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.
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 world has almost always been pretty crazy. I think there is a bias, which isn’t necessarily a bad thing, to believe that now is a special time, it’s different. Now is “the best of times” or “the worst of times.” In a very real sense the current time IS the most important because the present is the only time we can directly impact. Also as humans we seem to enjoy superlatives. But it’s important to realize that things have almost always been fairly crazy. The world has almost always been mad.
Supply Chain Breakdown
So what is the crazy du jure? Well, the US and probably other countries are realizing what was obvious to anyone who cared to think about it: if you shut down industries, print money, pay people to stay home and otherwise disrupt and destroy supply chains you get price increases, delays and shortages. As if labor wasn’t tight enough, vaccine mandates are driving more people out of the work force.
One of the scariest phrases is “I’m from the government and I’m here to help.” When I heard Biden was going to get involved in the supply chain issues, particularly the ports on the United States left coast I knew it was only going to get worse.
Their brilliant solution? Fine Shipping Companies if their shipping containers remain in the marine terminals for too long. How that will actually enable the shipping containers to get unloaded and moved faster is anyone’s guess. Perhaps the shipping companies weren’t sufficiently motivated before and that was the problem? It makes no sense to me.
But I don’t have the experience in supply chain management that Biden and Harris do. Wait, scratch that, as a kid I worked in a warehouse shipping packages for four summers. Not stellar credentials in supply chain but four more summers experience than these public “servants” have.
Government Dysfunction
Forgive me for repeating myself when I use the phrase government dysfunction. When it became apparent Biden was going to occupy the White House and the blue team was going to have both chambers of congress I thought it was going to be bad. Really bad. I thought it would be bad because I don’t think that taxing, regulating and spending work and that is pretty much all Biden can or would do.
If you do think that taxing, spending and regulating work then we’ve been deprived from the socialist paradise by two moderate Democrats (or if you’re from New York or California, right wing extremists).
I am waiting for the other shoe to drop because Senator Joe Manchin a blue team member from West Virginia and Kyrsten Sinema, another blue teamer from Arizona are actually doing things I don’t wholly disapprove of. Or to be more precise they are not doing things.
That is the standard I have for politicians: did they do one or two things I don’t wholly disapprove of? If so they’re doing pretty good relative to their peers.
When his wife was appointed to a federal position that pays some $163,000 per year for public “service” I thought for sure Manchin was bought and paid for and would march to whatever beat Biden (who whomever is actually in charge of the executive branch) drummed.
But so far he hasn’t.
Manchin has put the Kibosh down on ending the filibuster (which is a racist Jim Crowe relic when anyone but the Democrats use it), he’s stopped the IRS from violating the fourth amendment by being able to snoop on anyone’s bank account with more than $600 $10,000 in transactions in a year, which is basically everyone not on welfare. He’s stopped the carbon tax and done some other good stuff. I didn’t realize there were still moderate Democrats but there is Joe Manchin.
Kyrsten Sinema gets some credit too. See? I can say something nice about Democrats.
Politicians always fail us, usually miserably, so I’m sure it is only a matter of time before Manchin and Sinema are brought in line and they click their heels like a good party members and do as they are told. But not so far.
Biden the Lame Duck
President’s who don’t accomplish anything are great. Gridlock in Washington is great for ordinary Americans. If Biden turns out to be a lame duck that would be fantastic. If you’re on the government dole it is a bummer, if you’re connected with the right folks in government you might not make another few million which is a bummer, but I’m convinced that for everyone else government inaction is a real plus.
Biden’s approval rating is pretty bad. I’m glad the US isn’t officially in Afghanistan anymore and I give Biden credit for having actually withdrawn. Obama didn’t make it happen, Trump didn’t make it happen. Biden (or whomever is actually in charge of the executive branch) made it happen. Full credit for that.
But even still it was a disaster. Incompetent leadership is not without its costs, some of which are deadly serious.
I’m not a military man (and neither is Biden) but why wouldn’t you make sure the US civilians (and Afghan allies) were evacuated PRIOR to withdrawing most of the military? I don’t think you need to have gone to West Point or the Naval Academy to have that instinct. What happened over there makes no sense to me.
Seeing desperate Afghanis clinging to airplane landing gear so they would not be left behind to be killed by the Taliban was disturbing and horrifying. But perhaps the worst was when the United States government killed an innocent family of 10 including 7 children.
That combined with how he is “handling” COVID-19 and the economy I think Biden’s prospects at a second term, should he decide to run, are not great. Disclaimer: “In my opinion the President has more power than he should have but less than people realize. The President gets blamed when the economy is doing poor and gets credit when it is doing well. But it’s all unwarranted.” But while not impossible (as we’ve seen with Jimmy Carter, George H.W. Bush, and Trump in recent decades) it is tough to beat the President in an election.
Regardless I expect the blue teamers to do poorly in the mid-term elections. My political predictions haven’t been stellar, but if history is any guide the party occupying the White House tends to lose ground in the next election cycle, and with Biden being less popular than most things (ok that link is to a satirical news site), I don’t expect 2022 to be any different. At this point in my life, I would be content if no new laws were passed and the government was in deadlock. When either party gets control particularly bad things happen.
Gold Has Failed as an Inflation Hedge
This has been a real bummer because I’ve written about gold a lot. I’ve written about how I think it is an important part of a diversified portfolio. Well inflation is here and gold hasn’t done much of anything. Stocks are up, real estate is up, Bitcoin and Ethereum are up, plywood is up, Costco has reinstated paper towel quotas, even $163,000 a year isn’t enough to buy a US Senator anymore, the CPI for goodness sake, a metric seemingly designed to not measure inflation is up. It seems like the price of everything is up, except gold. Gold is not up. Maybe it is a “barbarous relic”. If you own any I wouldn’t sell it, but it has been a disappointment.
Sure, it had that tease-of-a-run-up in 2020 where it broke over $2,000, but since then it has dwindled and is stuck around $1,800. While it is better than a sharp stick in the eye gold going form $1,500 at the start of 2020 up $300 as of writing this isn’t going to save anyone from inflation. That is about a 20% increase. Meanwhile, the dollar has depreciated some 15% during that time. Not fantastic.
I still think gold is important. It doesn’t have counter-party risk, it’s been subjectively valued for thousands of years. It’s not liable to get replaced by Bettercoin 2.0 like Bitcoin is, but I would have expected it to go up more during COVID times.
The World Has Gone Mad
The world has gone mad, but it didn’t happen in 2020, it happened much, much earlier. Twenty-twenty was certainly crazier than other years but it could have been worse.
I don’t mean to downplay these past few years for those who have lost loved one or who have had their life dramatically impacted by COVID-19 and the ensuing government response. Almost 5 million people worldwide have passed as a result of COVID-19. If you’ve lost a friend, family member, co-worker, teammate or anyone else due to COVID-19 it is not a statistic it is a very real tragedy. If you’ve lost someone because they couldn’t get preventive care or screening because of the lockdowns, if they committed suicide as a result of the social isolation resultant from social distancing policies and lockdowns, if they’ve lost hope because of job losses these are all real tragedies. Perhaps you yourself are suffering. These are all real and tragic realities that we’ve all been coping with to one extent or another.
Having said that I want to end on a (relatively? kind of?) upbeat note. The last couple years have not as bad as the Bubonic Plague outbreak of the 14th century where perhaps 25 million people (about 2/3 of Europe at that time) perished. It’s not been as bad as the 1918 pandemic where perhaps 50 million people died. It wasn’t as bad as the mid 1940s in Europe during World War II when an estimated 50-70 million people died. Or the 1950s in China under Mao where some 30-40 million people died or were killed. Thankfully, nearly 223 million people worldwide have recovered from COVID-19. It’s not like we’ve had World War 3. And while that is a low standard perhaps that is good enough for now. And God willing, perhaps 2022 will be a little better.
Stock valutations in the United States are no longer driven by profits, future earnings, productivity or any other free market measure of value. Instead they are controlled, in practice by President Donald Trump trade war tweets and Fed Chair Jerome Powell’s comments about future interest rate levels.
These two economic central planners met on Monday the 18th to talk about “Everything”.
Trump
Trump has already made clear he wants negative rates and more quantitative easing. He mentioned discussing negative interest rates with Powell.
“Trump called the meeting ‘very good & cordial,’ adding that ‘everything was discussed,’ including interest rates, negative interest, low inflation, easing, dollar strength, and its effect on manufacturing, trade with China, the EU ‘& others, etc.'” (Emphasis added)
Powell sounded like a 3 year old parroting some rehearsed line, stating monetary policy will be set to support maximum employment and “stable prices”.
The Fed’s target for price inflation is 2%. Which means that the value of a dollar will be cut in half in about 36 years. This is hardly what I would consider to be price stability.
On the topic of “maximum employment”. The unemployment rate is at a half-century low of 3.6%. To have a lower unemployment rate you have to go back 50 years to 1969.
Do interest rates need to be below the level of inflation in order to support maximum employment?
A Health Person on Life Support
Interest rates are at 1.75% and central bank balance sheet growth has resumed. These are the kind of extraordinary life support measures seen during economic crashes and recessions.
If the economy is healthy, vibrant, growing and strong you don’t need to pump it up with stimulants and preventative measures. Yet these extraordinary measures have been going on for a decade.
Say you have a patient in a hospital. The doctor says they are fine and doing great. However, we’re going to pump them full of antibiotics, keep a morphine drip and IV going, and hook them up to an iron lung, “just in case”.
You would rightfully be suspicious of that doctor. If the patient is fine then why do they need all of those extraordinary life preserving measures?
It seems clear to me the Fed is keeping interest rates low for some reason other than price stability or supporting maximum employment.
Until recently market dynamics have been something like the following: Trump threatens more tariffs, the market sells off, the fed eases and the market rallies. I wrote about this in a past article entitled Trump is Beating the Fed like a Rented Drum Set.
Recreation of a BofA Merrill Lynch Diagram
Phase I: Get Interest Rates Low
The result is interest rates at 1.5-1.75%, “This is not QE” QE, and the S&P 500 at all time highs.
Trump Playing the Trumpet in a badly Photoshopped image
I believe Trump’s prospect for reelection is tied almost entirely to how the stock market performs. So why would he threaten tariffs if they cause the market to go down?
I conjecture firstly that Trump genuinely believes in tariffs and secondly: so he gets lower rates.
But this is only Phase I: where interest rates are already low and perhaps the Fed has signaled they intend to keep lowering. On 30 October the Fed poured a little cold water on Phase I by indicating they intend to pause easing.
Low interest rates and QE is just the first tailwind.
Phase II: “Win” Trade War
I expect Phase II, the “Double Tailwind”, to occur in 2020 and be timed for the election.
Phase II is kicked off either by winning the trade war, or (more likely) simply declaring the trade war won.
The market believing there won’t be new tariffs is the second tailwind, which combined with the first forms the “Double Tailwind”.
Phase two means fewer tariffs or even a complete trade war victory
The “Double Tailwind” means the market isn’t getting freaked out by tariffs and selling off and interest rates are low.
The US stock market could go to even higher highs and secure Trump’s re-election. Trump can then use the bully pulpit of the presidency and appoint an uber-dove to ensure that rates are raised slowly or not at all.
Interest rates might very well stay where they are at. During the 30 October press conference Fed Chair Powell said, “I think we would need to see a really significant move up in inflation that’s persistent before we even consider raising rates to address inflation concerns.”
Why he appointed Jerome Powell only to throw him under the bus is beyond me, but he will probably do more to ensure he get’s a low interest rate puppet as Fed Chair for his second term.
I don’t know if Trump is planning this out in some grand ‘3D chess’ maneuver or not. But if he is, I have to admit it has a sort of Machiavellian genius to it.
Potential Problems
3D Chess – metaphor for using multiple, non-obvious levels to outmaneuver one’s opponents
Whether it is intentional or not, Trump is now responsible for blowing more air into what is now an even bigglier and uglier bubble and can join the ranks of the Presidents responsible for destroying the dollar and the US economy.
Quarter three GDP was up 1.9% beating the expected 1.6%. Employment is robust. Inflation as (not) measured is “contained”. Between that and the S&P 500 rise will the Fed be able to justify continuing to cut rates?
Another problem is when you get high on heroin you have to deal with the crash. You can’t take the heroin away and keep the high. In fact you have to keep taking more heroin to get a similar high.
Low interest rates are monetary heroin. So if interest rates don’t continue to fall then the market will fall. This most recent “insurance” rate cut may have been the last. If so there is a whole year between now the election in which even the Double Tailwind can fade, bringing the economic ship to a halt. Timing the trade war “victory” correctly before the election will be essential.
The uninitiated often think of the United States as a free market economy. It is in some specific ways but it is a far cry from a laissez-faire free market system. The main reason why the United States isn’t a free market is because of the Federal Reserve System, which controls money and how much it is worth. Money which is on one side of every single transaction that occurs in the economy.
Another reason the United States is not a free market is because of the myriad of taxes, rules and regulations prescribing how virtually all aspects of economic activity must be conducted.
Conventional foolishness states that deregulation causes the 2008-2009 financial crisis. However there were 115 agencies regulating the U.S. financial sector. As Tom Woods says, “Your friends think things would improve if there were 116.”
Monday the 28th of October was another example of how distant the US stock market is from a free-market and how the US economy is very much controlled, manipulated and centrally planned. Trump primed the trading algorithms this morning by stating he, “Expects A Good Day In Market Today”.
The S&P 500 then opened at a new all-time record high as a result. Meanwhile the Federal Reserve, the biggest currency manipulator in the history of the world, is expected to cut rates from an extremely low 1.75-2% to an even more extremely low 1.5-1.75%.
A free market economy is not driven to all time highs by the words of one man or a small group of bankers.
But a larger question remains: if everything is so great, why the rate cuts and “This is not QE” Quantitative Easing?
One factor driving the market is the trade war. When China and the US talk and say nice things to each other the market rallies. When they say mean things or refuse to talk the market sells off. The Federal Reserve is perhaps trying to give some support to the markets when China and the US seem like they can’t play nice.
But I believe the main reason is because the market is expecting it. The Fed isn’t data dependent. The Fed is market dependent. The odds of a rate cut are really just a voting machine to tell the Fed what to do.
I’m sure it doesn’t help the US Fed to be “independent” when Trump pounds on the oval office desk demanding more rate cuts and QE. The irony is that Trump is now just as guilty as Clinton, Bush, and Obama in blowing a big, “fat, ugly bubble.” Trump, if reelected, will be lucky if he can pull an Obama and exist stage left before it blows up during his tenure.
If the US were a free market interest rates wouldn’t be set by a small cabal of unelected, semi-private, pseudo-governmental bankers. It would be set by the supply and demand of lenders and borrowers.
The central banks, who artificially lower interest rates and inflate asset bubbles, fuel greed and cause recessions and crashes. Meanwhile, free markets get blamed and the plutocrats call for more regulations that simply reduce competition from smaller players who can’t afford an army of attorneys to both comply with the new rules and look for and find the loopholes. Regulations also raise costs for consumers.
Meanwhile the regulations wouldn’t have prevented the crisis anyway.
This can’t end well but who knows when it will end.
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