondering whether the answer might be to emulate their relative equality rather than wringing our hands about us not being able to withstand deflation as they have.

I hope I didn't waste your time with the silver/zero thing. I was only really thinking about the last few years. I wasn't meaning that it was a sensible thing to do. I was just trying to illustrate just how much "rebalancing bonus" can mitigate things.

About an asset tax encouraging mattress cash. I don't see a problem with having paper cash needing to be handed in and exchanged for fresh every so often. I think we have that in the UK anyway. We have signs in shops every so often saying that a certain class of £20 note won't be accepted after such and such a date.

D1984, are such fixed for floating swaps available for small retail savers?

D1984, I'm not entirely convinced by the relevance of the guesstimate for hypothetical free market gold prices over the 1950s and 1960s. To some extent gold price tracks the purchasing power of middle class Indians doesn't it? It is not simply something that gets bought by people concerned about western currencies. If you are going to say that gold price is going to fall in the future you have to also imagine people in Asia not being able to afford so many gold nose rings etc. Am I in a muddle about this

Again, to those worried about the volatility of cash alone to protect against the damage that rising rates would cause to gold and LT bonds, why wouldn't you simply convert the LT bonds and Cash portion of the PP into a 5 year treasury ladder? This seems to me to be the simplest way to confront this issue and still have 50% of your assets in the safety of treasuries. Sure, you are giving up yield and capital gains if rates continue to fall in the short run, but you protect yourself much better against a rising rate environment. FSBIX is currently yielding around 1% I believe, which isn't bad compared to around 1.5% yield of cash and LT bond barbell. Stocks are yielding around 2% - 3% as well and they are protected against big moves to the downside by Federal Reserve QE. If bad deflation were to happen I think that the central bank and politicians would have to interfere in the economy with money injections and work projects....their hands are kind of forced with that.  

No strategy is going to be perfect, but this one in my mind comes as close to preserving the structure of the Permanent Portfolio and protecting against rising rates as I can come up with. Is it perfect? Not by a long shot, but it is a workable and easy to implement way to deal with dangers that PP faces when interest rates sit at historical lows.

Another tweak might be to do 40% in a five year ladder and 10% in a zero coupon ETF like EDV. If rates continue to fall to lower levels that are unsustainable (like Japan's 20 year touching .7%) you could sell the zero's for a big capital gain and transfer fully to a five year ladder. If rates were to rise you would have a smaller percent of your total assets getting hit by rising rates....

Someone else in another post made the argument that the Pareto (80/20) principle applies to the PP and that as long as you have a reasonable portion of your money spread among all 4 asset classes you will do okay even if they don't exactly match the 25% allocations.

"Perfect is the enemy of good" - Voltaire

A slightly less PP way of dealing with the issue is to begin to look at utilizing CD's versus treasuries. I know this is heresy to many here, but CD's yield about twice that of treasuries and come with federal backing as well. My feeling is that if FDIC or NCUA insurance folds, then civil society and paper obligations of any kind will be something in America's rear-view mirror.

Is this a potential solution to LT treasuries and the rising rates dilemma?

At the end of the day if deflation happens, having 50% of your assets in low yielding ST treasuries or CD's wouldn't be much different than a cash/30 year bond barbell, with the exception of the loss of capital gains from rebalancing event.

So as I see it there are three potential passive investing solutions to the dilemma of rising rates and the PP:

1. 5 year treasury ladder.
2. 40% 5 year treasury ladder and 10% volatile zero coupons
3. CD ladder with FDIC insurance.

No, that would be tactical allocation (market timing).  I think a cumulative probability distribution over 100+ years of economic history is likely the best way to set the fixed strategic allocation.  It wouldn't be a bad idea to update the weights as its been 30 years or so since HB formulated 25%x4.  I just would not expect much from the adjustments other than theoretical purity.

You have to pay 12% to get back 2.25% netting you a cost of 9.75%?  That seems very speculative.

MG

D1984 wrote: Would the percentages start out static-say 29/26/25/20 just as an example-and then change as conditions dictated?

Especially if you used fixed-for-floating 2X swaps (pay 2X LT rates but get 2X LIBOR or 2X Federal Funds Rate) or even fixed-for floating Turbo swaps (pay LT rates squared but get LIBOR or FFR squared...i.e. the rates times themselves...if LT rates were 3.5% you'd pay 12.25% and if LIBOR was 1.5% you'd get 2.25% but if LIBOR increased to 5% you'd still be paying 12.25% but receiving 25%..and if rates increased to Volcker levels your counterparty would cry....); these are-as you can plainly see-VERY leveraged to increases in rates.

Some of the proposed solutions to the issue of rising rates (although maybe effective)...

if you used fixed-for-floating 2X swaps (pay 2X LT rates but get 2X LIBOR or 2X Federal Funds Rate) or even fixed-for floating Turbo swaps (pay LT rates squared but get LIBOR or FFR squared...i.e. the rates times themselves...if LT rates were 3.5% you'd pay 12.25% and if LIBOR was 1.5% you'd get 2.25% but if LIBOR increased to 5% you'd still be paying 12.25% but receiving 25%..and if rates increased to Volcker levels your counterparty would cry....); these are-as you can plainly see-VERY leveraged to increases in rates.

are starting to stray from the general principles of simplicity and safety that the permanent portfolio espouses...

Adjusting the 4x25 approach seems reasonable in light of historically low rates; especially for those people who are looking for stable cash flow from investments at the expense of potential capital gains...utilizing "turbo swaps" on the other hand seems like a bit of a perversion of some of the fundamental tenets of the PP

D1984 wrote: I'm assuming here that rates rising are coincidental with prosperity and the economy showing signs of life again.

If you look at the US stock market over the last 70 years, we really only had two things going for us.  One: we were the victors of WWII, and two: we invented the internet/computer technology.  These two things have been the driving force for stock returns above inflation.

I picture the coming decades as characterized by a stagnant economy and devaluation of our currency as we roll the printing press to keep up with our deficit spending.  Unless we can invent the next big wealth creator, I think the US is destined for decades of failing wages and devalued savings until we fall more in line with the developing world.  You are correct that in a typical inflationary environment with mild to moderate prosperity, there is no problem with the PP.

If the economy is just barley inching by and you can't count on stocks to lift you, LTT are in the toilet, and gold probably isn't doing that great -- I think that is going to be a very painful time for the PP.