Gyroscopic Investing

As I type this, interest rates (both short-term and 30-year) are at historical lows, gold is up almost sevenfold from just a dozen years ago, foreign stocks have been hammered fairly recently by what's going on in Europe, and US stocks (at least the S&P 500) have shown almost no nominal growth since January 2000 and negative real (inflation-adjusted) growth since that time.

At some point - I admit I don't know when, and probably none of us do...that's why we hold the PP - this above trend will end. Barring either a descent into high inflation (maybe the Fed doesn't mop up the QEs as well as it thought it could) or Japanese-style deflation (maybe in the end the Fed didn't do enough), the economy will pick back up, yields will start to rise along with it, and gold will most likely get hammered as it typically does in non-inflationary prosperity. My question is this:

If the latter scenario (non-inflationary prosperity with mild to moderately rising yields) comes to pass, how will the PP do when two of its assets (gold due to non-inflationary prosperity and positive real rates and bonds due to rising LT rates) are losing value? This worries me as I don't think cash and stocks as the two "winning" assets will provide enough muscle to significantly offset (after say 2% inflation) what gold and bonds will be doing.

Cash/STTs will provide a real yield of (if we're lucky) inflation plus one percent or one-and-one-half percent or so. It also is the asset that provides the least amount of chances for volatility capture gains (additional gains above and beyond the regular return as per MPT when non-correlated assets are combined in a portfolio) as it is the least volatile of the four.

That leaves stocks...and historically, to offset losses in two simultaneously falling (and by "falling" , I mean "providing negative real returns" ) assets, the other asset had to do VERY well. How well? Consider that when stocks and bonds provided negative real returns in the 70s and cash just kept up with inflation, gold had to go up (between 1968 and 1979) at around 25.3% per year in nominal terms. Does anyone (besides perhaps some "expert" like James Glassman or Larry Kudlow) expect stocks (including reinvested dividends) can go up that much over any sustained period of time? As far as I know, never before in US history have they done so. Not during the 1990s (from 1993-1999 US stocks were up about 21.6% per year and that ended in the dot-com crash and three years of negative returns),1980s (from 1982-1989 US stocks rose bout 19.1% per year but that was starting from single-digit PE levels), not during the 1950s (from 1949-1958 stocks were up a little over 20% per year and this boom began in the late 40s when many stocks were trading at near-Depression PE levels), and not even during the 1920s (stocks up a little under 25% per year from 1921-1928 and that ended in the Crash of '29 and the Great Depression).

Furthermore, while stocks are certainly "cheaper" than they were in 2000 or even 2007, they are not at single-digit PEs yet which typically happens before long bull market runs like the ones mentioned above which adds still more weight to the argument that stocks can't carry the Permanent Portfolio when two assets (bonds and gold) are falling together.

One could argue that only two assets (stocks and bonds...via the 1982-1999 bull market and rates falling from double-digits, respectively) DID in fact carry the PP through the 80s and 90s so why shouldn't two asset classes (in this case, stocks and cash) but that ignores two consequential observations:

One, cash yields (yields, not total returns on cash or STTs including capital gains or losses) were falling through the 80s and 90s but they were rarely negative in real terms during those years. This means that you actually had positive returns from one of your "out of favor" asset classes (even more amplified if you used STTs instead of money market funds since this let you capture some capital gains from falling yields as well) as well as from "in favor" assets stocks and bonds. As such, cash/STTs didn't actually lose value during the 80s and 90s like gold did. This means that you really had THREE asset classes (stocks, cash, bonds) contributing to the positive real performance of the PP, and only one (gold) lagging.

Two, in the 1950s and 1960s, you truly did have (or likely would have had, if gold had been freely priced and dropped from its postwar inflation-induced highs during the non-inflationary prosperity from roughly 1952 to the mid or late 1960s) two asset classes lagging (gold...see above for why...and bonds, due to rising rates) and the results were not impressive. I have calculated returns for STTs (three-month and six month treasuries), LTTs (20-year bond rate plus capital gain or loss; bond rolled over each year and a new 20-yr bought in its place as per HB's instruction to keep your LTTs at 20 years or longer), and stocks (S&P 500) for 1952-1967. If we add gold to the attached chart and assume it dropped roughly 6% per year on average (as it did in the non-inflationary prosperity of the 80s and 90s) then it will be difficult to get a "real" inflation adjusted average return for this period of more than about 2% per annum (at least I did...if you'd like I'll post the returns for the asset classes from 1952-67 and let you all see what you can come up with) despite the fact that the PP supposedly provides 3-5% real returns.

I believe much of the  historical performance of the PP from roughly 1968 to the present is a relic of:

A. Falling rates since the early 1980s and how those helped LTTs and even benefited STTs somewhat (short term rates-the main driver or STT/cash returns-remained abnormally high on a historical basis for most of the 80s and into the mid 90s),

and

B. The rising interest rates from 1968-1980 being mostly masked (as regards PP performance) by the skyrocketing price of gold when we went off the gold standard...which is an issue since you can only go off the gold standard once and therefore it most likely won't happen again (if you choose to get around this by starting the backtest at, say, 1975, 1982, or 1990 that's still "cheating" because in those cases stocks were MUCH cheaper on a PE10 or dividend yield basis than they are now and bond yields were far higher).

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?

And these are all possible points for sure. But what is your proposed alternative? I am asking because I have thought a lot about these issues in the past and realized that 1) I was usually wrong about what would happen. 2) Even if I was right I might not have been able to correctly guess how the markets would interpret the activity to profit from it.

There were falling rates since the 1980s for sure. But I can't do anything about that now except hold the bonds. The same bonds that people said would get killed years ago and didn't.

I think that actually you can ignore the first few years of the 1970s for gold, but not all of them. Yes it is true the first year or two gold shot up, but then in 1975 it dropped by -24.5% in value and another -4.3% in 1976. So I would counter by saying that if the entire decade of the 1970s was due to breaking the gold standard, then why did it drop so much those years? The markets must have thought the price was fair (too fair) and adjusted it downwards for the correct price at the time. Further, why would it take the markets which are hyper efficient 10 years to figure out the price of gold?

So the point right there is you had a period of rising rates and the portfolio still did OK.

But honestly I don't know what is going to happen. We are in unchartered territory. All I know is that now more than ever I'm happy I own a variety of assets in my portfolio. Concentrating bets at this point on anything seems especially risky to me.

And these are all possible points for sure. But what is your proposed alternative? I am asking because I have thought a lot about these issues in the past and realized that 1) I was usually wrong about what would happen. 2) Even if I was right I might not have been able to correctly guess how the markets would interpret the activity to profit from it.

I don't have a specific alternative to the PP; I'm actually not 100% into the PP as is. I am currently working on modifying and backtesting a version of a FTM portfolio (although it will include some gold as well) so it doesn't have as much tracking error in good times vis a vis the whole market as the 70/30 does.

I'm not trying to predict what will happen, guess, or time markets so being "right" or "wrong" in that sense is irrelevant. I was just pointing out that an asset allocation strategy (in this case the PP) had enjoyed string tailwinds historically but could be facing significant headwinds and that as such perhaps a slight change of course might be called for.

There were falling rates since the 1980s for sure. But I can't do anything about that now except hold the bonds. The same bonds that people said would get killed years ago and didn't.

Fair enough but one has to admit that a bond at say, 8% has a lot more room on the upside (if rates fall) to "make a killing" than a bond at less than 3% , while the latter has a lot more room on the downside (if rates rise) to "get killed"

I think that actually you can ignore the first few years of the 1970s for gold, but not all of them. Yes it is true the first year or two gold shot up, but then in 1975 it dropped by -24.5% in value and another -4.3% in 1976. So I would counter by saying that if the entire decade of the 1970s was due to breaking the gold standard, then why did it drop so much those years? The markets must have thought the price was fair (too fair) and adjusted it downwards for the correct price at the time. Further, why would it take the markets which are hyper efficient 10 years to figure out the price of gold?

If most of the good performance of the first few years (1968-1974) was from breaking the gold standard then how might gold have done in those years if it had been freely priced before then (i.e. in your opinion how much of gold's gains were one-time only vs a response to inflation and negative real rates)? If gold had only returned a third each year of what it did from 1968-1974 how would that effect the PP's performance for those years (especially in 1973 and 1974 when stocks and bonds both fell simultaneously)?

And even if gold's impressive (well....impressive overall; I know '75 and '76 were down years) gains from 1975-1979 (it gained around 23% nominal per year in those years; the real returns were still upwards of 15%) were due to the market price already being adjusted and the "going off the gold standard effect" not applying, what asset do you suggest will provide 15% real returns for the next five years or next decade to offset both bonds and gold if they fall together?

You also have to consider that stocks provided about a 6.2% real return from 1975-1979 (6% is historically the average real return for stocks...not great but not bad either...if it hadn't have been for 73-74 bear market the 70s wouldn't have been so awful for equities) which also helped the PP during this period. I guess the equivalent of what stocks did then would be gold providing a 6 or 7% real return during times of non-inflationary prosperity with positive real yields...as far as I know that hasn't happened for any extended period of time

So the point right there is you had a period of rising rates and the portfolio still did OK.

Rates rising when starting from 8% LT and around 7% ST (what we had in January of 1975) are a bird of a rather different feather than rising rates when starting with 2.9% LT and 0% ST yields. Use the bond calculators Clive or I posted to see what a 5% or 6% rise (i.e. rising to 13-14% as in the early 80s) from 8% would do to the value of a 30-year bond paying 8% versus what a 5-6% rate rise (to 7.9 or 8.9%...rates which prevailed as recently as the early-mid 90s) would do to the value of a 30-year bond paying current yields of less than 3%...and to add insult to injury, with the former at least you are getting 8% to take some of the sting out of the capital losses whereas with the latter...well 3% won't offset much.

If you want to realistically see how rising rates from our (fairly low) current levels might effect the PP you have to go back to a time when long-term Treasuries were paying such low yields and rates began rising. That time would be the early 1950s. Look at where LT yields started out (around 2.75% in January 1952) and where they ended up (around 5.6% in 1967...rates rose for years after that but I chose 1967 because it's the last year anyone could not use "non-hypothetical" gold values to backtest a PP for since we had no free market gold price until those years). IIRC LT bonds lost (presuming you bought and rolled over each year to maintain the 20-yr maturity) a little less than half their value during those years (and that includes reinvested coupons). With gold falling as well (which if we had been in a free market almost certainly would have happened in every year except for perhaps the last three years from 1965-67....look at the BGMI for those years and you see maybe gold would have started rising by then)-unless anyone can somehow come up with an explanation for why gold should have done well during these non-inflationary prosperity years when rates were positive over inflation-stocks and cash didn't provide enough punch to lift the PP beyond 2% real returns. Adding insult to injury was the fact that the PP-even if gold had been in a free market then and had offset postwar inflation from 1946 to 1948-didn't exactly shine from 1937-1951 either (although that is a moot point since we are looking at what it might do in non-inflationary prosperity with positive real rates, with gold and bonds are both falling...and the best template we have for that would be the 50s and early to mid 60s).

But honestly I don't know what is going to happen. We are in uncharted territory. All I know is that now more than ever I'm happy I own a variety of assets in my portfolio. Concentrating bets at this point on anything seems especially risky to me.

Indeed we are. While I see nothing wrong with owning  a variety of assets and don't advocate concentrating bets either I am just trying to point out (based on what historical data we have) that the future might be quite different from the past 40 or so years for the PP (and what we should do about that).

D1984 wrote: I don't have a specific alternative to the PP; I'm actually not 100% into the PP as is. I am currently working on modifying and backtesting a version of a FTM portfolio (although it will include some gold as well) so it doesn't have as much tracking error in good times vis a vis the whole market as the 70/30 does...

While I see nothing wrong with owning  a variety of assets and don't advocate concentrating bets either I am just trying to point out (based on what historical data we have) that the future might be quite different from the past 40 or so years for the PP (and what we should do about that).

If you think that "the future might be quite different than the past 40" (or 60? or 100?), then I would not concentrate any bets based on back-testing. I'm not familiar with the FTM portfolio. But I'd love to know what ideas you have other than the PP which are non-concentrated and/or which do not assume that the future will behave like the past?

The key thing from what I can see is that "savings" have much less scarcity value now than they did. That is basically the same thing as saying that there is a lot of treasury debt out there. As such isn't it hard to imagine interest rates going up? I presume that we will have a long period of negative real rates so that the government debt sort of treads water in real terms. I really do think the ratio of the median wage to the government debt is a very significant factor. With a massive government debt in relation to the median wage, how could rates go up?

I'm not saying I know what is going to happen but I just think it is far from clear that rates will go up in the future. Perhaps high rates were a one off consequence of the transfer to a fiat system. Perhaps just as the gold boom of the early 1970s was a one off, >2% interest rates were a one off. Once things reach equilibrium, rates might stick to what they were in gold standard times. People have said that Japan now looks to all the world like an economy on a gold standard except that in reality it is the end point for the fiat experiment. Perhaps fiat currency just gives a tempory one off jolt and then things settle back down into a gold standard style mild deflation despite everything the government tries.

Perhaps all the assets will aimlessly jitter about but the PP will still do fine purely from the rebalancing bonus. In principle LTT, gold and stocks could ALL independently give negative real returns and yet the PP as a whole could do well if the assets had enough counter directional volatility

I would say that the FTM portfolio, even with some gold included, is a heavy bet against deflation.  Despite what Larry Swedroe says, I would like to see some evidence that TIPS will protect you against deflation.  Just compare how TIP and TLT did in 2008.  Or how they've compared recently. 

I certainly can't predict that we're headed for a deflationary spiral, but I've seen some good cases made for that outcome in the past coupe of years. I think deflation is a big risk with all of the deleveraging that is taking place globally. 

So IMO, the FTM portfolio only predicts one fat tail scenario (inflation) and leaves out completely the other possible outcome. Bill Gross covered the two polar opposite fat tails in his 2012 outlook and how either or a combination of both fat tail scenarios could happen in the near future depending on the actions of world governments and central banks.

When I think about the deflation scenario that Shilling and others make, I keep coming back to the fundamental question of how this is going to be politically feasible over any appreciable period of time once unemployment rates start to climb to unacceptable levels. A true deflationary scenario creates an open door for populist politicians to crank up the printing presses and create government work projects.  Deflation and high unemployment in a fiat money economy over a long period of time seem completely nonsensical to me. People's reaction to austerity can be clearly seen in Greece. In addition to unemployment, deflation would be crushing in terms of home values and stock based retirement portfolios, both of which are unacceptable to the general population.

Why would a government stand idly by and let the economy collapse in on itself in a deflationary spiral when they have the tools to prevent it? I'm not saying that inflation has to happen, but simply that I don't see a strong case for sustained deflation. Everyone knows that if the S&P drops 20 percent the government would be right there injecting money into the economy.

By the way...Shilling is a permabear who has had a deflationary bias since the early 90's.

doodle wrote: A true deflationary scenario creates an open door for populist politicians to crank up the printing presses and create government work projects.  Deflation and high unemployment in a fiat money economy over a long period of time seem completely nonsensical to me. People's reaction to austerity can be clearly seen in Greece.

Why would a government stand idly by and let the economy collapse in on itself in a deflationary spiral when they have the tools to prevent it?

Do think the public would be any happier in a true inflationary scenario?  

Doodle, I guess as you say the government will "inject money in" to as to prop up stock prices. BUT I don't think that will cause any increase in interest rates. If the money they "inject in" is only used to buy stocks, why would that increase interest rates? QE acts in the long term to depress interest rates. That is pretty much what it is supposed to do. I really don't think that the government will do much other than keep real inflation adjusted interest rates negative for the forseeable future and endevour to fling the gold price around enough to scare people away from that.

doodle wrote: When I think about the deflation scenario that Shilling and others make, I keep coming back to the fundamental question of how this is going to be politically feasible over any appreciable period of time once unemployment rates start to climb to unacceptable levels. A true deflationary scenario creates an open door for populist politicians to crank up the printing presses and create government work projects.  Deflation and high unemployment in a fiat money economy over a long period of time seem completely nonsensical to me. People's reaction to austerity can be clearly seen in Greece. In addition to unemployment, deflation would be crushing in terms of home values and stock based retirement portfolios, both of which are unacceptable to the general population.

Why would a government stand idly by and let the economy collapse in on itself in a deflationary spiral when they have the tools to prevent it? I'm not saying that inflation has to happen, but simply that I don't see a strong case for sustained deflation. Everyone knows that if the S&P drops 20 percent the government would be right there injecting money into the economy.

By the way...Shilling is a permabear who has had a deflationary bias since the early 90's.

First, I am not just referring to Shilling.  There are others such as Kyle Bass, Bill Gross and Harry Dent that are calling for deflation and they can all make compelling arguments.  On the flip side, there are many calling for inflation and they make very solid cases as well.  Or we could just thread the needle and muddle through for all I know.  My point, is that betting against deflation as a possibility, goes against the entire premise of the HBPP.  

I cannot predict the future and the global economy is far too unpredictable as a quasi-science.  That is why I like to stay hedged for all outcomes.  

Regardless of what is "acceptable to the general population" deflation (or inflation for that matter) may not be entirely preventable by Central Bankers and politicians. Even if they are hell bent on preventing deflation, the deleveraging that is taking place by circumvent their efforts and override their tactics.

AdamA wrote:

doodle wrote: A true deflationary scenario creates an open door for populist politicians to crank up the printing presses and create government work projects.  Deflation and high unemployment in a fiat money economy over a long period of time seem completely nonsensical to me. People's reaction to austerity can be clearly seen in Greece.

Why would a government stand idly by and let the economy collapse in on itself in a deflationary spiral when they have the tools to prevent it?

Do think the public would be any happier in a true inflationary scenario?  

Exactly!

People should be really careful what they ask for. I'd take bad deflation over bad inflation any day of the week. Deflation certainly hurts the economy, but inflation is magical. Inflation is the only economic condition that will destroy the largest amount of wealth the fastest across the most amount of people.

I really don't think that the government will do much other than keep real inflation adjusted interest rates negative for the forseeable future

I agree with you, Stone. I think that the argument that the "bond vigilantes" are going to drive up interest rates has been generally discredited by MMT. I think financial repression for a long period of time is a more likely outcome. I do see a strong case for de-leveraging induced deflation, but I just think that politicians and the central bank will do everything including and up to "helicopter drops" to keep asset prices stable and unemployment at acceptable levels.

If the United States were to experience a depression like unemployment  rate of 30% or great you better believe there would be a hell of a lot of pressure on the government to do whatever it takes to put people back to work.

doodle wrote:

I really don't think that the government will do much other than keep real inflation adjusted interest rates negative for the forseeable future

I agree with you, Stone. I think that the argument that the "bond vigilantes" are going to drive up interest rates has been generally discredited by MMT. I think financial repression for a long period of time is a more likely outcome. I do see a strong case for de-leveraging induced deflation, but I just think that politicians and the central bank will do everything including and up to "helicopter drops" to keep asset prices stable and unemployment at acceptable levels.

If the United States were to experience a depression like unemployment  rate of 30% or great you better believe there would be a hell of a lot of pressure on the government to do whatever it takes to put people back to work.

doodle,

I agree with this sentiment completely.  Maybe our advantage of having the world's reserve currency would allow this to be successful.  Hopefully it never comes to this and their muddle through approach works.

The key thing from what I can see is that "savings" have much less scarcity value now than they did. That is basically the same thing as saying that there is a lot of treasury debt out there. As such isn't it hard to imagine interest rates going up? I presume that we will have a long period of negative real rates so that the government debt sort of treads water in real terms.

Stone, if we have negative real rates that would still not be good for LTTs as they yielded 2 or 3% (and STTs yield 0 or 1%) when inflation was maybe 3 or 4%. It may or may not be good for stocks but it would certainly (at least in theory and based what on what we've seen in the 1970s and 2000s) be good for gold. The problem with that is that for as far as the PP is concerned that is only forestalling the inevitable; if and when rates finally DO start rising, LTTs will begin from a point yielding roughly what they are now (and thus will still get hit by rising rates) and gold will be at an even higher value (the bigger they are, the harder they fall) to start its descent from.

I'm not saying I know what is going to happen but I just think it is far from clear that rates will go up in the future. Perhaps high rates were a one off consequence of the transfer to a fiat system. Perhaps just as the gold boom of the early 1970s was a one off, >2% interest rates were a one off. Once things reach equilibrium, rates might stick to what they were in gold standard times. People have said that Japan now looks to all the world like an economy on a gold standard except that in reality it is the end point for the fiat experiment. Perhaps fiat currency just gives a temporary one off jolt and then things settle back down into a gold standard style mild deflation despite everything the government tries.

If this is the case it won't be good for the PP either...what you are basically describing is Japan from the early 90s to the present. For this period a Japanese 4x25 PP was up less than 2% per year in real terms. That's no better than what a hypothetical US PP might do in a time of deflation, or for that matter (as I was originally concerned about) in a time of rising rates and falling gold but rising stocks and cash. In either case, the original worry that the PP could not provide the 3-5% real returns we'd come to expect still stands.

In principle LTT, gold and stocks could ALL independently give negative real returns and yet the PP as a whole could do well if the assets had enough counter directional volatility

Please prove this. I don't see how it is possible unless cash yields enough to make up for all of them (unlikely) or unless each asset does very well for one year (while all the other assets do poorly) and then does poorly for the next three, while the next year a different asset does well while the others all do badly, etc. In such a scenario each asset if invested in individually would lose a few percent after inflation overall after several years but the PP would have a slight after-inflation (real) gain overall. I find the latter scenario unlikely as well.

By the way...Shilling is a permabear who has had a deflationary bias since the early 90's.

First, I am not just referring to Shilling.  There are others such as Kyle Bass, Bill Gross and Harry Dent that are calling for deflation and they can all make compelling arguments.  On the flip side, there are many calling for inflation and they make very solid cases as well.  Or we could just thread the needle and muddle through for all I know.  My point, is that betting against deflation as a possibility, goes against the entire premise of the HBPP.

I'm not sure about Bass but I wouldn't listen to much of what Shilling (permabear...even a stopped clock is right sometimes), Dent (he of Roaring 2000s and Dow 40K fame), or Gross (kicking Treasuries out of Pimco's flagship fund and advocating shorting them right before they went up 30%) have to say. The point is that during either persistent deflation (as in Japan from the 1990s to now) or non-inflationary prosperity with falling gold and rising rates (US from early 50s to mid or late 60s) it is hypothetically possible that the PP from current levels of bond yields, stock prices, and gold prices could post sub-2% real returns for many years which could be a huge issue if one is using a 3 or 4% withdrawal rule.

Exactly!

People should be really careful what they ask for. I'd take bad deflation over bad inflation any day of the week.

My understanding (correct me if I'm wrong) is that you are already retired and living off your assets (the large majority of which is invested in the PP). For many people who still have to work for a living (and thus have to worry about having a job to get by), inflation in the low double digits with 3% unemployment might be more bearable than 3% inflation but double-digit 1930s style bad deflation and the accompanying double-digit unemployment...of course ideally we'd have near full employment at a fairly low or minimal rate of inflation, but given a choice, some might choose higher inflation if it meant having a job and an income vs being unemployed and homeless.

D1984 wrote: My understanding (correct me if I'm wrong) is that you are already retired and living off your assets (the large majority of which is invested in the PP). For many people who still have to work for a living (and thus have to worry about having a job to get by), inflation in the low double digits with 3% unemployment might be more bearable than 3% inflation but double-digit 1930s style bad deflation and the accompanying double-digit unemployment...of course ideally we'd have near full employment at a fairly low or minimal rate of inflation, but given a choice, some might choose higher inflation if it meant having a job and an income vs being unemployed and homeless.

I am careful about trying to compare periods of time against each other. The country in the 1930s was much different than today. It is just not possible to predict what would happen.

But I am pretty sure that if people woke up to find that their life savings were worth 66% less (like in Argentina in 2001) or like Iceland in 2008, they would be pretty upset about it. Of course the mechanism of that happening in the US would be a lot different because we are on the top of the pyramid. But still it would be very very bad.

The Great Depression was protracted as a result of very bad government policies. The fact that there was deflation was a result of those policies. IMO. It was not the cause.

Which is why again I'm nervous about comparing periods of time and extrapolating them forward. The government of today will make different choices and the outcomes just as unpredictable.

But you bring up good points and it's valuable to think about them. I just don't know if there is much I can do other than to stay as widely diversified as possible. When you see the experts making guesses and being very wrong it doesn't bode well for us little guys trying to do it.

D1984 wrote:some might choose higher inflation if it meant having a job and an income vs being unemployed and homeless.

Also let me add this. There is no guarantee that high inflation is going to lead to low unemployment. It is more likely you'll get high unemployment and destroyed savings.

If you study places that had very high inflation in Latin America they almost always had horrible unemployment. In Argentina in 2001 they had unemployment officially at 25%. But if you speak with people living in the cities that went through it they will say it was almost as high as 50% at times if you ignored the official numbers.

Here is what it looked like during and after Argentina's last serious bout of high inflation. And again these are the official numbers which were cooked:

http://www.indexmundi.com/g/g.aspx?c=ar&v=74

Official inflation numbers (cooked):

http://www.indexmundi.com/g/g.aspx?v=71&c=ar&l=en

And here is Brazil. The spike in 2003 was a year of very bad inflation for them (around 15% officially):

http://www.indexmundi.com/g/g.aspx?v=74&c=br&l=en

Official inflation numbers (also likely cooked):

http://www.indexmundi.com/g/g.aspx?v=71&c=br&l=en

So I just can't accept the argument from some sectors of economics that say high inflation will mean low unemployment. And to anyone that has run a business this is just how it is. High inflation makes running a business very hard in terms of acquiring raw materials and pricing them ahead of the loss of purchasing power. Keeping big payroll around makes it that much worse. The reaction of a business in this case would be to get rid of people so they are no longer having to worry about cost of living wage demands, etc. It would not be to hire more people. IMO.

Craigr,

I wasn't saying that high inflation necessarily led to low unemployment (as I don't believe it typically does) but that given a choice, someone might not choose high deflation vs high inflation IF the opportunity cost of choosing high deflation (and by "high deflation" I mean deflation in the high single or low double digits per year, not the 1 or 1.5% average deflation the Japanese experienced from the early 90s to the present) was high unemployment. Do you know of any nation in the past hundred years or so that has ever experienced several years of high-single or low-double digit deflation during which it also experienced OK or good times for its ordinary (non-wealthy and non elite) citizens and less than 6 or 7% unemployment?

Also, many Americans might decide that Argentinian or Icelandic style inflation was OK anyway, as (and I think we on personal finance forums like this one or Bogleheads tend to forget this sometimes) a significant chunk of said Americans are not like us...we have decent quantities of assets whereas they have no or negative net worths. If you have a $200K mortgage on a house that's now worth $120K, $21K in credit card debt, and $33K student loan debt (not dischargeable in bankruptcy) but you only make $30K a year you might be hoping for some serious inflation and worried about any deflation as it would make your debts even harder to repay whereas high inflation would wipe the real value of much of them away (even if your wages only kept up with 85-90% of inflation you'd still be OK as long as your debt interest rates were fixed or at least capped...especially if real rates were neutral or negative to inflation).

Finally, while the examples you posted are valid ones regarding unemployment vis-a-vis high inflation, what about US unemployment or UK unemployment in the late 1940s (inflation was high single digits or low double digits, unemployment at 4% or less despite massive demobilization of soldiers back to civilian life), the US during the 1970s (1973-74....unemployment from 4.8 to 7.2% with high inflation; 1977-79 near double digit or double digit inflation but unemployment did not spend even one month near where it is today and certainly nowhere near Depression era levels or Argentinian inflation levels...and nowhere near the 14-22% levels seen in places like Ireland or Latvia where austerity and internal devaluation through deflation of wages and prices is the goal), or Israel in the early 1980s (unemployment generally below 7% and often around 5% despite several hundred percent per year hyperinflation)? Also, didn't Argentina finally stop having such bad unemployment (and I know they had inflation issues, but it didn't reach what I think most people would call "hyperinflation" ) when they dropped the dollar peg and then flat out defaulted?

So I just can't accept the argument from some sectors of economics that say high inflation will mean low unemployment. And to anyone that has run a business this is just how it is. High inflation makes running a business very hard in terms of acquiring raw materials and pricing them ahead of the loss of purchasing power. Keeping big payroll around makes it that much worse. The reaction of a business in this case would be to get rid of people so they are no longer having to worry about cost of living wage demands, etc. It would not be to hire more people. IMO.

Seems reasonable...but as a counterexample what would be the reaction of businesses (or consumers) to severe deflation or even (to a lesser extent) 1 or 2% Japanese style deflation? They would hold back on purchasing or hiring for as long as possible (if it's $20 today but was $21 last week why not wait another week and see if it's $19 then), which means that other businesses see their sales and margins slump, which means THEY fire workers and hold off on hiring or buying any more than they absolutely need, and so ad infinitum....not a really rosy scenario either.

To be fair, the businesses could also choose to pay their workers less and offer less to their suppliers for needed inputs (and the workers and suppliers would theoretically be no worse off in real terms because if price have declined say 8% then an 8% cut in wages or cut in what you get for your supplies shouldn't hurt...EXCEPT for the fact that wages and to some extent prices for goods are typically "sticky" in a downwards direction; people have a psychological aversion to accepting less in nominal terms even if it's the same in real terms and may either A. More or less grudgingly accept the new wage/price but cut their own consumption to make up for it which would only feed the deflation/recession more as their purchase are other businesses' sales, or B. refuse to accept wage/price cuts and end up unemployed (for the workers) or not being able to sell anything (for the suppliers) which would also feed continuing recessionary deflation (unemployed workers and busted businesses can't buy much).

That's not even considering that the supplier maybe paid, say, $10,000 for the supplies (when he bought them months ago) he's offering the business so taking a 7-8% cut in price would leave him with little or no profit or even a loss (even if he would be nominally no worse off since he could now re-buy those same supplies for $9,200 and sell them to another business at current deflation adjusted prices he has to account for the fact that he bought them in the past at a higher prices and either take a loss on them now or not move what he's trying to sell). The same dynamic applies to the workers; if each makes, say, $800 a week but must now take a pay cut to $720 they shouldn't be any worse off since food, clothing, gasoline, health care, etc would also have theoretically declined by 8% in price...EXCEPT for the fact that any debts (auto loan, home mortgage, credit card, student loan, etc) DIDN'T decline by 8% so now the worker has less to spend on anything besides debt service (it's true that the bank, auto lender, etc would now have 8% MORE to spend or lend in real terms but why would they lend in a deflationary environment when they can just make 7-8% in this case by just sitting in cash...and even if they were willing to lend much they'd still need borrowers in order to make loans....why would someone borrow any more than they've already borrowed when they have good reason to believe continued deflation will only make it harder to repay?)

Finally changing the subject a bit (since I'm not trying to turn this into another debate about Austrianism, austerity, and default vs MMT vs Keynesianism, etc) back to PP under-performance when two asset classes are falling....I wanted to posta  chart of a hypothetical PP when gold and bonds are falling together and see if anyone could come up with a plausible scenario where 3% or greater real returns could be obtained; can this forum accept image attachments or do I need to host the chart elsewhere on the web?

D1984,

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.  :-[

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?

D1984 wrote:

In principle LTT, gold and stocks could ALL independently give negative real returns and yet the PP as a whole could do well if the assets had enough counter directional volatility

Please prove this. I don't see how it is possible unless cash yields enough to make up for all of them (unlikely) or unless each asset does very well for one year (while all the other assets do poorly) and then does poorly for the next three, while the next year a different asset does well while the others all do badly, etc. In such a scenario each asset if invested in individually would lose a few percent after inflation overall after several years but the PP would have a slight after-inflation (real) gain overall. I find the latter scenario unlikely as well.

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.

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

Exactly!

People should be really careful what they ask for. I'd take bad deflation over bad inflation any day of the week. Deflation certainly hurts the economy, but inflation is magical. Inflation is the only economic condition that will destroy the largest amount of wealth the fastest across the most amount of people.

craigr,

I think whether someone will "want" inflation vs deflation has a lot to do with where they are in life.

I think it comes down to 2 overriding factors:

1) Your personal balance sheet
2) Your reliance on employment for income

Most young people have the worst balance sheets and are in the most need for stable work early in life.  Deflation, and moreso the uneployment that can come with the spiral, is awful for someone who's 26 with $20-50k of student loan debt and owns a home via mortgage.

On the other side is someone who's made their money... most retirees and people who have acquired enough wealth to pay off their debts and not have to work.  These people, obviously, are going to be much more sensitive to inflation, and won't care if unemployment gets high.

Based on where it seems that you are in life, I'm not surprised at all that you'd welcome deflation vs inflation.  There's nothing wrong with that.  Just realize that some people are in a very different boat, and their balance sheets can't weather deflation nearly as well as yours can.

moda0306 wrote:Based on where it seems that you are in life, I'm not surprised at all that you'd welcome deflation vs inflation.  There's nothing wrong with that.  Just realize that some people are in a very different boat, and their balance sheets can't weather deflation nearly as well as yours can.

Guys I don't welcome any of this. I'd rather the money supply be stable and gold standards do that. Fiat systems do not.

I am speaking as someone who has either run businesses or been involved with them at various levels. Inflation is not a good thing. Neither is deflation.

Businesses do not like uncertainty and the value of their cash flow moving up and down makes it very hard to do any kind of realistic planning. If you don't know what the money is going to buy you become very conservative because you want a cash hoard for emergencies. Or you want to get rid of the cash and hold raw goods you bought at a lower price that you can turn into products later. But even this has risks because if the money value whips the other way you paid too much for your inventory and now you take a big loss.

It's not a question of whether someone does or does not have money. Having money swinging around wildly in value hurts them, too. The kid out of college with big debt and facing high inflation is being hurt. They can pay off their loan faster, but they will not be able to get their heads above water in earning power. PLUS they may not have a job because companies don't want to expand payroll.

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

Look at a place like Japan and a place like Argentina or Brazil. Deflation has not ruined Japan. They still have a very large middle middle class and standards of living are quite high. People complain about the economy and yes it's been bad for stocks, but overall they are fine.

Then you look at Argentina or Brazil. The inflation in those places has destroyed the middle class over time. In Brazil you get very rich and dirt poor. The middle class is a minority. Inflation does that. It makes people that have saved and grew out their economic position and turns them back into paupers.

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.

I think readers of this thread would enjoy reading this book that talks about what really happens to businesses under bad inflation. From my own view of things I agree with them:

The Hyperinflation Survival Guide: Strategies for American Businesses

This book had a small team of economists travel to various Latin American countries and interview business owners that had to deal with high inflation and cooked numbers. It's a very fascinating read that goes beyond a lot of the theoretical stuff I see economists preach about the virtues of inflation (most of which have never been through very high inflation BTW). Again, be careful what you wish for and don't think I'm saying this stuff because of my own background. I have no more desire to live in a society with 25%+ unemployment than the next person.

moda the elephant in the room IMO is that Japan is the only country in recent years to have had deflation and it also has a much better employment situation than most of the World (edit craigr just said this too). I'm not saying it is great there I'm just saying that I don't buy this deflation is synonymous with unemployment way of thinking. It is a terrible waste to have lots of people unemployed. Deflation can be self reinforcing as can inflation but either problem is often best addressed by correcting the underlying cause IMO. If you deal with that actual problem and don't mess around monetarily then the monetary system will right itself IMO.

Anyway in Japan they brought the problem on by bailing out their banks when their credit bubble burst in 1990 and we have copied them. The "deflation risk" problem is basically an indebtedness problem. It was made massively worse when lots of debt that in a free capitalist system would have evaporated was kept whole by the bank bailouts in 2008. All of the corporate bonds of the TBTF banks should have evaporated. That debt mountain is the deflation. All that is needed is to scrap that lot. Then we wouldn't be faced with this issue.

craigr,

I didn't mean to imply you want to bend the money supply to your own benefit... simply that deflation won't be very hard on you compared to inflation, but that other peoples' balance sheets lend themselves to different results.

You are right that lack of certainty on price level are bad for a society... it muddies the will to create real wealth for the currency, and reduces the country's potential.

That said, changes in price level are only one consideration in the "certainty" equation.  Certainty about demand or employment are also helpful.  There are also real winners and losers after an inflationary or deflationary event that defies what expectations were especially when credit is involved.  That may be short-lived as the economy adjusts its expectations, but "short-lived" can make things go on for a while when self-fulfilling deflationary factors are involved.  

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.  

I'd say that the high savings rate of the Japanese caused their complacency with deflation... it didn't have nearly the shock to their employment level because people didn't need jobs to pay their rent.

Lastly, I think it's a mathmatical 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.

stone,

Yes... deflation in a society with extremely high household savings rates will have a much more muted effect than one in debt. 

But to pre-designate your currency for deflation (gold standard once most of it's been mined) is just a bad idea.... no worse than debasing it to pay for moral hazards throughout the economy, but still a bad idea.

craigr wrote: Guys I don't welcome any of this. I'd rather the money supply be stable and gold standards do that. Fiat systems do not.

Inflation is not a good thing. Neither is deflation.

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.

On the other hand, maybe 20 years from now there will 10 times or 100 times more debt (or whatever), and we'll all be remembering the good ol' days when the national debt was still just in the single (or double, depending on how you count it) digit trillions.  (I think that would be MMT's prediction, although I'm still trying to figure out exactly what this theory really says).  

Speaking of the future:  http://www.nbc.com/saturday-night-live/ ... 2/1379138/

(SNL skit, about 4 minutes long...yes, this reply was basically just an excuse to post the link...you have to sit through a 30 second commercial to watch it, but it's pretty funny).