Do we need more protection than just the PP?

[doodle]

Deleted

[MediumTex]

Hyperinflation is a nonstarter.  In a debt based monetary system where secular shifts are underway with respect to consumer debt, there is really no mechanism for hyperinflation.

I think strong and sustained inflation is also unlikely.  A spiral of rising prices requires wages to rise as well.  Globalization has put intense pressure on U.S. wages, and with 8%+ unemployment it's hard to conceive of a sustained upward spiral in average wages.  Without rising wages, there is no sustained inflation.  What one should expect in the face of rising prices is another recession as people simply run out of money to buy things and the economy stalls.

This leaves us with deflation or endless cycles of QE-type measures aimed at preventing it.  For a model of how this unfolds all we need to do is look at Japan, which shows us that such a system can stay afloat literally for decades.

What will happen?  I don't know, but I think news of the dollar's demise has been greatly exagerrated.

Remember, the U.S. has the largest manufacturing sector in the world, which can benefit nicely from a weakening dollar.  Considering that the Chinese currency will at some point see a dramatic rise from its current levels, I can see at least one future scenario where the U.S. comes out of this mess healthier, with a re-energized manufacturing sector.

As long as the U.S. dollar is the world reserve currency, the U.S. has the largest economy in the world, the most powerful military in the world, and the grocery store on the corner accepts only U.S. dollars, I wouldn't worry about the dollar nearly as much as I would worry about the euro and the yen, which are (IMHO) facing much bigger challenges going forward than the dollar.

The U.S. is clearly in a mess, but it's not a worse mess than a lot of other places.

[clacy]

I tend to agree with everything that MT just said. I really don't know of a better way to protect your money than the HBPP and still grow it.

[pershing83]

Well, we can't default since you just pay your creditors off with dollars.

If you wish to bet against the dollar and want more than  PRPFX gold/Swiss francs plus stocks such as BHP then buy some FXA, FXC or FXE. FXA is up nicely last 12 mos nd pays 3.8% divy.

[AdamA]

Here is a synopsis of the book "Good-bye Great Britain

I wonder how a British PP would have done during this time period. 

Does anyone know?

[Lone Wolf]

I think strong and sustained inflation is also unlikely.  A spiral of rising prices requires wages to rise as well.  Globalization has put intense pressure on U.S. wages, and with 8%+ unemployment it's hard to conceive of a sustained upward spiral in average wages.  Without rising wages, there is no sustained inflation.  What one should expect in the face of rising prices is another recession as people simply run out of money to buy things and the economy stalls.

How does that square with the 1970s?  That was a period of both fairly high unemployment and quite high inflation.  At times you saw unemployment rates north of 8% co-existing with double-digit inflation.

To me, it seems that wages only need to rise in nominal terms in order to "support" inflation, not in real terms.  I do agree that globalization will place downward pressure on wages.  Furthermore, I believe that the government's outright assault on savings is harmful to capital investment, which could also push wages downward.  Still, it seems to me that in the face of currency depreciation wages could climb in nominal terms even while falling in real terms.

[moda0306]

Clive,

I'd say that inflation being like defaulting on debt is a bit of a stretch.  It may seem to have that effect on the surface, but take a look at the implied contract that anyone that holds a US bond is getting into.  They KNOW that we can inflate our currency, and they (hopefully) price it in accordingly and diversifiy accordingly.  What they DO fully expect is to get the interest and principal in nominal terms given the agreement in the contract.

I think it's interesting that for all the QE that we print out, a small default by the U.S. would have a much more disasterous affect on the confidence in our bonds.  I think it's as Heath Ledger's Joker said, as long as horrible things are "part of the plan," nobody really cares.  But when one little default happens, "everyone loses their minds."  Some of the social observations in that comic book movie are pretty spot on, if a bit over stylized and over exaggerated.

[MediumTex]

I think strong and sustained inflation is also unlikely.  A spiral of rising prices requires wages to rise as well.  Globalization has put intense pressure on U.S. wages, and with 8%+ unemployment it's hard to conceive of a sustained upward spiral in average wages.  Without rising wages, there is no sustained inflation.  What one should expect in the face of rising prices is another recession as people simply run out of money to buy things and the economy stalls.

How does that square with the 1970s?  That was a period of both fairly high unemployment and quite high inflation.  At times you saw unemployment rates north of 8% co-existing with double-digit inflation.

The demographic profile in the U.S. in the 1970s didn't have enormous numbers of people scaling back their levels of consumption due to advancing age, as we have today.

Also, the role of labor unions in the U.S. in the 1970s was still a mechanism for wages in many parts of the economy to rise in tandem with prices (regardless of unemployment levels).

The globalization movement was not yet fully underway, and thus the idea of simply shipping U.S. jobs to another country was not nearly as popular as it is today.

Households were not severely overleveraged (as they are today) and had more savings to use to dampen the effects of rising prices.

After Vietnam, the U.S. military was perceived as severely diminished, which spilled over into many seemingly unrelated areas, including currency and bond valuations.

[AdamA]

Here is a synopsis of the book "Good-bye Great Britain

I wonder how a British PP would have done during this time period. 

Does anyone know?

http://www.fool.co.uk/news/investing/in ... -gold.aspx

There's a couple of errors in the original article, as detailed in the comments to the article (overall the errors don't make much of a difference)

That's a great link, Clive. 

It seems like the British PP worked very well during the collapse of the pound.

[moda0306]

Clive,

I understand your point of view and even share it to some degree, and while I'm sure you understand this complexity, the real world implications of real default vs printing money, both economical and moral, are quite different.  Think of every bond purchased as having a little asterisk fine print on it saying "Though we will do everything in our power to pay you given the terms of this bond, it will remain in our power to print as many dollars as we see fit to keep employment at proper levels, and the currency stable."  It's the fed/treasuries trump card that ever bond purchaser knows full-well they're taking the risk of.

The point is, when you buy a bond, you assume the full risk that the fed can print money.  What you should not have to assume, given the terms of the bond, is risk of non-payment by the treasury.

It's that difference that probably operates that unreasonable difference in reaction by our bond markets to printing vs default, but I think the difference is clear.  It's almost (ok, maybe not "almost," but close enough) like saying that calling a callable bond is a form of default (or not abiding to the terms of the bond).  The bond issuer did something that was fully within their rights and understood by both parties at purchase of the bond.  Likewise, everyone who purchases a bond should know that the fed has the ability to print money, and after 38 years of being off the gold standard, it's no surprise that they'll exercize that ability when they determine the need to be there. That asterisk and fine-print may not be written on the bond, but it may as well be.

[Lone Wolf]

I'd say that inflation being like defaulting on debt is a bit of a stretch.  It may seem to have that effect on the surface, but take a look at the implied contract that anyone that holds a US bond is getting into.  They KNOW that we can inflate our currency, and they (hopefully) price it in accordingly and diversifiy accordingly.  What they DO fully expect is to get the interest and principal in nominal terms given the agreement in the contract.

I agree that outright default and "inflating the problem away" are different (because one's in the fine print and the other is not.)  Still, I wouldn't say that "default" is completely off the mark.

I prefer to call this a "soft default" (and I know Clive has used this terminology as well) because it is a way of shedding obligations that you cannot or do not wish to meet.  A corporate bondholder understands that they face a risk of haircut or non-payment.  A government bondholder (of a fiat currency) understands that they face the risk of inflation, which is a haircut delivered via alternate means.

[moda0306]

Well put LW... I guess we're all pretty much close enough in agreement and just coming from it from opposite directions.  Printing is 1) reducing your obligations by the flick of a button, and 2) fully understood (or should be) by the purchasers of the bonds.

I just find it funny that the US defaulting on a couple million of treasuries would probably have a much more significant effect on the bond market than 600 billion in "printing." 

Even the printing itself isn't exactly clear to me, as the Modern Monetarists would put it QE is almost like buying CD's (owned by banks) with cash ("printed" by the fed), which are almost the same anyway, simply changing the average term of the "bonds/cash" available in the market.... hardly huge in implications if thought of on those terms.

Though I still have to work through my internal-logic machine the effects of fractional reserve banking and the fed literally giving loans out to financial institutions.  Those are the things that confuse/scare me more than QE.

[moda0306]

To add one more layer of confusion I have about the fed's monetary expansion is this:

If you break it down to a pretty simple, basic level, I see the "zero-sum game" aspect and the "variable sum game" aspect of expanding the money supply.  The "zero sum game" aspect could basically be bond/cash-holders vs debt & hard-asset holders.  For any inflation is causing a sort of double sided netting balance sheet entry amongst those two classes of assets, at least in concept.

The next level, the "variable sum game" piece, seems to be positive to Keynesians (more people expect prices to rise, therefore consume and work, as opposed to save and hoard), and negative to Austrians (assets are misallocated, causing less overall wealth to be created, not to mention the fear of currencies not holding their value putting everyone into a certain state of fear that troubles free transactions).

If we concentrate on the "zero sum game" aspect of fed easing, it would seem pretty obvious to me that since most of the holders of hard-assets that are also heavily endebted are in the U.S., and most of the bond-holding entities are the foreign governments from which we buy our products, are we in a position to benefit strongly from the zero-sum game aspect of printing money, since we're on the benefitting side of that heavily-indebted, hard-asset-holding entry.

Just some thoughts, probably discussed several times on some levels in terms of "can we really benefit by inflating away our debts?" terms.

[Lone Wolf]

I just find it funny that the US defaulting on a couple million of treasuries would probably have a much more significant effect on the bond market than 600 billion in "printing." 

Yeah, that would certainly panic me!

If the United States reached a moment where it was willing to trade away the cachet of its "full faith and credit", I'd know that we were in a heaping pile of trouble.  Since inflation is usually the more politically attractive option compared to default, it would make me think that things had spun completely out of control.

Though I still have to work through my internal-logic machine the effects of fractional reserve banking and the fed literally giving loans out to financial institutions.  Those are the things that confuse/scare me more than QE.

It's confusing.  I'd love to have built a straightforward narrative about QE.  I would very much like to feel that I understand all of its implications.  Unfortunately, while there are many things that I believe about QE, the only things I am sure of is that nobody completely understands it, including those implementing it.  So much depends on what happens to these bank reserves and whether the policy is effectively unwound as promised.

[moda0306]

What's scary is that there are such polar opposite ideas of how the bus should be driven, that even giving both sides an equal say on how to drive the bus will certainly lead us off a cliff eventually... if not already, and we just don't know we're falling yet.

[Pkg Man]

Personally I like holding pure international equities, bonds, and silver in the VP to add a bit of international diversification (in addition to what you get naturally from US equity revenue derived from international sources).  In terms of amounts I am plan to keep it between 10-15% of total assets.

[KevinW]

On the OP's question, my definition of "financial investing" is something like "trading currency for assets with the promise of more currency later."  The goal is to get currency later, so on a basic level you have to be comfortable with that arrangement for the whole enterprise of investing to make sense.

If I were dead certain that US dollars are about to become worthless, I'd be working on fleeing the country, not analyzing foreign bonds or silver .

The "more currency later" clause does have a caveat due to the possibility of inflation eroding the purchasing power of nominal dollars.  IMO the PP's gold allocation is adequate inflation protection.

I do think that diversification into "non-financial investments" is a good idea.  Those might include marketable skills, practical skills, a supportive social network, physical tools and resources, and a flexible attitude.  If the economy were to ever fall apart, I think those will be more valuable than exotic securities.

[murphy_p_t]

I think strong and sustained inflation is also unlikely.  A spiral of rising prices requires wages to rise as well.  Globalization has put intense pressure on U.S. wages, and with 8%+ unemployment it's hard to conceive of a sustained upward spiral in average wages.  Without rising wages, there is no sustained inflation.  What one should expect in the face of rising prices is another recession as people simply run out of money to buy things and the economy stalls.

How does that square with the 1970s?  That was a period of both fairly high unemployment and quite high inflation.  At times you saw unemployment rates north of 8% co-existing with double-digit inflation.

The demographic profile in the U.S. in the 1970s didn't have enormous numbers of people scaling back their levels of consumption due to advancing age, as we have today.

Also, the role of labor unions in the U.S. in the 1970s was still a mechanism for wages in many parts of the economy to rise in tandem with prices (regardless of unemployment levels).

The globalization movement was not yet fully underway, and thus the idea of simply shipping U.S. jobs to another country was not nearly as popular as it is today.

Households were not severely overleveraged (as they are today) and had more savings to use to dampen the effects of rising prices.

After Vietnam, the U.S. military was perceived as severely diminished, which spilled over into many seemingly unrelated areas, including currency and bond valuations.

MT,

Why do you consider these to be arguments relating to inflation rather than supply/demand? From reading your responses, it seems that you view inflation as a rise in price level. How do you distinguish between a rise in price due to increased demand & fixed supply vs. a rise in price due to more paper chasing the same amount of goods/services? Please provide your definition of "inflation".

Also, you state: "A spiral of rising prices requires wages to rise as well." Please elaborate. Your statement seems to conflict with what's happening for many years...prices have risen much faster than working-class wages, leading to a general lower standard of living. I think this can be largely attributed to globalization of labor (factories move to China, limits bargaining power of workers; massive immigration from 3rd world into the USA, suppressing wages of many segments, including professionals such as IT consultants)

[MediumTex]

MT,

Why do you consider these to be arguments relating to inflation rather than supply/demand? From reading your responses, it seems that you view inflation as a rise in price level. How do you distinguish between a rise in price due to increased demand & fixed supply vs. a rise in price due to more paper chasing the same amount of goods/services? Please provide your definition of "inflation".

I view inflation in terms of what the same paycheck will purchase at different points in time.

I don't view inflation in terms of measures of money supply because if the money supply is growing at the same rate as the economy it won't necessarily translate into higher prices, whereas a growing money supply against a backdrop of economic contraction could be very inflationary.

In general, I am not that concerned about why prices are rising, I am more concerned about understanding the probability of rising prices setting off a self-perpetuating cycle of actual inflation creating future expectations of more inflation.  In the 1970s we had favorable conditions for a wage/price spiral; today we do not.  The key missing ingredient today is the unwillingness/inability of consumers to take on more debt.  With a consumer that is shrinking his balance sheet, no matter what the Fed does it will feel as if the amount of money in circulation is shrinking, and thus rising prices will be met with demand destruction (as we saw in 2008) not rising wages (as we saw in the 1970s), since many of the mechanisms for wages to rise simply no longer exist in the U.S.

Also, you state: "A spiral of rising prices requires wages to rise as well." Please elaborate. Your statement seems to conflict with what's happening for many years...prices have risen much faster than working-class wages, leading to a general lower standard of living. I think this can be largely attributed to globalization of labor (factories move to China, limits bargaining power of workers; massive immigration from 3rd world into the USA, suppressing wages of many segments, including professionals such as IT consultants)

When I say "spiral" I mean a situation where the rate of inflation is accelerating over an extended period of time.  In an inflationary spiral you would expect to see inflation at 3% in year 1, 4% in year 2, 5% in year 3, 6% in year 4, etc.  This is what we saw in the 1970s.  What we are seeing today is more like one or two years of rising inflation that is then met by a recession, which pushes prices back down (as we saw in 2008).  

I guess what I'm really saying is just that the people who fear dramatic inflation in the U.S. are probably not going to see it any time soon.  What they are more likely to see, IMHO, are more frequent recessions and a persistent set of economic headwinds that manifest themselves in high unemployment, tight lending standards, and rising taxes.  It will still suck, but in a diffeent way than people are imagining.

EDIT: I saw a pretty good Bloomberg story touching on a lot of these issues HERE

[Kshartle]

The permanent portfolio has proved itself completely inadequate to deal with hyperinflation. Stocks will be crushed in both an inflationary collapse and a deflationary one. That leaves gold facing off against the home currency at 50% disadvantage. To be sure, the pp holds up well during deflation for the same reason. One could argue that gold is deflation nuetral if the price spikes initially due to crisis and then tapers off. Then even if the nominal price of gold goes down,  if other prices fall it might still add purchasing power. In order to rescue the pp from an inflationary collapse at least half the bonds and half the cash should be in another safe haven currency. Either yen or francs would do. Personally I don't think cash has a place in the portfolio. It might smooth out some volitility but at the cost of lower average returns. Diversified global small caps, ultra long bonds in the safe haven currencies (at least 2 or 3) and gold will hold up better in nearly every economic environment. 1/3, 1/3, 1/3 of course.

[MediumTex]

The permanent portfolio has proved itself completely inadequate to deal with hyperinflation.

You got a cite for that, cowboy?

Stocks will be crushed in both an inflationary collapse and a deflationary one.

Really?  Show me where stocks get crushed in an inflationary collapse.  Stocks certainly won't like it much, but I think that crushed is probably overstating it a bit.

That leaves gold facing off against the home currency at 50% disadvantage.

If I have three assets with $100 in each, and two assets lose 90% of their value, and the remaining asset goes up by 1,000%, am I REALLY at a disadvantage?  Take a look at how an Icelandic PP would have done in 2008.  It's not what you are thinking.

To be sure, the pp holds up well during deflation for the same reason. One could argue that gold is deflation nuetral if the price spikes initially due to crisis and then tapers off.

I don't really understand what you are saying here.  Gold's performance is normally a function of real interest rates.  If real interest rates are positive, gold should suffer, if they are negative, gold should do well.  Deflation/inflation is less important than what real interest rates are doing.

In order to rescue the pp from an inflationary collapse at least half the bonds and half the cash should be in another safe haven currency. Either yen or francs would do.

The first part of your statement is simply not true, and using another currency is only helpful if that currency is not also being devalued, and based upon the recent actions by the Swiss, that's a risky bet.

Personally I don't think cash has a place in the portfolio. It might smooth out some volitility but at the cost of lower average returns.

Well, you're new, so I will simply invite you to think more deeply about this topic and maybe check out 1980-1982, when "cash" in the form of 1-2 year t-bonds yielded 14.1%, 18.9% and 19.5%.  Cash performs a vital function in the PP.

Diversified global small caps, ultra long bonds in the safe haven currencies (at least 2 or 3) and gold will hold up better in nearly every economic environment. 1/3, 1/3, 1/3 of course.

Do you have evidence for this position, or is it just a strongly held belief?

[moda0306]

I tried typing a response, but I think MT hit it all pretty well.

My one note:

Reserve currency collapse = exponential move for gold... (as in, gold will go up in relation to the price of consumer goods considerably).

I wonder, with 25% gold, if you wouldn't have real return with the gold alone after a US dollar hyperinflation.

Though 30-second rebalances would be a b*tch.

[MediumTex]

Bear in mind when discussing Iceland that its total population is about 320,000, or about the size of a large suburb of an American city.

Arlington, Texas and Iceland have about the same population.

[moda0306]

Clive,

Until the dollar loses its status as the worlds reserve currency, don't you think gold will rise considerably in relation to other commodities & costs, and therefore probably offer a lot more than just purchasing power protection, but actual real growth?

I do wonder whether a small side-set of very safe currencies for part of cash/bonds would be appropriate.

[stone]

http://www.x-rates.com/d/JPY/USD/graph120.html

As Medium Tex said before, when things get nasty Yen seems to be what does best of all. The fact that the Japanese actively try and keep the currency weak in the face of a trade surplus gives a big safety margin for bad times. Also Japanese people have lots of foreign investments so if they take fright and repatriate, the Yen spikes up.