Bond Funds and Fertilizer: Worth Less, Not Worthless
By Paul Price
(Featured in our Newsletter, Bond Funds and Fertilizer. This week's newsletter includes sections on inflation/dollar, bond funds and the stock market. For email notice of new articles and Paul's stock market activity, sign up with your email address on our home page.)
Perhaps surprisingly, the buying power of the dollar had been increasing for three and a half decades before the Federal Reserves’ creation in 1914. Since the Fed’s been minding the store, however, the value of the dollar has been on an almost non-stop decline. It’s now worth merely 5% of its original value. (To simplify the terms “inflation” and “deflation,” inflation occurs when the value of money declines. The dollar buys less and less. Conversely, deflation results from an unchecked rise in the value of money, which shows up lower prices.)
The Fed wants inflation, even though it destroys the purchasing power of the U.S. Dollar.
The Fed’s Zero Interest Rate Policy (ZIRP) and its push for higher prices (inflation) favor borrowers at the expense of savers. ZIRP discourages saving and delayed consumption because the U.S. dollar’s buying power continuously shrinks. When a currency’s value is declining, and interest rates are nearly zero, there is no reason to save and every reason to spend. In this environment, bank CDs and fixed-income bonds are virtually guaranteed to lose buying power in the long-term.
The Great Depression of the 1930s briefly triggered some deflationary action. President Franklin Roosevelt stopped deflation when he abandoned the gold standard in 1933. Executive Order #6102, the Gold Confiscation Act, made it illegal for U.S. citizens to hold gold. (See Gold-Confiscation-Act-of-1933 for background.)
President Richard Nixon closed the door on asset-backed currency in 1971. Dollar bills stopped carrying the label ‘silver certificates’ and started bearing the term ‘Federal Reserve Notes.’ This allowed for unlimited money printing with no assets backing up the currency.
Regarding the Dollar’s decline, the remaining 5% of the pre-Fed dollar is overstated. After double-digit inflation in the late 1970s and early 1980s, the Bureau of Labor Statistics (BLS) changed its rules in calculating the Consumer Price Index (CPI), thereby lowering the reported inflation rate. Low reported inflation allowed the Federal government to save billions in its cost of living adjustment (COLA). A higher COLA would have increased payments for workers and retirees.
Inflation benefits debtors who repay borrowed money with lower-valued paper. The U.S. government is the largest debtor in history with over $16 trillion in debt; it also has trillions in unfunded promises for Social Security, Medicaid/Medicare and pension obligations. (See Death by Leverage)
Treasury Inflation-Protected Securities (TIPS) are the Treasury Department’s version of inflation-protected bonds. Interest rates earned on these were designed to offset inflation. However, the less than trustworthy CPI data understates real inflation. TIPS have failed to accomplish their stated goal. Their ability to offset the dollar’s loss of purchasing power is an illusion.
Even though cash continues to lose value, there is no suitable substitute except for barter. Keeping one to two years of money liquid for day-to-day needs is prudent even though it will gradually lose buying power.
Preserving wealth comes from owning real, income producing assets, including rental real estate and profitable businesses. These help pass along the effects of a weakening currency. Unless you own a company that meets this standard, stocks represent the best way preserve wealth.
Stocks are liquid, often pay dividends, and the underlying company can adjust to future conditions. Shares of a profitable company represent partial ownership in an income-producing asset. While the stock market goes up and down, no matter what befalls the country, people will continue to eat, drink, need shelter, work and seek entertainment.
Present-day Japan shows what happens when government officials set out to undermine their own currency. The plan to devalue the Yen prevailed in last November’s election. Over the past 12-months the Yen drop by 21% against the dollar. Everything imported into Japan now costs much more.
Many Japanese savers transferred money from Yen to Japanese equities, which could be marked up as the fiat-based currency was marked down. While citizens couldn’t stop the insane politicians, they could protect their life savings. During this time, the Nikkei-225 index rose more than 70%. Those unwilling to ‘take stock market risk’ lost money. Owners of equities are still ahead.
American equity markets have been hitting new highs as QE programs dilute away the value of the US dollar. When the U.S. shit hits the fan, holding appreciating assets and not fiat-based garbage will be beneficial.
Our strategy: Hold some emergency cash. Avoid any fixed income except for ultra-short term bonds or CDs. Buy stocks. Prepare for a wild ride.
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