The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

[c1ue]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

I get the impression you may have misunderstood a previous post C1ue

GRG,

I may have missed the satirical angle. I get easily distracted when the collapse of Western civilization is at hand ;)

[c1ue]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

Last time I checked, I was able to get an equity mortgage on my house (which is paid for) for $100,000 at 6.7% fixed with no costs.

I take the $100,000 and invest in T-bills at whatever the going rate is now . . . let's say 4.5%. So at this rate I'm losing 2.2% on my money.

But inflation (hopefully) begins to climb, and I keep reinvesting the money in T-bills at ever higher rates. When T-bonds hit 15%, 20% or higher in 3 or 4 years (or whenever), I invest the money in 30-year T-bonds at say 20%.

So for 25 years or so I'm making 20% on the $100,000, and paying the bank back at 6.7%, which is a profit of 13% per year . . . all using the bank's money -- my own little personal carry trade.

The only risk I see is that T-bill interest will not rise, in which case I pay back the bank loan and experience a small loss. No risk, no gain.

Raja,

You are giving everyone on iTulip a great example of failure to recognize risk.

Instead of focusing on the 'carry trade' you mention, I suggest you think in terms of what the equivalent interest rate swap would cost you - because that is what you are doing.

The difference between what you are paying (2.2%) and what the swap would cost is what the market considers risk - and the market for risk is STILL quite low by historical standards. This means the swap will cost more in the future should risk-aversion set in.

As for specific considerations:

1) You are assuming interest rates are higher than inflation. Historically the interest rates lag. As I've mentioned before - the problem then is your money gets inflated before it earns equivalent interest. It is like the dealer's advantage in Blackjack - busting last = equal for house.

2) Will you be able to time the market? It is not a trivial exercise to lock in the 30 year T-bill at the peak; if you are 10% wrong then you're going to have a long long miserable time of it.

3) You're borrowing money to invest. Never a good idea. This is very similar to buying a house you can't afford with an Alt-A loan - believing all will be made right by one thing: house price appreciation.

4) You're taking on debt - when the economy is getting worse, it is generally though unwise to count on present cash flows continuing to grow or even keeping steady. This of course very much depends on the personal situation.

[zoog]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

What would be the inflation index from 1980 to 2006 as per Shadowstats, compared to the inflation index using official CPI? -- The figure using official CPI is 2.443 using the CPI calculator This figure may help crystallize my thinking.

My cursory reading of the CPI inflation graph below gives me a figure of 7.4 but that can be deceiving when eyeballing and estimating an exponential series from percentage changes.

Elsewhere I've read that the US MZM has increased about 9 times since 1980, and that collectively, first-world countries money supply has increased about 6 times. So 7.4 sounds reasonable to me.

[Rajiv]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

What would be the inflation index from 1980 to 2006 as per Shadowstats, compared to the inflation index using official CPI? -- The figure using official CPI is 2.443 using the CPI calculator This figure may help crystallize my thinking.

My cursory reading of the CPI inflation graph below gives me a figure of 7.4 but that can be deceiving when eyeballing and estimating an exponential series from percentage changes.

[GRG55]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

mikew, c1ue, hayfield and GRG55,

Thanks for your responses to my question on the effects of currency devaluation on savings.
If I may follow up . . . .

I've been thinking for some time now about what commodities would be good investments in recessionary times.

I see two opposing factors determining the value of commodities:

-- inflationary effects due to a devaluing dollar, which would boost the price of commodities
-- economic slowdown with reduced spending and less demand, which would lower the price of commodities

Oil: Seems to me there might be a lot less driving if people reduce their shopping, lose jobs, cut back on vacations, etc. If demand for retail products is reduced, there will be a lot less of those Walmart trucks lugging stuff around and burning up gas. It's true that a certain amount of oil is used for home heating (I have no idea what percent), and people will still have to heat their homes. But they also might turn down their thermostats to save money.
On the other hand, the price of oil would be boosted by the loss of dollar value and/or political instability.

Natural Gas: Don't know much about this, but I assume it's used a lot for cooking, home heating and industry. However, unlike oil, there seems to be far less discretionary use, so perhaps this is a good bet.

Uranium: Used primarily for electricity generation, and there's a large discretionary use component there. IIRC, if we didn't have instant-on appliances -- like TVs that are constantly on so they respond to a remote -- we'd save up to 3% of electricity costs. So people becoming conscious of saving electricity during hard times might have a significant impact on electricity consumption, thus reducing the demand for uranium.

Coal might have a similar outlook as uranium, since I assume its primary use is for electricity generation.

Food: This looks to me like the safest bet. It's hard to believe that people would eat much less of basic foodstuffs in hard times. Sure, restaurants will suffer, but the food people ate in the restaurants they will now consume at home.
As I understand it, agriculture requires a lot of oil for pesticide and fertilizer manufacture, transportation, and running farm machinery, so betting on food is partly betting on oil.

I have a question about the timing of investing in commodities: Will commodity ETFs be taken down with other stocks when/if the market fails? Isn't there a tendency for all stocks to tumble in a crash?
Many commodity prices seem high right now. I'm wondering if I should buy now, or wait for some huge stock drop, and invest in commodities at that time?

I'd appreciate any opinions or feedback . . . .

Raja, C1ue, et. al:
I think we can all agree that if credit is contracting then, in general, having debt can be hazardous to your (investing) health (individual situations will vary of course).

I am of the view that we are in just the early stages of what may be a major contraction following the biggest credit bubble in human history. The authorities have signaled unequivocally that they intend to reflate. Therefore at some point in the future, when credit is again cheap and plentiful, it might make sense for some people to take on prudent levels of debt. I get the impression you may have misunderstood a previous post C1ue; to be absolutely clear, my opinion is that the prudent level of debt for most people today, in the face of shrinking credit availability and rising cost of credit, is ZERO - but that's just an opinion folks.

Raja: I will comment on the two commodities with which I am most familiar - oil and gas - and I am keen to hear the views of others on your questions above on all commodities, especially agriculture. This is NOT investment advice but instead some things you may wish to investigate or factor into your own investment analysis. I will try to hit on a few things that you won't generally hear about on Bubblevision:

- for the first time ever the marginal demand for crude oil is coming from the developing economies. In the past crude oil demand was dependent on the economic cycles in the OECD countries - when the OECD was recovering from its most recent recession, crude demand increased and prices eventually responded. That is NOT what is happening this time so, unlike Bubblevision, you may want to put less emphasis on US (& European) demand patterns. If greater Asia continues to grow at even a moderate pace, energy consumption is probably going to rise regardless of what happens in the USA. If you expect an economic set-back in Asia you probably want to avoid, or short, crude.
- The cost of finding and developing oil has skyrocketed in recent years. Saudi Arabia expects to spend $30 Billion to add the next 1 million bbls/day of new incremental production. Wasn't this supposed to be the "cheap oil"? Saudi exports fell more than 3% full year 2006 compared to 2005. There are no places left to add cheap barrels of reserves or deliverability because the NOCs (National Oil Companies) are subject to the same escalating cost and manpower pressures as Exxon, BP. et. al.
- OPEC no longer controls the market. I know there are many that will dispute that statement - and persist in believing the price is manipulated by OPEC, or Big Oil, or the Carlyle Group (or maybe even the Easter Bunny ). Some of those people reside in the fairyland known as the US Congress. I wouldn't recommend basing your investment decisions on that cohort's pronouncements. Note that oil blew through $80 on the day OPEC announced a production increase this month. I can see one scenario whereby OPEC regains control in the future, but for now they are price takers, not price setters.
- Do not underestimate the importance of political risk. If you are investing in a company that finds and produces oil or gas it matters not where it is headquartered or which stock exchange it trades on. What matters is where are their reserves located.
- Unlike crude oil which is global, gas markets are continental. This will change as blue water LNG volumes increase and that sector of the industry matures - but that's a few years away.
- North American natural gas markets are much more "just-in-time" than other energy sources. The drilling and subsequent supply response is very quick to adjust to price changes. At this moment nat gas prices in Canada have collapsed. So has drilling. If you believe in the old adage that the best time to invest is when there is "blood in the streets" you may want to check out what is happening in Alberta gas right now (take a first aid kit with you). By the way, one of the Arabian Gulf sovereign wealth funds run by an acquaintance of mine has recently purchased two Alberta-based natural gas producers, effectively taking them private.
- Finally, I have a personal bias against resource companies that try to price hedge future production. These so called "risk management" groups within many resource companies are nothing more than an expensive fashion accessory, and have collectively cost industry shareholders tens of billions of dollars in lost opportunity over the past decade - in falling and rising price environments. In my mind it is internally inconsistent for a company to bet against the commodity it extracts and then merrily go ahead and continue spending its shareholders money to find and produce more of it. :mad:

Hope this helps. Good hunting.

Quick postscript raja: Blood in the streets often means some of the patients die. You don't want to stuff your portfolio with "attractively priced" cremation candidates!

[raja]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

it might make sense to go take out a mortgage or some other type of loan. in which you pay back in future with less valuable dollars.

I had this idea a few weeks ago, but haven't acted on it yet . . . .

Last time I checked, I was able to get an equity mortgage on my house (which is paid for) for $100,000 at 6.7% fixed with no costs.

I take the $100,000 and invest in T-bills at whatever the going rate is now . . . let's say 4.5%. So at this rate I'm losing 2.2% on my money.

But inflation (hopefully) begins to climb, and I keep reinvesting the money in T-bills at ever higher rates. When T-bonds hit 15%, 20% or higher in 3 or 4 years (or whenever), I invest the money in 30-year T-bonds at say 20%.

So for 25 years or so I'm making 20% on the $100,000, and paying the bank back at 6.7%, which is a profit of 13% per year . . . all using the bank's money -- my own little personal carry trade.

The only risk I see is that T-bill interest will not rise, in which case I pay back the bank loan and experience a small loss. No risk, no gain.

Ohhh . . . forgot to mention that I'm deducting the mortgage interest paid to the bank from my taxes. I can get interest-only payments for the first 5 years, so when this is calculated in I take little or no loss for the first few years until interest rates rise.

I also should mention that the government only allows interest deductions for the first $100,000 on equity loans. But if my idea works, it would be a good deal even without any interest deductions . . . .

[raja]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

mikew, c1ue, hayfield and GRG55,

Thanks for your responses to my question on the effects of currency devaluation on savings.
If I may follow up . . . .

I've been thinking for some time now about what commodities would be good investments in recessionary times.

I see two opposing factors determining the value of commodities:

-- inflationary effects due to a devaluing dollar, which would boost the price of commodities
-- economic slowdown with reduced spending and less demand, which would lower the price of commodities

Oil: Seems to me there might be a lot less driving if people reduce their shopping, lose jobs, cut back on vacations, etc. If demand for retail products is reduced, there will be a lot less of those Walmart trucks lugging stuff around and burning up gas. It's true that a certain amount of oil is used for home heating (I have no idea what percent), and people will still have to heat their homes. But they also might turn down their thermostats to save money.
On the other hand, the price of oil would be boosted by the loss of dollar value and/or political instability.

Natural Gas: Don't know much about this, but I assume it's used a lot for cooking, home heating and industry. However, unlike oil, there seems to be far less discretionary use, so perhaps this is a good bet.

Uranium: Used primarily for electricity generation, and there's a large discretionary use component there. IIRC, if we didn't have instant-on appliances -- like TVs that are constantly on so they respond to a remote -- we'd save up to 3% of electricity costs. So people becoming conscious of saving electricity during hard times might have a significant impact on electricity consumption, thus reducing the demand for uranium.

Coal might have a similar outlook as uranium, since I assume its primary use is for electricity generation.

Food: This looks to me like the safest bet. It's hard to believe that people would eat much less of basic foodstuffs in hard times. Sure, restaurants will suffer, but the food people ate in the restaurants they will now consume at home.
As I understand it, agriculture requires a lot of oil for pesticide and fertilizer manufacture, transportation, and running farm machinery, so betting on food is partly betting on oil.

I have a question about the timing of investing in commodities: Will commodity ETFs be taken down with other stocks when/if the market fails? Isn't there a tendency for all stocks to tumble in a crash?
Many commodity prices seem high right now. I'm wondering if I should buy now, or wait for some huge stock drop, and invest in commodities at that time?

I'd appreciate any opinions or feedback . . . .

[mikew]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

yea clue that makes sense. thats what i was trying to articulate in my post but you did it much better

[rabot10]

Re: Gold rises vs. all major currencies as confidence flees central banks

I've held a GoldMoney account for about 3 years now and participate in their monthly gold accumulation program, where you dollar cost average into gold each month. So far I like GoldMoney and they have very low fees, but there is a little part inside of me that is concerned not being able to access the account and turn the gold back into cash when I need it. Every reference I have seen made about James Turk indicates that his a reputuable and honorable person, but I'm still a little nervous. I think part of my plan is to use GoldMoney to accumlate gold and once I hit certain break points in ounces, purchase physical and convert the GoldMoney into cash to pay for the physical.

Rick, I would like to get your thoughts on your opinion of GoldMoney.

I live in the US and things are going to get more than weird on this side of the pond. Don't know when for sure but U can put money on it that it's going to happen. GoldMoney will send me (I hope) my money back to me to any bank account that is in the same name as the sending account. I have many accounts in a few different places so this is a big thing for me and my family. Check out what the others will do regarding getting your money back.

[GRG55]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

If you are that good at predicting these complicated outcomes, I suggest you borrow money and start your own hedge fund instead

Isn't there a petition doing the rounds to include hedge funds on the endangered species list...

[c1ue]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

in one sense, it might make sense to go take out a mortgage or some other type of loan. in which you pay back in future with less valuable dollars.

GRG55, MikeW,

I didn't specifically respond to this because I thought it was pretty obvious.

However, it appears not so.

1) The strategy of borrowing money in the face of inflation only works if your savings are not similarly exposed.

Unless you are in the financial industry and using OPM (other people's money), I challenge you to get a loan today without putting a significant part of your own capital up. This capital is thus equally subject to the negative effects of inflation - unless you believe you will 'gain' more when the larger debt devalues as swiftly as your down payment/collateral? Note I am assuming you are able to hide all your other assets...itself a non-trivial exercise.

2) If you borrow to buy an asset, you are also assuming the asset worth growth equals or outpaces inflation.

This has not automatically true.

If there is a combination of BOTH inflation and price reductions to cause housing to revert to historical mean, you could wind up with both a lot of debt AND a lower worth house.

For example - if use the 100% increase as the recent housing market bubble, it is just as possible that inflation will rise 70% in the next 5 years while housing prices overall drop 30%. In this case you would have 'gained' in the sense that your debt was inflated away faster than the worth of the house. But you still owe more money than the house is worth.:mad:

The other example is a 50% inflation with a 50% house price drop. I think you can see this is even worse than above.

Note I haven't even talked about paying interest on the loan yet.

Of course you can buy assets other than a house with debt - my caution to you is just that you had better understand that you are making a double-leverage bet on the asset with several degrees of movement and furthermore are investing in a world of still inflated values due to the global liquidity glut.

If you are that good at predicting these complicated outcomes, I suggest you borrow money and start your own hedge fund instead

[FRED]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

Raja: You are getting some good answers from others who have responded to your post. As a supplement what others have said, one of my preferences is to listen carefully to the grizzled old market veterans -they've seen much more than the average 36 year old hedge fund manager. All of these folks are concerned about inflation, lots of inflation and here's how they think you should protect yourself:
- 83 year old Richard Russell (Dow Theory Letters) advocates holding some gold, some gold mining shares, a bit of oil, and recently has turned cautiously bullish on the large cap DJIA;
- Jim Rogers (of Quantum Fund fame) has been a strong advocate of commodities since 1999, and currently suggests agricultural sector particularly cotton and sugar (hard for us small investors to buy although there are some ETFs in London), Yen and Swiss Franc. He expects a significant correction in the US stock markets at some point. Also he prefers owning the commodities outright rather than the extraction (mining) companies (of course he trades the futures). Rogers recently sold his Manhattan home and moved his family to Asia - he has been an Asia bull for quite some time, especially China. On gold, Rogers thinks it will rise (and holds some), but believes it's better to own commodities that people need and use;
- Marc Faber also expects a US stock market correction, but thinks it may not fall very much in nominal terms due to the massive reflation now underway (the iTulip thesis applies this same logic to expected nominal house price changes in the US). Faber thinks everyone should have some gold.

Three people, three views. Hope that is of some help. Below are links to a couple of extended Bloomberg interviews with Rogers and Faber last Tuesday just before the FOMC decision was released.
Cheers, GR. ;)
Rogers Interview:
http://www.bloomberg.com/avp/avp.htm...USJ.lwS8e0.asf

Faber Interview:
http://www.bloomberg.com/avp/avp.asx...oNtU.D0pcE.asf

You can add iTulip to the inflated DOW list. See Real DOW.

[GRG55]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

you lose 20% of your wealth simply because everything else becomes 20% more expensive, not cheaper. this is inflation. the price rise is an effect from the excess supply of currency which is the cause.

so, as i understand it, savers basically get screwed.

in one sense, it might make sense to go take out a mortgage or some other type of loan. in which you pay back in future with less valuable dollars. but use the loan for what? surely not a house. and if you use the loan and buy gold, then youre doubling your bet on inflation, which exposes you to greater risk..

in other words i have no clue what to do

anyone else have any insight?

mikew: You are absolutely correct that during inflationary times it is better to be a borrower instead of a lender. During the latest reflation (2001-2006) this paid off in spades as those who borrowed and speculated the most were the biggest winners ("Give me leverage or give me death").

But then came the day the music died, and it was bye bye miss American pie for every overlevered hedge fund and condo speculator, as power transferred instantly back to the creditors. They are now claiming what is left of the assets. After Tuesday last we all know the Fed is warming up the printing presses (hedge fund manager Bill Fleckenstein has started calling them Bennie and the Inkjets).

Seems to me that the global credit system is still contracting, and therefore better to hold ones inflation hedges outright with no margin - so you really own them. If the Fed and the other Central Banks reflate successfully then the use of leverage will once again be a good strategy. But if the reflation doesn't work (a monetary policy "accident" scenario), one probably won't want to have any debt at all.

Would like to hear others views on this suggestion...

[GRG55]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

Could someone explain to me what happens to savings when a currency is devalued?

For example . . . let's say I am retired (which I am) and I want to live off my savings that I have stashed away in Treasury securities. If there were a devaluation of the dollar, would I wake up some morning to find that I had lost 20% of what I was counting on for retirement, and will I then experience a 20% decline in lifestyle? Or, does everything become cheaper, so I will not really feel a difference?

I realize that this answer depends on what happens in other countries, since imported products from countries whose currencies remain strong must go up in price relative to the dollar. But what about U.S. products and services?

Raja: You are getting some good answers from others who have responded to your post. As a supplement what others have said, one of my preferences is to listen carefully to the grizzled old market veterans -they've seen much more than the average 36 year old hedge fund manager. All of these folks are concerned about inflation, lots of inflation and here's how they think you should protect yourself:
- 83 year old Richard Russell (Dow Theory Letters) advocates holding some gold, some gold mining shares, a bit of oil, and recently has turned cautiously bullish on the large cap DJIA;
- Jim Rogers (of Quantum Fund fame) has been a strong advocate of commodities since 1999, and currently suggests agricultural sector particularly cotton and sugar (hard for us small investors to buy although there are some ETFs in London), Yen and Swiss Franc. He expects a significant correction in the US stock markets at some point. Also he prefers owning the commodities outright rather than the extraction (mining) companies (of course he trades the futures). Rogers recently sold his Manhattan home and moved his family to Asia - he has been an Asia bull for quite some time, especially China. On gold, Rogers thinks it will rise (and holds some), but believes it's better to own commodities that people need and use;
- Marc Faber also expects a US stock market correction, but thinks it may not fall very much in nominal terms due to the massive reflation now underway (the iTulip thesis applies this same logic to expected nominal house price changes in the US). Faber thinks everyone should have some gold.

Three people, three views. Hope that is of some help. Below are links to a couple of extended Bloomberg interviews with Rogers and Faber last Tuesday just before the FOMC decision was released.
Cheers, GR. ;)
Rogers Interview:
http://www.bloomberg.com/avp/avp.htm...USJ.lwS8e0.asf

Faber Interview:
http://www.bloomberg.com/avp/avp.asx...oNtU.D0pcE.asf

[hayfield]

Re: The Face of Inflation: Does the U.S. Have a "Peso Problem" revisited

in other words i have no clue what to do

anyone else have any insight?

No one does... But I think c1ue has the right idea (it's what I've been doing)

1) Move money out of the currency in question.
2) Buy into businesses low in the hierarchy of needs: Food, water, shelter (maybe not this one this time )
3) Buy into inflation hedge commodities like gold

But how to move money out of the country without actually traveling to the destination? I have been buying US$ denominated foreign currencies, PowerShares, MERKX, BEBGX, or the like.

The other idea commonly kicked around in this community and others is to invest in commodities. Of this, I am less certain, but I find it hard to argue with the logic that energy/commodities will be the next bubble