Do we need more protection than just the PP?

[cowboyhat]

I agree with Clive that the standard PP does not address currency risk in an appropriate way for everyone, and that this issue deserves some thought. One point is that makes this subject difficult is that the individual's specific circumstances would seem to have huge implications for need for currency protection, so a general solution may not exist for the problem.

Consider three different people:

An eastern European with a new mortgage denominated in Swiss Francs and a extensive leveraged business interests in Russia.

A retired farmer living in Hamilton County Illinois who has zero debt, a two acre vegetable garden, and a flock of hobby chickens.

A Canadian autoworker with a 15-year-old daughter who dreams of going to NYU.

[doodle]

Watching a recent CSPAN debt committee meeting with all the big names (Erskine Bowles, David Walker, John Stockman, etc. etc.) it seems like there are some very rosy scenarios baked into CBO debt to GDP predictions in the coming years such as 4.6 GDP growth and 6% Medicare cost increases when 10% is much closer to reality. Failure to meet these numbers means debt grows even more rapidly than commonly stated by govt.

I know that there currently aren't any great reserve currency alternatives to the US dollar, but if the congressional super committee doesn't come out with a serious plan in the next two months to address long term fiscal outlook, it will only spur international concern regarding dollar. I think that the next few years in this country are really crucial to international faith in the dollar. If politics in Washington remains toxic and we are unable to stabilize long deficit spending, it seems that there is the possibility of negative repercussions to dollar's status.  

I think it would be prudent to think about a small variable portfolio incorporating some international stocks and bonds. I was thinking that one option could be:

20% US Stocks
20% US Cash
20% US Bonds
20% Gold

6% DBC (Commodities)
6% VSS/VEU/VWO mix
6% ELD/GIM/ALD mix (mostly Asian and Em Market Debt...mostly creditor nations)

(yeah, I know that only comes to 98%)

Anyways, this might guard against possible future dollar reserve currency issues without removing too much PP protection.

[kw]

Hi Clive,

My latest dividend from EDV was in June this year and the withholding tax was 15%.
This is according to the USA/Holland tax treaty, all dividends are taxed 15%.
The UK can have a different withholding tax percentage.

Best Regards, K

[stone]

It is bizare how EDV pays a dividend. Why do they do that? I don't see how they decide what the dividend should be. It would make no more sense if GLD paid a dividend. Am I in a total muddle about what EDV is? I thought it was LTT STRIPS (ie just the non-coupon paying part of the LTT).

[stone]

Thanks Clive, it now makes sense.   STRIPS with only 25years to maturity cost more than those with 30years to go and the price difference is paid out as a dividend. I find it weird how EDV, TLT and SHY are all sort of in themselves perpetual bonds paying out a variable dividend. I guess it is the open ended fund structure of the ETFs that causes them to retain the volatility and yield characteristics of their constituent holdings rather than taking on one of their own

[stone]

Clive I thought gilt STRIPS had some tax weirdness such that any capital gain even unrealized counted as "income" for tax purposes.  Because of that, they had a very small market and so trading them always entailed a big cost. I supose if you held them for many years then, as with gold coins, the high trading cost might not be such a big deal. Perhaps they could be a core holding in a tax sheltered account and a normal 50year gilt could be held for rebalancing purposes.
Personally I'm not too sure that a catastrophic quick collapse of either the USD or the GBP is anything like as great a risk as that of all the developed world currencies steadily  eroding over the years. Like doodle, I think an emerging market currency bond fund is a better bet if you don't want to rely on gold to protect against currency risk. Perhaps some Yen might counter the "risk on" nature of emerging market currencies. It seems to me not a tail risk but a racing certainty that long term the emerging market currencies will keep level with the developed world currencies whilst having >6% inflation and positive real interest rates as compared to the developed world currencies having <5% inflation and negative real rates. It doesn't take long before that amounts to a transformation. Basically it is just an unwinding of the opposit squeeze that was put on the emerging market economies from 1981 onwards. We used an unsustainable ruse to bleed them dry and they are starting to wriggle out of it. We could potentially focus on getting our own economies to work well but instead I guess we will try and fail to reinstate the "great moderation".
For myself, we are so overweight in cash (because that is all my better half trusts), I just put the non-cash in gold,50yeargilts and stocks with one third of the stocks being TEMIT (emerging market investment trust).

[stone]

Cowboy hat, about your example of "An eastern European with a new mortgage denominated in Swiss Francs and a extensive leveraged business interests in Russia."

Whatever everyone else on here says, I still think paying off that mortgage before contemplating putting any money in the PP would be by far the lowest risk option. Has the Swiss PP beaten swiss cash by enough to match the Swiss Franc mortgage rates offered to Hungarians or whatever? If it did in the past I'd be amazed if it does now. Such a mortgage sounds to me like a timebomb.

[cowboyhat]

Stone,

You are probably right about that Swiss mortgage. I was thinking about situations where currency risk would be huge and multifaceted, those where it would be minimal, and those where it would be very specific. I'm struggling with this aspect of the PP, because I really want a portfolio I can neglect.

One thing about debt against a tangible asset is that it is a hedge against a currency crisis. If my PP was suddenly reduced to the purchasing power of a Big Mac I would be slightly less upset if I could still exchange it for my house.

Having a mortgage denominated in a foreign currency does seem like a recipe for disaster.

[Kshartle]

So we're all gathering here with the intent of improving our investments. In no way should we accept the HBPP as some sort of magical formula for success in any investing environment. HB was not a magician. He was a brilliant investor and philosopher. I've read most of his books and consider the HBPP to be revolutionary and brilliant, but tragically flawed should the home country experience runaway inflation. Harry explains very cleary in "How to profit during a monetary crisis" what happens to business and the economy during ruanaway inflation. You can be sure the value of the stock investments will be rocked. Having 50% in fixed income denominated in the home currency you are sure to suffer catastrophic losses. It's only a matter of time with fiat currency and the massive debts in the US.

What simple steps can be taken to improve the portfolio?

Simple, hold your cash in foriegn currency. Franc, Yen, Yuan - all good choices. Why are they good choices? Their governements choose to devalue to keep pace with the US, not the other way around. They are not certain to inflate if the US does and hopefully would stop short of destroying the currency. This doesn't prove that they won't, but it is certainly less risky.

Consider two portfolios: One is US T bills and 30 year US treasuries and one is Swiss Francs and 30 year US treasuries. It's obvious which one is more risky! How about half 30 year TBs and 1/4 Yen 1/4 Francs? Better still! This is a simple way to make the portfolio more bulletproof. Now, you can look at this and say that the portfolios with foriegn cash are more volitile. Yes, that's true nominally, but not so for purchasing power. if your entire portfolio was dollar denominated you are exposing yourself to massive risk of dollar devaluation.

25% gold is not enough protection. As stated look at Iceland. The HBPP performed terribly there and this wasn't even a hyperinflation, only severe devaluation. Someone argued that maybe they should have held US bonds or US dollars as a hedge. Well....if it's good for Iceland it's good for the US or any country. Again, previous posters have gotten caught up with nominal gains instead of real ones. It doesn't matter how high gold goes in the home currency. How can 1/4 of your wealth make up for the loss of the other 3/4? Icelandic purchasing power with the HBPP was destroyed. It would likely be the same in any country regardless of the size.

Some argued that the dollar is unlikely to collapse. That's not an argument that the HBPP will survive runaway inflation. Instead it's the hope that the fed/US govt will preserve the dollar. Betting on that is playing Russian Roulette with your wealth. Just because it's worked for 40 years doesn't mean the risk hasn't been there and will continue to be there.

As for stocks, globally diversified small caps should be sheilded better from any one country's currency collapse. Small caps are less reliant on international revenue and better represent the global economy than do large caps. They might be more volitile in nominal terms but I think ultimately they are safer. Think about the effect on US small caps vs large caps if the Euro disintegrated. Since 94% of US small cap revenue is domestic you'd think they would hold up better. Imagine how a US hyperinflation would hit Chinese lag caps vs small caps. I would think the small caps again would hold up better since the revenues are more localized. I haven't given this hypothesis as much attention so please everyone respond with your thoughts.

I think we can do better than the HBPP. Let's try.

[Indices]

So we're all gathering here with the intent of improving our investments. In no way should we accept the HBPP as some sort of magical formula for success in any investing environment. HB was not a magician. He was a brilliant investor and philosopher. I've read most of his books and consider the HBPP to be revolutionary and brilliant, but tragically flawed should the home country experience runaway inflation. Harry explains very cleary in "How to profit during a monetary crisis" what happens to business and the economy during ruanaway inflation. You can be sure the value of the stock investments will be rocked. Having 50% in fixed income denominated in the home currency you are sure to suffer catastrophic losses. It's only a matter of time with fiat currency and the massive debts in the US.

What simple steps can be taken to improve the portfolio?

Simple, hold your cash in foriegn currency. Franc, Yen, Yuan - all good choices. Why are they good choices? Their governements choose to devalue to keep pace with the US, not the other way around. They are not certain to inflate if the US does and hopefully would stop short of destroying the currency. This doesn't prove that they won't, but it is certainly less risky.

Consider two portfolios: One is US T bills and 30 year US treasuries and one is Swiss Francs and 30 year US treasuries. It's obvious which one is more risky! How about half 30 year TBs and 1/4 Yen 1/4 Francs? Better still! This is a simple way to make the portfolio more bulletproof. Now, you can look at this and say that the portfolios with foriegn cash are more volitile. Yes, that's true nominally, but not so for purchasing power. if your entire portfolio was dollar denominated you are exposing yourself to massive risk of dollar devaluation.

25% gold is not enough protection. As stated look at Iceland. The HBPP performed terribly there and this wasn't even a hyperinflation, only severe devaluation. Someone argued that maybe they should have held US bonds or US dollars as a hedge. Well....if it's good for Iceland it's good for the US or any country. Again, previous posters have gotten caught up with nominal gains instead of real ones. It doesn't matter how high gold goes in the home currency. How can 1/4 of your wealth make up for the loss of the other 3/4? Icelandic purchasing power with the HBPP was destroyed. It would likely be the same in any country regardless of the size.

Some argued that the dollar is unlikely to collapse. That's not an argument that the HBPP will survive runaway inflation. Instead it's the hope that the fed/US govt will preserve the dollar. Betting on that is playing Russian Roulette with your wealth. Just because it's worked for 40 years doesn't mean the risk hasn't been there and will continue to be there.

As for stocks, globally diversified small caps should be sheilded better from any one country's currency collapse. Small caps are less reliant on international revenue and better represent the global economy than do large caps. They might be more volitile in nominal terms but I think ultimately they are safer. Think about the effect on US small caps vs large caps if the Euro disintegrated. Since 94% of US small cap revenue is domestic you'd think they would hold up better. Imagine how a US hyperinflation would hit Chinese lag caps vs small caps. I would think the small caps again would hold up better since the revenues are more localized. I haven't given this hypothesis as much attention so please everyone respond with your thoughts.

I think we can do better than the HBPP. Let's try.

A few points:

1. The PP worked fine in Iceland.
2. Stocks aren't necessarily "rocked" in high inflation.
3. If runaway inflation is affecting the dollar, it may very well be affecting a lot or all other currencies too.
4. I don't feel like searching for something better than the HBPP. Why don't you tell us what you have in mind and we critique it?

[moda0306]

I tend to think of currency diversification with 5/25ths of your bond & cash holdings as maybe being reasonable if you really feel like the PP doesn't diversify itself well enough for inflation.

That 5% of your overall portfolio (10% if you count the bonds and cash) could maybe consist of the francs and yen you mention.

[Kshartle]

A few points:

1. The PP worked fine in Iceland.
2. Stocks aren't necessarily "rocked" in high inflation.
3. If runaway inflation is affecting the dollar, it may very well be affecting a lot or all other currencies too.
4. I don't feel like searching for something better than the HBPP. Why don't you tell us what you have in mind and we critique it?

1. It worked fine if you consider a 70%+ decline in purchasing power against the dollar and 50%+ in the Eurozone fine. I would consider it a disaster. Clive posted on this earlier. A deeper analysis than he provided is available here: <http://europeanpermanentportfolio.blogs ... eland.html>

The post praises the fact that the portfolio beat more "traditional" strategies but this is only due to 25% gold. And this wasn't even a case of runaway inflation which would surely have been more disasterous.

2. I referred to runaway inflation, not high inflation. The economy suffers terribly in runaway inflation. Please get a copy of Browne's 1974 classic "You Can Profit From a Monetary Collapse. Pages 65-79 describe in detail what occurs to an economy durining runaway inflation. I'll sum it up for you in case you don't get a copy: Economic disaster. You can be sure that stocks will not perform well. As for stock performance during high inflation, it is also less than stellar. Stocks struggle to keep pace and deliver real returns. Look at the performance during the 70s. Even this last decade has seen negative real returns in the S&P. Again, Browne explains why in the book previously mentioned and again in his his 1981 work "Inflation-proofing your investments".

His outlook for stocks in different environments was as follows : Medicore to good in level inflation, poor to medicore in rising inflation, Poor in runaway inflation, excellent if inflation goes to zero and very poor in a deflationary depression.

In this book he also suggests ideal portfolio's when you feel very strongly that you can recognize the coming economic environment, with a small allowance made for being incorrect. In a rising inflation environment he suggests only 10% in stocks and a measly 5% in fixed dollars with 50% in gold/silver and 15% Francs or other "safer" currency. During runaway inflation the fixed dollars go into negative amounts (be a net borrower) 60% Gold/silver, 20% Francs and only 5% equities.

3. Yes I absolutely agree. I believe I said there was no certainty that the Franc or the Yen would hold up during a US runaway inflation scenario. However, there is an absolute certainty that 50% of the PP would go to near or total worthlessness if you don't diversify. How can $100 be safer than $50 and 45 Swiss Francs? Honestly, if you substituted Yen or Francs for the dollar holdings in the past 40 years you would dramaticaly improve the results. More volitility yes, nearly all of it to the upside! Obviously this does not mean those trends will continue. This isn't about currency speculation it's about safety. When you make 50% of your wealth dollar denominated fixed income then you are really a speculator in my book! Too much risk without the foriegn cash.

On a side note, imagine instead of your cash account just sitting their static, it actually goes up and hits a 35% band or when either gold or bonds or stocks hit one you have to sell some foreign cash to buy lagging assets  Even during the 2008 deflation and spector of it this year these currencies have pounded the dollar and shown to be even better options of last resort as i think Browne reffered to cash.  For all the efforts over the years of their central banks interveneing both currencies hit all time highs against the dollar this year.

4. I understand you don't want something better. To me, the HBPP is just too risky and underperforming during high and runaway inflation. Therefore I would propose a portfolio made up of 1/4 high beta global stocks, 1/4 LTT, 1/4 Gold and 1/4 foriegn "safe-haven" cash. Just a small tweak but I think it takes the risk of the portfolio down significantly.

Guys, let's not get too defensive about the HBPP. It's just one man's idea for an easy to maintain portfolio that should hold up in nearly every economic environment. It HAS real shortcomings. It CAN be improved upon.

What do you guys think?

[escafandro]

I like the PP because I can see the low volatility and the consistent return in different scenarios.
Maybe it helps if you can run some numbers of this hypothetical PP modified.

[stone]

Clive, that BWX etf has 25% Japanese gov bonds but the second largest holding at 10% is Italian gov bonds . It also has "commodity risk" gov bonds such as Australia and Canada. The duration is not really cash either (7years). It is a shame that there is not a real "safe haven STT" fund with only Japanese, Swiss and US  STT. Also I'm wary of ETFs. For me the allocated gold etfs seem the least dodgy etfs. The treasury etfs lend out half of their holdings at any given time. You are really only owning an etf provider's  promise to track the index.

[Kshartle]

I'll do a backtest of the portfolio I've been discussing with the cash split between Yen/Francs. This is kind of cherry-picking two currencies that have appreciated 400%+ against the dollar in 40 years though. Maybe I'll throw something else in there but other than the Zimbabwe dollar almost everything has been better than the dollar 

The test is really how these guys perform during years of dollar strength. If they win in those years surely they are an improvment all around.

Also, the ETF ISHG has a duration of 1.75 years so similar to SHY. It's not exactly cash but extremely close. It's roughly 25% Yen, 35% Euro, 5% GBP, 5% Loonie 5% Aussie and others (Swiss, Norway).

Maybe not the "safe-haven" we'd like but definately the currency diversification that I think the PP needs to be safer from a Dollar crisis.

The Euro is nearly as shaky as the greenback IMO though.

[longeyes]

Why not split the SHY/SHV quadrant between FXF and FXY?  Does that work?

[longeyes]

Over the last three years that portfolio (FXF & FXY replacing SHY) beats PRPFX by 11.9 per cent to 9.9 per cent per year CAGR with a much lower draw-down.

[longeyes]

What's universal about a PP with no U.S. equities at all?  Why TLT instead of long-term global treasuries?

[Kshartle]

What's universal about a PP with no U.S. equities at all?  Why TLT instead of long-term global treasuries?

It's not universal. VT captures US markets and is a better reflection of global stocks but although the difference is probably minimal. I think stock or currency risk is bigger when you concentrate, not exclude. So VEU should have less risk or major loss than VTI.

TLT represents the most liquid long-term bond ETF out there and it's in a supposed "safe-haven" currency. It would be great if there was a swiss Franc 30 year bond fund or something similar but I haven't seen it. I think if your ST term bonds are non-dollar then your fixed income portion is dollar neutral. Yes if the dollar strengthens then you might see nominal losses in the ST bonds and not see the currency gains in TLT. But, your real purchasing power shouldn't be affected because import prices should go down with the dollar strength.

Our goal in investing should never be the nominal gains but instead purchasing power gains. The HBPP is very good during deflation so even though the portfolio gained only a few percentage points in 2008 anyone holding it should have felt much richer. I have a good job working in the Areospace industry and have recieved raises throughout the recession. The lower prices of everything at the end of 2008 made me feel much wealthier even though my investment weath lost nominal value that year (I didn't have any concept of gold or LTT for someone my age).

So for right now TLT or EDV and foriegn cash will have to do for fixed income.

Thanks to the earlier post for the look back at holding Yen and Francs for the last few years. It's very easy to find the exchange rate gains every year but a little more difficult to track down the interest rate gains. If anyone can find them it would be really helpful.

[cowboyhat]

I 'm not sure there is a universal PP solution to the currency crisis scenario, because I think individual investors exposure to currency risk varies hugely. One of the biggest factors to my mind is how much debt you have relative to your PP, and how each is denominated. If you owe $100,000 on a house and you have a $100,000 PP with your cash holdings all in foreign currencies, then you are making a leveraged foreign currency bet.

If a dollar crisis occurred in the next year, where would the money run? The Euro? The Yuan? The Yen? Maybe the Yen, but my thought is that a ton of money would run into oil. A good hedge might be to buy something like VDE. But then buying VDE would mess up the equity balance in the PP. And how much would you buy compared to the other assets? And what will you do when everybody starts deleveraging like it's 2008 again and oil prices collapse?

[murphy_p_t]

A few points:

1. The PP worked fine in Iceland.
2. Stocks aren't necessarily "rocked" in high inflation.
3. If runaway inflation is affecting the dollar, it may very well be affecting a lot or all other currencies too.
4. I don't feel like searching for something better than the HBPP. Why don't you tell us what you have in mind and we critique it?

1. It worked fine if you consider a 70%+ decline in purchasing power against the dollar and 50%+ in the Eurozone fine. I would consider it a disaster. Clive posted on this earlier. A deeper analysis than he provided is available here: <http://europeanpermanentportfolio.blogs ... eland.html>

i agree 100%

2. I referred to runaway inflation, not high inflation. The economy suffers terribly in runaway inflation. Please get a copy of Browne's 1974 classic "You Can Profit From a Monetary Collapse. Pages 65-79 describe in detail what occurs to an economy durining runaway inflation. I'll sum it up for you in case you don't get a copy: Economic disaster. You can be sure that stocks will not perform well. As for stock performance during high inflation, it is also less than stellar. Stocks struggle to keep pace and deliver real returns. Look at the performance during the 70s. Even this last decade has seen negative real returns in the S&P. Again, Browne explains why in the book previously mentioned and again in his his 1981 work "Inflation-proofing your investments".

His outlook for stocks in different environments was as follows : Medicore to good in level inflation, poor to medicore in rising inflation, Poor in runaway inflation, excellent if inflation goes to zero and very poor in a deflationary depression.

In this book he also suggests ideal portfolio's when you feel very strongly that you can recognize the coming economic environment, with a small allowance made for being incorrect. In a rising inflation environment he suggests only 10% in stocks and a measly 5% in fixed dollars with 50% in gold/silver and 15% Francs or other "safer" currency. During runaway inflation the fixed dollars go into negative amounts (be a net borrower) 60% Gold/silver, 20% Francs and only 5% equities.

Did HB refer to this in his later work? Or was the PP developed to supersede this portfolio as he gave up on waiting for this SHTF scenario?

Lately, I've been thinking that a solution to this concern is to hold a complete PP in another currency. Ideally, I would hold this outside my country of residence, for purposes of increased geographic diversification. One reason I'd like to do this sooner than later is the pending FATCA 30% withholding tax to liberate funds from the USA. Initially, I was thinking to set it up to invest the PP for Germany, being the largest Eurozone country & until recently had the strongest possible bond rating. Because there is much talk about a pending demise of the Euro, maybe a better choice would be a Norway PP. From the little I know, they are a wealthy, stable country with oil resources.

I would stick with the PP, rather than just holding currency, because the PP seems a well-proven way to increase nominal (and real) value in a given currency, evidenced by folks in the UK & Netherlands holding the PP with pleasant results in their native country.

Maybe a Swiss PP is also something to look at?

[murphy_p_t]

What's the opinion on

VEU
TLT
ISHG
GLD

?

VEU chart looks almost just like VTI...I don't know what the implication is during a "currency event"...do global stock markets crash in tandem? In 2008, the Euro was much stronger vs US$...I dont' see any reflection of that when I compare these ETFs over the past 5 years in yahoo finance.

ISHG is very interesting...is this the recommneded cheap & cheerful way to get broad-based foreign currency exposure? Has any due diligence been done on ISHG? (like does this have minimal counter-party risk?)

[Bongleur]

Back to inflation vs partial bond default...

Seems to me that on a net basis, it results in the same thing.  Of course the pathway is different, the time scale is different, and different people take the losses.

It seems more rational that the Govt could run the numbers and determine that if X inflation is needed for Y years, then a haircut of Z on its bonds would give the same result.

Its not apparent that inflation, which makes all persons suffer, is better than a haircut for investors who knowingly took a risk.  Except that the bond owners control the decision process...

[BearBones]

Lately, I've been thinking that a solution to this concern is to hold a complete PP in another currency. Ideally, I would hold this outside my country of residence, for purposes of increased geographic diversification. One reason I'd like to do this sooner than later is the pending FATCA 30% withholding tax to liberate funds from the USA.

I'm interested. For the Newbs of us out here, how would you set this up? And can you elaborate on how you'd avoid the FATCA withholding?

[MachineGhost]

Holding the major foreign currencies is a zero-sum game.  In the long-term, they all return the same purchasing power, so theres no net effect of buying or selling one currency over another unless you plan on trend following in the shorter term.

But, it does not make sense to not hold the currency or bonds of the world's current reserve asset.  Nothing will be "safer".  Gold is the hedge against currency snafus, not other currencies.

MG

What's the opinion on

VEU
TLT
ISHG
GLD

?

VEU chart looks almost just like VTI...I don't know what the implication is during a "currency event"...do global stock markets crash in tandem? In 2008, the Euro was much stronger vs US$...I dont' see any reflection of that when I compare these ETFs over the past 5 years in yahoo finance.

ISHG is very interesting...is this the recommneded cheap & cheerful way to get broad-based foreign currency exposure? Has any due diligence been done on ISHG? (like does this have minimal counter-party risk?)