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Price Inflation is Here

Price Inflation is Here

My first article on this website was over 5 years ago, Inflation Destroys Dollars. I certainly did not have any idea that the price inflation would be triggered by the government’s response to the COVID-19 pandemic. I certainly didn’t anticipate the lockdowns and supply chain disruptions back in 2016.

I know the fiscal and monetary policy pursued by the United States and virtually all the world: money printing, onerous regulations, taxes and spending, would eventually result in significant price inflation. Government response to COVID-19 has made the situation worse and pulled the day of reckoning forward but it certainly isn’t the largest factor.

Timing is always a challenge and I was quite early.

Price inflation is here and it is happening fast enough where people notice it and are actually talking about it. Depending on who you trust and how you measure it, prices are rising at a rate of 6-10% per year now. I think what is interesting is that the government’s own numbers (the CPI-U) shows inflation at 6%. This is far beyond the 2% the Federal Reserve has been calling for.

Source: http://www.shadowstats.com/

Gold and Silver as an Inflation Hedge

In Inflation Destroys Dollars I write about how gold and silver are an inflation hedge. On 16 May 2016 when I wrote that article, gold was trading at $1,252 per ounce. As I write this it is currently up to $1,864.61, an increase of 48.9%. That is an annualized return of roughly 7.5%.

On 16 May 2016 Silver was trading at $17.14. It is now trading at $25.29. That is a 47.5% increase for an annualized return of approximately 7.3%.

So, if you think that inflation has been somewhere between 4% and 8% over the past five and a half year, gold and silver have on just kept up with inflation during this timeframe. Not bad but also not great. Gold and silver remain the boring reliable hedge and that is a good thing.

Value Stocks as an Inflation Hedge

Value stocks are another asset class I mentioned in Inflation Destroys Dollars. I didn’t mention specific funds. I have made some of my own individual value stock picks with some fantastic picks, but also some not so good picks.

Vanguard’s Selected Value fund (VASVX) is a mid-cap fund that could serve as a proxy for “value stocks”. It was trading at $26.41 on 16 May 2016. It is currently at $33.39. This is a return of 26.4% and an annualized return of 4.3%. Not stellar as I would not say this has kept up with inflation.

The Vanguard Value Index is a large cap value fund (VVIAX). It started this period at $32.49 and is up to $56.68. This is a return of about 74.5% and an annualized return of 10.65%.

A final example to look at, Vanguard’s Mid-Cap Index Admiral Shares Fund (VIMAX) started in this timeframe at $150.33 and is now at $320.62. That is a total percent return of 113% and an annualized return of 14.7%. Much better.

Compare those to the Vanguard 500 (VFIAX), which started this timeframe at $184.53 and is now at $432.9. The total return of this fund was 134.6% an an annualized return of 16.77%.

So while value stock fund did beat the rate of inflation and are a good hedge, they didn’t outperform your vanilla S&P 500 index fund.

Bitcoin as an Inflation Hedge

Compared to gold and silver, Cryptocurrencies, particularly Bitcoin has had all the action.

On 16 May of 2016 a Bitcoin was trading at about $454. Today Bitcoin is trading at $64,346. That is an astounding increase of 14,073% or an annualized return of about 146%.

Clearly Bitcoin has outperformed Stocks, Gold and Silver during this timeframe in an astounding way.

I own Bitcoin and I’m not anti-bitcoin. But I’m also not a Bitcoin maximalist. I think it is possible and perhaps even likely that Bitcoin will be replaced with a superior cryptocurrency that has some combination of faster transactions, higher transaction throughput, anonymity and or additional features. In my view Bitcoin in its current state is too slow and transactions are too costly for it to work as a medium of exchange for day to day transactions. These views are very unpopular with Bitcoin maximalists that ignore or downplay Bitcoin’s weaknesses.

However, Bitcoin has provided an incredible return and far outpaces inflation.

The 14,073% return is not just a result of inflation, although it is increasingly being viewed as a safe haven alternative investment.

Bitcoin has had several great tailwinds 1) It is an emergent asset class 2) It is trendy and popular and gets media attention 3) It is viewed as a Federal Reserve / dollar debasement hedge in place of gold.

Inflation Hedges

Protecting one’s wealth and purchasing power from inflation is important. Just keeping up with inflation is not ideal either, if the assets are not tax advantages, the government will tax the “gains”, and so purchasing power is eroded.

Let’s look at a simplified example. Say you frequently buy a widget or pay a service that costs $100 per year. Say the price goes up 5% per year due to monetary inflation. You also have a $100 investment that also goes up 5% per year. You’re still not keeping up with inflation because of taxes. If your $100 investment goes up 5% to $105, the government is going to want some taxes on that $5 gain. Say you’re on the hook for 15% capital gains taxes, the government is going to take their share and leave you with a $4.25 gain.

So you now have to come up with another $0.75 to pay for the item or service. Scale this up to include all of your expenses for the year and you see that you need to not only keep up with inflation, but exceed inflation so you have the money to pay the taxes on the gains.

In order to keep up with inflation your investment would need to be in a tax advantaged account that would lower or eliminate the tax burden owed or (again assuming a 15% gains tax) you’d need the investment to go up by about 5.9%.

This also shows how insidious inflation is. Not only is money worth less, but the government taxes the gains, even if there was no gain in terms of purchasing power.

One other thing to keep in mind, in the United States at least, realized gold and silver gains are taxed at the generally higher income tax rate rather than capital gains tax rate.

Are Gold and Silver Great Inflation Hedges Anymore

Gold and silver might not be very good inflation hedges anymore. If I owned gold or silver I wouldn’t sell unless I needed to rebalance my portfolio. I would expect these assets to at least keep pace with inflation, but unless the demand for gold and silver increases in excess of new supply, I don’t think gold and silver will beat inflation in the way needed in order to truly hedge for inflation when accounting for taxes. While it has produced a positive return in excess of inflation, it certainly hasn’t been a fantastic play over the last five and half years since I started HowIGrowMyWealth.com.

The Prices are Too Darn High

The Prices are Too Darn High

According to the United States Bureau of Labor statistics the rate of consumer price increases, as measured by the Consumer Price Index (CPI) is 2.4%. That is the combination of a variety of factors such as food, fuel, clothing et al. One of the factors is “Shelter” and the rate of price increases for shelter according to the BLS comes in at 3.3% for the 12 month period ending in march 2018.

It sounds comical for me to write it out but I am passionate about inflation. Inflation is a terrible injustice to the people, destructive to the economy and a leading contributor to many economic crises such as the “dot-com” bubble in 2000 and the 2008 financial crisis.

When I talk about inflation I typically mean an increase in the money supply which in many cases leads to price inflation which is an increase in prices as a result of an increase in the money supply.

I have long believed that the BLS CPI is flawed and that the actual rate of price increases is much higher, between 5-10%. And in fact if the BLS measured price inflation in the same way they did in 1990, the CPI would be 6%.

Source: http://www.shadowstats.com/alternate_data/inflation-charts

The Rent is Too Darn High

I recently renewed my apartment lease. My apartment hasn’t changed at all. And after the previous 10 month lease has ended my renewal lease rate is 2.6% higher for a new 12 months lease.

That doesn’t seem like much, and in the grand scheme of things it isn’t, but rent is the largest expense I have so it is an unpleasant increase.

I have to admit I’m not as passionate about the rent being too high as compared to say Mr. James McMillan III, who ran for Governor of New York numerous times, with high rent being a core pillar of his political platform.

Parental warning: Video below contains the “D” word

Healthcare Price Increase

According to the BLS healthcare costs rose 2% for the 12 month period ending March 2018.

Source: Bureau of Labor Statistics

It’s time for my annual enrollment in health insurance. I’ve written about health insurance costs and how the affordable care act made healthcare less affordable for me.

I am fortunate (and grateful) to have health insurance coverage through my employer and I would prefer to be in a scenario where health insurance wasn’t tied to employment. I would prefer a true free market system in health care and health insurance. But recently I have been trying, to quote the serenity prayer, to take “as Jesus did, This sinful world as it is, Not as I would have it.”

My health insurance monthly premium actual fell by 0.66%. However, the devil is in the details.

Prior Plan

My previous plan had a $3,000 deductible, 10% coinsurance once the deductible was met and a max out of pocket (or “MOOP”) of $5,000. So if I had the worst year ever I wouldn’t pay more than about $5,000. Since I’m single, relatively young and relatively healthy I think this is a pretty good deal since my monthly premiums are very low.

New Plan

However, this plan was “discontinued” and the new “comparable” plan now has a $3,500 deductible, 20% coinsurance once the deductible is met a $5,950 MOOP.

So this means that while my premiums fell by just 0.66%, my deductible went up by 14.29%, my maximum out of pocket went up 15.97%, and the amount my insurer pays once I reach my higher deductible falls from 90% down to 80%.

I hope I don’t have to use my medical plan at all, and if I don’t I will have saved token amount of money (which I will take!), but if I do have the worst year ever (medically) then I’ll be paying nearly $1,000 more.

Why the Increase?

I’m just one person so it isn’t fair to generalize my experience to the United States as a whole, with this caveat in mind I suspect that the individual mandate being removed has something to do with it.

If people don’t have to buy health insurance anymore then that means there are fewer younger, healthy people buying insurance and on a percentage basis, more sick people with insurance. I’m sure there are a variety of factors as well but this could be part of it.

Of course I think that removing the individual mandate was a good thing–I don’t see how a “free society” can require individuals to buy something.

However, in order for Obamacare to work your really need that mandate. Obamacare made it so that people with pre-existing conditions could still get “health insurance”.

I list “health insurance” in quotes because at this point health insurance in the US is no longer insurance. Insurance is a way of protecting against a potential risk. For example you can’t buy fire insurance when your house is on fire because once it is on fire it is no longer a risk it is a certainty.

But Obamacare made it so that people can essentially buy health insurance after they get sick (they might have to wait until annual enrollment but still).

I want everyone to have access to medical care. Co-opting and ruining the health insurance industry is not a good approach to working towards a world where everyone has access to medical care.

With the individual mandate revoked but the inability for insurance providers to take into account pre-existing conditions means that prices will have to rise. A lot. This is the tradeoff, if you want to force insurance companies to “insure” sick people then the government would need to force people healthy people to buy insurance.

Of course I don’t believe in initiating force to get anyone to do anything. I am saying that in order for this coercive system to work in which insurance companies are forced to “insure” people with pre-existing conditions that you have to coerce healthy people to buy insurance.

What I’m Doing About It

In the short term nothing. I hope to remain relatively healthy and hope I don’t have to foot a $5,000 medical bill any time soon. However, in the medium to long term I have a plan that will help me pay for medical care and fight against health insurance price increases. I’ll write more about this strategy in an upcoming article.

We are In an Negative Interest Rate Environment

We are In an Negative Interest Rate Environment

The United States is in a negative interest rate environment. Bank accounts essentially pay zero interest but price inflation is at a minimum 2.2%. That is if you believe the CPI.

Source: https://www.bls.gov/news.release/cpi.t05.htm

I don’t know what the actual rate of price inflation is, however, I think it is rather closer to 5% than 2.2%.

If the CPI were calculated the same way it was in 1990 it would be 6%.

Source: http://www.shadowstats.com/

I like to save tweets like this for posterity

The tweetist above is wrong about us not being in a negative interest rate environment. Are nominal interest rates negative? Basic math tells us of course not.

Are real interest rates negative? Definitely. Real interest rates are what matter. If the rate of inflation is greater than the rate of interest paid then real interest rates are negative. This is the situation we find ourselves in.

While we are already in a negative real interest rate environment I do think there is a good chance that we will see overtly negative interest rates in the future in the US. If the Federal Reserve starts buying bonds again, the price of bonds in dollar terms will go up and yields will drop, as anyone who knows anything about bonds knows.

However, bonds are paid in dollars and if the Fed were to restart Quantitative Easing what would that eventually do to consumer prices? Would the market wake up and realize the Fed can never shrink it’s balance sheet? What would that do to the value of the dollars the bonds are claims on?

Buying the 10 year right now would be a winning trade in dollar terms if the Federal Reserve adopts negative interest rates but I think the dollar would tank.

The Fed is raising interest rates. So bond prices naturally fall as yields rise. Does it make sense to buy bonds in a tightening cycle? No.

And if you think everything is fine and you believe the CPI then you wouldn’t want to own bonds anyway since they pay a very small yield relative to the official rate of price inflation.

In my view treasuries are reward free risk and I see no point in owning them.

I Don’t Own US Treasuries

I Don’t Own US Treasuries

I would not buy US treasuries and I don’t understand why there is even a market for them.

I know the Federal Reserve is a big part of the “market”, officially and otherwise, but surely they aren’t 100% of the “market” (yet).

If the Fed isn’t 100% of the market that means someone besides the Fed is still buying treasuries.

I would like to talk to someone who is buying US treasuries and understand WHY they are doing so.

Reward-Free Risk

US debt yields are paltry. As of today the 10 year treasury has a 1.5% coupon. That means if I buy a $100, 10 year treasury, I’ll get $1.5 per year, in two $.75 payments and after ten years I’ll have gotten $15, plus the $100 face amount of the treasury.

Ten year treasuries are trading at a discount rate of $97.89 so if I hold the treasury to maturity, I could gain $17.11 ($1.5 per year times 10, plus $2.11 (difference between the bond price and face value)).

Price from Bloomberg: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us

In other words if I were to purchase a 10 year treasury I’ve loaned the government $97.89 and ten years later the government pays me back $115. While $17.11 isn’t fantastic it looks positive.

The problem is price inflation.

The 2015 consumer price index (CPI) was 1.7%. So using a handy inflation calculator (link below), I know that $115 ten years from now has the same purchasing power as $97.16 in today’s dollars.

Source: http://www.calculator.net/inflation-calculator.html

Basically, I would have loaned the government $97.89 and in ten years they pay me back with the purchasing power of $97.16.

I’ll have lost purchasing power!

When I loan someone money (unless I really like them) I should be compensated for not having access to those funds. I certainly don’t accept being paid back with less valuable money when I make an investment.

Personally, I don’t think the CPI is accurate. I think that price inflation is at least 2%, perhaps even as high as 10% per year. So let’s say prices are rising on average 5% per year.

With a 5% annual price inflation rate, that $97.89 is worth just $70.60 ten years from now, so the ten year treasury lost over $27 in present day purchasing power.

Compound Interest

If you reinvest the bond coupon payments (the $.75 you get every six months) you would start taking advantage of compound interest and the math works out a little better.

The calculations become much more complex but if I were to reinvest the coupon payments, best I can tell is the $97.89 would grow to around $135 after ten years. With a 5% inflation rate the $135 would be less than $83 in today’s dollars so it is still a loser investment. That assumes the 10 year continues to trade at the current price and the coupon stays the same for the treasuries purchased with the reinvested coupons.

If I were to reinvest the coupons and if inflation really was 1.7%, the $135 ten years from now would be around $114 in today’s dollars, so I will have gained purchasing power.

But as I said before I don’t think inflation is that low.

Short Term Treasuries are No Good Either

The 12 month treasury pays no coupon but sells at a discount such that it yields .64% upon maturity. With inflation at 1.7% it is another situation in which a buyer is guaranteed to lose purchasing power if the treasury is held to maturity.

The only way to gain real value with a treasury would be to sell the treasury for more than the purchase price by a wide enough margin to beat the rate of price inflation or to hope that there is significant price deflation.

The Federal Reserve will fight any price deflation that might occur so I don’t think that will work. I also think that bonds are in a bubble, so while right now there might be an ample source of greater fools willing to pay more for a bond than the last person, eventually the only greater fool will be the Fed.

Again, I don’t understand why any rational investor would loan money to the US government in exchange for being paid back with dollars that are less valuable later. It’s the opposite of how the time value of money is supposed to work and it isn’t sustainable.

It’s one of the reasons I think bonds are in a bubble. I’m not the only one who thinks that. Folks much smarter and experienced than I have been saying the same thing.

The takeaway for me is don’t buy US treasuries. They are reward-free risk and there is no place for them in my portfolio.

Disclaimer: The information on this site is provided for discussion and educational purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.

Downfall of the US Dollar

Downfall of the US Dollar

The United States dollar has the privilege of being a widely used currency even outside the US. However, over a hundred years of failed policy, bad laws, and poor decisions have primed the downfall of the US dollar.

The World Reserve Currency

The US dollar is often referred to as the “world reserve currency”. For example, if a company in Canada were to buy something from China, it would not be uncommon for the exchange to be priced in dollars.

Oil is priced in dollars and despite efforts to move to renewable energy the world economy is (and will continue to be for some time) very reliant on fossil fuels.

This dollar dominance has given the United States a great advantage.

The global demand for dollars has helped keep the value of greenbacks up despite unprecedented US central bank manipulation in the form of trillions of new dollars being created.

Normally the creation of new dollars (inflation) would cause a great deal of upward pressure on consumer prices once these newly created dollars find their way into the real economy.

But because of the global demand for US dollars and US government debt these newly created dollars are exported throughout the world lessening the impact of inflation.

The Dollar Doesn’t have the Fundamentals it once did

VE DayThere are a variety of historical reasons why the United States dollar was made the “world reserve currency”.

The 5,000 foot view is that at the end of World War II the United States had the most productive and largest economy in the world and US dollars were backed by gold.

I would venture to say that none of these reasons apply anymore.

The Nixon Shock was a key milestone in the downfall of the US dollar

The United States defaulted when President Richard Nixon took the gold backing from the dollar.

The United States effectively defaulted when it went off the gold standard in 1971 in what is known as the “Nixon Shock”.

Depending on what metrics you look at China has surpassed the United States as the largest economy in the world.

Dollars are not a good store of value and the US banking system is a pain to deal with. As an example, French bank BNP Paribas was fined $9 billion for violating US laws regarding who they could do business with.

There is Nothing Exceptional about the US Dollar

The downfall of the US dollar follows in the footsteps of many other dominant global currenciesIn history there are other examples of dominant countries with the privilege of internationally recognized currencies.

Dating back to first century Rome and the aureus, the solidus of the Byzantine empire, the Spanish dollar backed by the mighty Spanish fleet, the dominance of the British pound in the 19th and 20th centuries, and now the US dollar in the 20th century. Each of these powerful empires rose and fell and with it went their currencies.

The Days of the Global US Dollar are Numbered

The days of the US dollar as a world reserve currency are limited.

The United States was once a business friendly environment that allowed entrepreneurs to thrive and bring unheard of prosperity. The United States of today has a labor force participation rate at multi-decade lows, a lack of manufacturing, stifling regulations, the highest corporate tax rate in the world and a hopelessly manipulated fiat currency.

Countries are Already Looking for Alternatives to US dollars

German economist Ernst Wolff has talked about how smaller countries already tried to break from US dollar hegemony with lethal results.

Saddam Hussein of Iraq wanted to sell his oil for euros. Muammar Gaddafi of Libya wanted to introduce a gold backed currency. These men ended up dead.

Source: http://sputniknews.com/europe/20160817/1044347872/brics-economies-expert.html

BRICSRussia and China and other “BRICS” nations would benefit from moving away from dollars. They have already moved to trade more in the ruble and yuan rather than the US dollar. No doubt China and Russia would love to see the downfall of the US dollar.

Source: http://www.globalresearch.ca/russia-and-china-the-dawning-of-a-new-monetary-system/5423637

It’s also possible, although this is just my own speculation, that China is positioning its national currency, the Yuan, as the replacement to dollars as the world reserve currency.

China’s documented actions, like importing and mining metric tons of gold and lobbying for and inclusion in the International Monetary Fund’s (IMF) basket of currencies, support this belief.

Source: http://globalriskinsights.com/2015/12/impacts-of-the-yuans-inclusion-in-the-sdr-currency-basket/

Unites States Economic Decline

Because the dollar is a fiat currency it’s value is dependent on the strength of the United States economy, the political stability of the country, and the military power of the US armed forces. All of these factors are in decline.

As flawed a metric as it is, it’s worth noting that US average annual GDP growth has been on a downward trajectory for some time.

This election has surpassed the last presidential election in divisiveness. The level of political discourse seldom gets above name calling and personality. Discussing ideas and principles is an afterthought. Corruption and cronyism are rampant.

The United States military is a bloated mess. The US spends more on defense than the next seven combined. Despite this the military is bogged down in failed projects like the F-35 and hopeless engagements in the middle east.

0053_defense-comparison-full

Source: http://www.pgpf.org/chart-archive/0053_defense-comparison

The process of US decline has been ongoing. The downfall of the US dollar is not because of one particular event, but the cumulation of many bad policies and decisions.

One can look at a variety of events, the creation of the Federal Reserve in 1913, the Federal income tax, growing national debt, the post World War II perpetual warfare state, the Nixon Shock of 1971, the Iraq war fiasco, Federal Reserve actions in 2000 and 2008. Historians will debate what went wrong.

Don’t expect the fall of the US economic might to happen overnight. It’s been an ongoing process where one bad decision leads to another.

As the United States’ economy continues to decline, as the US government debt continues to grow unabated and as the US Federal Reserve continues to debase the dollar, more and more countries will move away from US dollars.

As this happens it will cause increased price inflation in the United States and the impact of US Federal Reserve recklessness will be more keenly felt.

It could be that 10, 20 or 50 years from now people look around and realize the United States is no longer the superpower it once was.

How I Protect Myself from the Downfall of the US Dollar

gold-295936The downfall of the US dollar informs some of the investing decisions I make. I’m investing in physical gold, gold mining stocks, and quality foreign stocks trading at a discount. I’m also dabbling in blockchain investments, despite the added risk in that arena.

One of the easiest and in many respects best ways to buy and store physical gold is by opening up a Goldmoney personal account. To learn more about this opportunity and sign up for account, click here.