Financial Sarcasm Roundup for 05/18/15

Behavioral finance research discovered that good financial decisions are often counterintuitive.  Sarcasm can also be counterintuitive but that is not an iron law.

Credit card companies love doing business in hyperinflationary Venezuela.  Charging fees to banks that pay in hard currency (the US dollar at present) is the key to success.  When hyperinflation comes to the US, expect card companies to charge banks using Australian and Canadian currency.  Americans won't know the difference because they'll be swiping that card for a jar of peanut butter priced at $10M of worthless US currency.

Critics of the TPP's fast-track bill may be right about some of its risks.  The business elites pushing the trade deal don't care much for Dodd-Frank rules.  Wall Street sees the rules as little more than a nuisance because its lobbyists helped write the law.  Sleepwalkers at the SEC have little incentive to enforce rules that will harm their chances for future employment on Wall Street.  Waving a weakened Dodd-Frank in the progressive Left's face is a cheap tactic for policymakers who know how banks get around rules.

Fannie and Freddie securities will soon be one combined issue.  The sucker institutional investors who buy MBS will now have an easier time going bankrupt.  They only have to buy one product full of subprime mortgages for people who can't pay bills.  No one learned anything from the mortgage loan nonsense of the last housing crash.  The chase for yield in a zero interest rate world now means dumb fixed-income portfolio managers will pile into MBS all at once.

I have spent way too much time lately dealing with trivial things and people.  I must now make more effort to ignore those things and avoid those people.  I will soon discover whether a small amount of time I spent on a high-payoff opportunity was time well spent.

Modern Portfolio Theory Before Hyperinflation

Modern portfolio theory (MPT) has been around since Ike was in the White House.  It's old enough to be Generation X's cranky parent, yelling at the neighborhood kids to get off the lawn.  It's also old enough to deserve some improvements.

The authors of MPT and related investment strategies were old enough to have lived through the Great Depression.  Images of people who lost everything from overconcentration in one stock, style, or sector made lasting impressions.  MPT's emphasis on diversification is a natural result.  Most investment theorists in the Anglo-West have not lived through a hyperinflating economy.  Using MPT to rebalance portfolios during hyperinflation poses hidden risks.

Fixed income investments comprise a significant allocation of many MPT models in the real world.  Bonds, notes, cash instruments, and other things denominated in a face amount of currency will rapidly turn worthless in a hyperinflationary economy.  Ask anyone who invested in Zimbabwe, Argentina, or Venezuela in the last decade.  MPT investors in those countries could be heard howling all the way across the Atlantic, if anyone listened.

Hyperinflation turns MPT inside out.  Asset allocations that include hard assets are far more likely to survive a hyperinflating economy than anything with fixed income.  Hard asset sectors like energy, agriculture, mining, and now infrastructure as an emerging theme will hold their worth through inflation because they produce output that can be valued in any currency.  They may even experience strong valuation growth during hyperinflation as investors rush to convert the declining power of their currencies into hard goods that will retain utility.  The end of hyperinflation will also end such rushed growth, but a productive farm will still be a farm.  A bond won't be the same at all.

Updating MPT for a highly inflationary economy does not require adjustments in risk-return calculations.  It does require the inclusion of other asset classes that do not behave like fixed income.  Consider that oil drillers and metal miners have been hit particularly hard in recent months by oversupply and declining world prices.  Consider also that lengthy monetary stimulus has pumped an unsustainable global bond market bubble.  Rebalancing means a rotation away from overconcentration in fixed income is due any time.  Underpriced hard assets are ready for any MPT-based portfolio manager with enough foresight to prepare for inflation.

SIFIs Make Double-Dumb Bet On Fixed Income

The biggest investment banks prove they are willing to follow the bond market to oblivion.  They have just doubled-down on reorganizations that commit to even more bond underwriting.  The comment at the end of that article shows some rare sanity in a financial sector gone mad.  These dumb banks are betting that huge sovereign debt issuance will continue as interest rates rise, and that said rising rates will entice investors back into fixed income.

I won't restate my long-held contention that central bank stimulus has driven global bond markets far past their natural equilibrium points.  Go read some of the World Bank's regular reports from 2013.  I sure did.  The end of this historic coordinated stimulus means the end of excess profits in bond underwriting.

It's even more amazing to see the SIFIs unwind their commodity operations to make room for bond desks.  Commodities are useful hedges in hyperinflationary periods.  Going long in fixed income with no commodity exposure was the kiss of death for investors who lived through hyperinflation in Weimar Germany.  I will not feel one ounce of pity for the spoiled preppie bond traders who are going to lose their shirts.  They all have it coming to them.  A run on the US dollar will not treat Wall Street kindly if this is what passes for strategy.  

SGS Begins Calling Hyperinflationary End Game

I periodically note the excellent economic analysis over at Shadow Government Statistics.  The author, John Williams, began signalling the hyperinflationary end game last week.  I have long anticipated hyperinflation as a likely outcome of the Federal Reserve's uncontrolled monetary stimulus.  My chief difference with the Shadow Stats analysis is the sequence of events in an unfolding economic catastrophe.  I expect a deflationary episode first as asset prices crash, followed by a national policy response that adds hyperinflationary pressure.

SGS is correct to identify the dollar's increasing weakness.  I have considered foreign investors selling dollars in the currency markets or foreign central banks selling US Treasuries as likely triggers for hyperinflation, regardless of any change in policy from Washington.  A collapse in the dollar's confidence abroad would make asset deflation and dollar hyperinflation occur nearly simultaneously in the US, but I still expect at least a minimal time lag as a panicked policy response attempts to reflate asset markets.  The window available for bargain US asset purchases may be as short as a few weeks or as long as a few months.

The lackluster performance of US stock indexes so far in 2014 may be a mere statistical blip, or they may be the latent realization that the Fed's asset pumping has reached its natural limits.  I have no confidence in reports of political deals that continue federal deficit spending, because they cannot and will not avoid the fiscal train wreck from unfunded entitlement spending.

I do not share doomsayers' infatuation with gold as the sole textbook hedge against hyperinflation, although I recognize how my continued position in GDX may benefit during the onset of hyperinflation.  I continue to examine hard asset hedges for my portfolio.  I know what I want to buy and I await desirable prices in the capital markets.  

Measure the Wage-Price Spiral and Economic Growth Discrepancies During Hyperinflation

There will be little warning in the event hyperinflation begins in the US.  There aren't many real-time tracking tools that function well during hyperinflation besides the prices of food and energy in your local neighborhood.  I expect the federal government to continue to rely upon the Employment Cost Index (ECI) to track wages and the Consumer Price Index (CPI) to track prices.  Economists traditionally regard a wage-price spiral as a hyperinflationary phenomenon.

I believe it will also prove worthwhile to track the difference between Gross Domestic Product (GDP) and Gross Domestic Income (GDI).  They are theoretically supposed to be equivalent but the BEA has revised the calculations behind GDP so much that there is now a noticeable statistical discrepancy between the two figures.  Here's the BEA's 2010 explanation for its preference of GDP over GDI as a reporting metric.  I can live with the preference for more timely data sources, but the ideal solution would be an interagency effort to get the GDI source updates more frequently.  Here's the BEA's regular update of differences between GDP and GDI.  If you get lost, just go to the BEA's website and find this info on the page for GDP, or use that site's search function that we paid for with our taxes.

Here's the FRED chart for GDP.

Compare it to the FRED chart for GDI.

They compare pretty darn well according to my eyeballs.  I'll perform more robust statistical comparisons if they start seriously diverging.  I expect the statistical discrepancy between GDP and GDI will describe the nature of any stagflation period during the early onset of hyperinflation.  If the discrepancy grows rapidly, it will indicate a rapidly stagflating economy that will tempt policymakers (specifically the Federal Reserve) to increase any hyperinflationary stimulus.  Comparing the discrepancy to ECI and CPI will indicate how quickly the hyperinflationary response takes effect.  Rapid rises in ECI and CPI will show the wage-price spiral taking effect.  This is all Alfidi Capital theory at this point.  Time will tell whether my expectations prove correct.

These statistics won't be useful as triggers for investment decision points once hyperinflation really gets roaring.  Their monthly and quarterly updates won't be frequent enough for a wage-price spiral that adjusts daily in the real world.  They will instead be useful as integrity checks for policymakers.  Any attempt to suppress knowledge of deteriorating economic conditions will reduce policymakers' credibility in the eyes of the public.  

Really Dumb Alternative Income Hedges

I frequently gripe about the nearsightedness of fixed-income portfolio managers and their investors.  It seems to me that the best they can do is eek out minimalist returns with ZIRP distorting credit markets.  Hanging on at the top of a bond market is dangerous when the only place interest rates can go is up.  Holding long-duration fixed income investments of any kind is suicidal on the cusp of hyperinflation.  Money managers look for alternatives to conventional credit products, like in Index Universe's ETF Report article on alternatives in fixed-income for October 2013.  They're not looking hard enough to impress me.

No way will I look at bonds, loans or notes that float with Libor.  That rate is still subject to manipulation and a few fines aren't fixing anything.  The World Bank should give me a call if it ever takes note of my GIBOR concept and wants to implement it worldwide.

I am sick and tired of hearing about variable demand rate obligations (VRDOs).  Those instruments were among the first to freeze in value during the 2008 financial crisis and most investors sold out of them in frustration as soon as they could.  I tried pitching them when I was a financial advisor in 2005-6 and none of the so-called fixed-income experts at my firm could ever give me consistent answers on how they were priced or how they paid interest.  Brokerages were labeling them as "cash alternatives" simply because they were subject to auctions that had not failed . . . until 2008.  The fine print of a VRDO prospectus mentions that the instruments' viability in auctions is backed by a credit facility known as a standby bond purchase agreement.  If an investment bank is unwilling to lend in support of such an agreement, the VRDO auction fails and the investor is stuck holding what becomes de facto a long-term bond.  That will be dangerous during the onset of hyperinflation.

International bonds might work if they originate in countries that have a strong rule of law orientation, a significant hard asset sector, and a low propensity to hyperinflate.  That rules out anything except bonds from Australia, Canada, New Zealand, and Switzerland (which lacks the hard assets of the other three, unless you consider Swiss chocolate).  I tune out the remaining China bulls who think dim sum bonds are China's ticket to reserve currency status.  That makes me LOL.  Investors who ignore China's debt-laden shadow banking system deserve what's coming if they love dim sum bonds so much.

I've blogged about BDCs before.  They work great in normal times by providing asset-secured loans to companies that can't qualify for low-interest bank loans but aren't in such distress that they need investment banks to underwrite high-yield debt.  These aren't normal times.  Hyperinflation will enable debtor companies to repay BDCs with less valuable future currency.  I expect the market value of BDCs to plummet in hyperinflation unless they supplement their loan portfolios with standby equity distribution agreements.

Fixed-income investments remain a minefield for many reasons.  Rising US interest rates will lower bond valuations.  Hyperinflation will destroy bonds altogether.  Fiscal cliff wrangling makes non-US institutional investors more likely to dump US dollar bonds at any moment.  Very few coupon-based securities are going to tempt me to chase yield under these conditions.

Brief Notes on Asia and Hard Assets in Hyperinflation

I'm adapting this brief commentary from a conversation I had today with another private investor.  We discussed the possibility of dollar devaluation as a response to America's continuing debt funding problems.  Hedging against devaluation is not difficult with a broad mix of non-dollar assets.

There's more to hard assets than gold.  Anything I consume - - food, energy, basic materials - becomes very desirable in a currency crunch.  Advanced purchases of raw materials become "secondary" stuff as additional inventory kept for future needs.

The need for hard assets as a hedge against the potential devaluation of the US dollar begs the question of where to obtain said assets.  Why buy stuff in China?  I think the renminbi is as likely to have high inflation as the US dollar.  On the other hand, Australia, Canada, New Zealand, and Switzerland have well-managed currencies.  China is the least transparent of the G-20 economies.  I believe all of that country's official economic statistics have been falsified for years.

My longtime readers know that I own John T. Reed's book on hyperinflation and depression.  I have implemented many of his ideas at little cost.  His free articles on inflation are worth my time.  Hedging my net worth with a hard asset component of my portfolio gives me peace of mind that I will survive a hyperinflationary depression in the US.  Consumers will have a difficult time shopping for necessities if our currency becomes worthless as a store of value.

Currencies do have value as units of trade, so the yuan may gain some temporary acceptance as a dollar alternative among China's trading partners.  The problem for those who hold yuan will be the same as for those who hold US dollars.  Inflation in China will make the yuan (renminbi outside of China) worth less in that local economy.  Malaysians, Indonesians, etc. will then dump remminbi because they want to preserve their ability to buy things locally.

The secondary effects of simultaneous US and Chinese hyperinflation on Pacific Rim economies are too complex to predict.  Countries that peg their currencies to the dollar will have to de-link immediately or follow through with their own hyperinflation.  Countries that have significant hard asset sectors - mining, energy, agribusiness, timber - and sectors that service hard assets (specifically pipelines, railroads, and barges) are hedged for a currency crisis.

I remember being in South Korea in 1999 just after the Asian currency crisis had passed.  South Koreans donated their private gold holdings to the government so its currency could regain value.  The US dollar traded at a very beneficial exchange rate for Yankees like me who spent money in the local economy.  South Korea suffered because its main sectors were automobiles, semiconductors, and shipbuilding.  Those sectors were fully exposed to export markets.  I don't want any exposure at all to dollar-denominated fixed income during US hyperinflation.  The Fed under Janet Yellen will keep is foot on the QE gas pedal.  

Magical Thinking for Affordable Care

The Affordable Care Act is the law of the land.  The online insurance exchanges are activating - sort of, with glitches here and there.  The government shutdown means quite a few GS-rated IT pros will not be available to fix those glitches.  Consumers are finding out just how much they'll be subsidized or how much extra they'll have to pay to subsidize someone else.  Christmas is coming early for some folks while others are drafted to play Santa Claus.  The IRS helpfully lets us know how much more we'll pay for noncompliance. 

The wonder of our time is that Americans wonder about the origins of goods and services.  Several generations of creeping entitlement programs have conditioned Americans to think of transfer payments as a birthright.  I am certain that many Americans believe Social Security and Medicare are paid from a magical black box.  That box just got a lot bigger in the minds of everyone signing up for ACA-guaranteed health insurance.  Television comedians doing street interviews reveal that Americans don't even know this law's official name.

I used to mention the unfunded liabilities of our nation's middle class entitlements on this blog.  I did not expect many Americans to pay attention but I had to salve my own conscience and put facts on the record.  I won't do that for ACA so much because I don't expect it to survive a hyperinflationary economy.  The law's subsidies may be useful to our political class during the onset of hyperinflation.  ACA payouts to a newly destitute working class can increase rapidly along with whatever emergency bond buying program the Federal Reserve activates.  That transmission mechanism won't last long given the complex nature of this law's payment plans.  The rapidly hyperinflating payouts will encounter many delays in the ACA's claims activation process, rendering them unable to keep up with hyperinflating health care prices.  Other transmission mechanisms, specifically SNAP/EBT cards and home mortgage modifications, are much more effective channels for hyperinflation because the government can feed payments directly to banks.  

Americans holding ACA exchange health insurance during hyperinflation will wish for magical payouts.  The payouts will arrive in diminished form, too small and too late to be of much use in paying rising bills.  Frustration with the whole enchilada will only end when hyperinflation ends.  

Bond Investors Should Not Chill Out At All

CNBC allows PIMCO to give us three reasons why bond investors should "chill out" and stop worrying.  I'll give the folks at home three reasons why I'm not a bond investor.

1.  Economic fundamentals don't support much of anything anymore.  Go back to my article in June 2013 about the BIS study showing every asset market in the developed world pushed up by central bank monetary stimulus.  Consumer spending is 70% of GDP, higher than ever in history, and it has to come down eventually.  Government spending is higher than ever and has to come down eventually.  If federal spending comes down after a hyperinflationary period, bond investors are toast.

2.  Inflation is definitely coming back.  People who haven't read Shadow Government Statistics don't realize that inflation is already here.  Compare your grocery bill to what you paid last year, especially for energy-intensive staples like meat and bread.

3.  Investors always misread the Fed.  This is because many US investors haven't lived through hyperinflationary periods.  The necessary precursors for such an episode are in place:  a liquidity trap, government borrowing crowding out private borrowing, and political unwillingness to curtail government spending.

Bond gurus who assume that tapering QE won't require a higher Fed funds rate miss the boat.  Any tapering will raise real rates by lowering the market value of existing bonds.  Bond investors have no reason at all to chill out now that the bond market bubble awaits its pinprick.  

Hearing John T. Reed's Seminar At MoneyShow SF 2013

John T. Reed was back this year for another lively talk at the MoneyShow San Francisco.  I've followed his writings for several years and I attended his talk at the 2012 MoneyShow.  The dude shared a wealth of minute details assembled from research he conducted for his book How to Protect Your Life Savings from Hyperinflation and Depression, 2nd Edition.  I got the first edition and I've taken many of his suggestions very seriously.

John's talk this year introduced a ton of tips from his book and his recent exploration of the US-Canadian border.  His overall approach is still familiar to his longtime readers, that managing hyperinflation or depression risks is like having homeowner's insurance.  "Being early is the same as being wrong" is a bad strategy only if it's pursued at high cost or high risk, like hedge fund manager John Paulson's gold strategy.

John wants us to owe US dollar denominated debts and not own dollar-based fixed-income instruments.  Liquidity is important to pay US bills during hyperinflation and owning hard assets isn't enough.  John's book goes into detail on liquid hard assets that are suitable for barter but bill paying requires access to currency.  The currency of choice should not be contaminated by US hyperinflation and must lie beyond the reach of US capital controls.  I believe CurrencyShares ETFs held in US brokerage accounts can accomplish this goal but John prefers solid currencies held in banks.  My readers know that I am long FXA, FXC, and FXF in my own US accounts (that's money from Australia, Canada, and Switzerland).  Check out his writings on the subject; he explains his approach better than I can.  I intend to have a Canadian bank account open just as soon as I determine which one has the strongest capital adequacy numbers under the Basel III accord.

Speaking of currencies, John expects the currency markets to be the harbinger of US hyperinflation if non-US investors decide to sell dollar holdings all at once.  Foreign investors and central banks that get fed up with Fed QE will cause a run on the dollar that will shock Americans in no time flat.  We can then watch the graphs at MIT's Billion Prices Project turn sharply vertical and stay that way.

John adapts his real estate knowledge into concepts that work as inflation/deflation hedges.  He likes life estates, Home Equity Conversion Mortgages (HECMs), and a special concept he calls "reverse defeasance" that converts US dollar annuities into foreign currency lump sums.  He also expects hyperinflation to destroy the value of long-term leases in commercial properties, so landlords should protect themselves by only making month-to-month lease agreements that they can can raise to keep up with inflation.  John considers REITS in self-storage and timber harvesting to be acceptable inflation hedges in a liquid portfolio.

I only had one comment during John's talk.  Buying preserved food is a good hedge against rising food prices but I mentioned that we need not worry about the expiration dates on canned goods.  I've read about studies conducted by both the US Department of Agriculture and US Army that validated the nutritional content of ordinary canned food more than forty years after the canning date.  Here's an NPR story from 2012 that validates the discovery that canned food retains much of its quality for decades, based on research that was done in the 1970s on canned food from the 1930s!  The USDA even has a handy-dandy Complete Guide to Home Canning, in care of the University of Georgia's National Center for Home Food Preservation.  I wonder whether Uncle Sam will be able to keep this excellent research funded during hyperinflation.

Hey John, here are two action items to consider for one of your future articles.  They make sense to me as additional tools your readers can use as inflation/deflation hedges.

Item 1:  Home food production with aquaponics.  Backyard gardening is a diet supplement and affordable alternative to paying inflated prices in stores.  Consider an aquaponics installation as a closed-system production method that produces food constantly regardless of weather or available space.  Aquaponics systems can be maintained indoors, out of the view of potential food thieves in the neighborhood.  The only downside is that buying the implements may attract the attention of law enforcement agencies who monitor gardening shops to see who's cultivating illicit stuff.  Maybe it would be wise to invite the local chief of police over for a tour of one's aquaponics installation so the brass knows it's legal.  Here's a YouTube video produced by Purdue University demonstrating aquaponics.  I think this can be done in a garage, basement, commercial warehouse, or self-storage unit.

Item 2:   Common stocks in hard asset sectors.  Thanks for mentioning my currency ETF ideas in your Reed Theory Fund article.  There are other things investors can select if they don't want to abandon their IRAs or other tax-advantaged US investment accounts.  Common stocks in companies that generate revenue from hard assets - specifically mining, energy, and agribusiness - already have geologically confirmed hard asset inventories that they liquidate on world markets.  Some of the world's largest basic materials companies are domiciled outside the US and earn revenue in currencies other than dollars.  BHP Billiton (mining, energy) is in Australia and Potash Corp. (fertilizer for agribusiness) is in Canada, two of your choice countries.  These types of stocks typically pay cash dividends and have option chains available for covered call writing.  If desperate consumers in Europe, Japan, and the US crave food, fuel, and basic commodities, these types of producers stand to benefit.

Excuse me, but I need to get over to my bank and pick up a few rolls of pennies and nickels as soon as the MoneyShow is over.  Those are John's equivalent of put options that retain their face value in deflation but have tremendous intrinsic value in hyperinflation if changes to legal tender laws allow investors to unlock the coins' melt value.

Full disclosure:  John T. Reed did not compensate me in any way for this article.  I do not receive any royalties from his books or other engagements.  I'm sharing these insights because John does great work and investors need all the information they can handle.  

Good Things Will Come From Hyperinflation

I've been gnashing my teeth for some time over the Fed's insane experiment in monetary stimulus.  It lays the groundwork for eventual hyperinflation when combined the federal government's unchecked appetite for spending on middle class entitlements.  I've had to adjust my portfolio and lifestyle from conventional solutions to extraordinary measures.  It's now time to look on the bright side.  Hyperinflation in the US will have multiple silver linings.

Hyperinflation will put a lot of useless charities and worthless private universities out of business.  This is a really good thing.  Their endowments are heavily invested in US dollar-denominated fixed income instruments that will be pulverized in hyperinflation.  Many non-profits are little more than perpetual motion machines that continue raising money but never solve social problems.  Most private universities teach little of value anyway, except the ones with large research facilities or hospitals.  The schools with good STEM and medical facilities can replace their government funding with private sponsorship once hyperinflation reduces the value of their government checks.  Other schools, particularly liberal arts campuses, will be gone.  Liberal arts schools churn out America's future dingbats anyway.  Those folks can save money on tuition if they start work as janitors straight out of high school.

Hyperinflation will eliminate household debts.  Homeowners can throw away their mortgages.  Former students can pay their entire law school loan balances with just a fraction of their hourly time sheet at the coffee shop.  They won't be able to start their debt binges over again because real interest rates will remain high even after hyperinflation ends.  This is another really good thing.  Consumer appetites will be suppressed for decades and the investors dumb enough to own securities derived from consumer debt will be wiped out.  Neither party will be able to continue their stupid ways.

Hyperinflation will provide me with enormous entertainment as I laugh at the unpreparedness of idiots around me.  I'll spend my days ridiculing the people waiting in line for hours just to buy rationed food and household staples.  I'll amuse myself when people dumb enough to set up black markets get caught, because there's nowhere to hide in a total surveillance society.  I'll laugh all the way to the bank buying auctioned-off assets from bankrupt people at fire sale prices.

Hyperinflation will be fun . . . for me anyway.

Fixed Income Facts and Fancy When Staring Down Inflation

An acquaintance got me thinking about the fixed-income universe.  I haven't thought about it much lately for good reason.  Fixed-income investments are wiped out in high-inflation economies and the Federal Reserve's implied policy of monetizing US sovereign debt dramatically increases the chances of high inflation.  The fixed-income universe is much broader than sovereign debt.  I ought to see if any income-generating instrument can survive high inflation.

The Dividend Yield Hunter lists multiple categories of fixed-income instruments that go way beyond bonds.  I was not aware that exchange-traded debt existed in forms other than preferred stock (not really debt, but acts like it) and funds.  The Tennessee Valley Authority, for example, lists its bonds on exchanges for the public to trade (TVC and TVE are examples).  The usual cast of characters like MLPs, royalty trusts, and REITs round out exchange-listed offerings.  I've never considered business development companies (BDCs) as fixed-income investments because they are unique ways to invest in undercapitalized small companies, sort of like VC firms but publicly traded.  Dividend Yield Hunter lists BDCs as fixed-income, presumably because they must pay out their earnings like other pass-through entities.  BDCs are also searchable over at QuantumOnline, and that site also lists exotic things like income deposit securities.

Fixed-income investing is a fine stabilizing element for a diversified portfolio in normal times when interest rates are at their long-term historical average and the national debt-to-GDP ratio is manageable.  Americans are not living in normal times any longer.  Most fixed-income investments will see their principal destroyed when high inflation reduces the dollar's value to nothing.

These are the types of fixed-income investments I have decided to avoid due to their vulnerability to inflation.
US sovereign debt of any kind.  The Fed is going to swallow these things whole when foreign central banks sell them in a panic.  The QE needed to absorb the world's outstanding stash of Treasuries will have to be monstrously huge.
Coupon debt of any kind.  This includes any corporate debt or municipal bonds that pay a fixed coupon based on the bond's face amount.  That face amount will be worth less than nothing after hyperinflation ends.  Say goodnight, internotes.
BDCs.  I don't care how generous the cash flow from repaid loans looks right now.  BDCs are highly sensitive to short-term interest rates and real rates will skyrocket at the onset of high inflation.  Their funding is unsecured, which means investors have little recourse to recover assets after bankruptcy.  No thanks.  Finally, their assets are loan portfolios.  High inflation is a debtor's dream come true because it allows them to pay existing debts with future dollars that are worth less than current dollars.  Inflation will destroy BDC loan portfolios.  These are the crucial differences between BDCs and other private equity vehicles.
High yield debt.  No way, ho-say.  This was the first debt category to crack when the market turbulence of 2007 became the crisis of 2008.  Junk bonds are always the first to be wiped out in any market downturn because their issuers have weak earnings or troubled business models.

These are the types of fixed-income investments I am open to considering, given the caveats mentioned.  Their common denominator is their basis in a hard asset sector.
MLPs.  I like pipeline MLPs as a play on hard asset servicing.  Oil and gas are energy hard assets whose demand will be price inelastic during high inflation.  My concern is whether FERC regulations will prove to be so onerous during hyperinflation that they destroy the pricing power of MLPs and their pipeline operating companies.  I cannot rule out regulatory risk with pipeline MLPs.  I may have to wait until renewable MLPs are active.
Royalty trusts.  These are collections of orphaned oil and gas wells whose owners do not need to spend capex to upgrade them.  They pass their earnings through to trust holders as the wells' reserves run down.
REITs.  These are the trickiest to consider.  Some residential REITs will fair poorly during hyperinflation if their holdings are concentrated in urban areas that are hostages to rent control ordinances.  Those will not retain their pricing power during hyperinflation.  Commercial REITs will fare better but many REITs own a mix of properties.  The best sector bet for me may be iShares Dow Jones US Real Estate (IYR), an ETF of REITs, but based on its dividends it's currently trading more than twice what it should be worth.

I feel like restating my enmity for actively managed funds of any kind, including fixed-income.  Bond mutual funds are no longer needed now that index funds and ETFs exist.  Active management of fixed income portfolios is for institutional investors and corporations who must immunize their portfolios against interest rate moves or match durations to liabilities.  They have specific goals in liability-driven investing.  The larger investing world doesn't need to constantly fine-tune a fixed-income portfolio.

I must also reiterate my disdain for the superficial analysis some fixed-income investors use to evaluate the attractiveness of securities.  I've heard some investors claim that MLPs and REITs trading for less than book value are bargains, but if those same entities have low ROEs then there's a reason they trade at such discounts.  The market is discounting their ability to generate cash flow because a low ROE indicates they use capital inefficiently.  They may be paying too much for debt because of past negative credit events or committing capital to operating payouts (like lawsuit settlements or regulatory fines) instead of facilities maintenance or improvements.

Finally, it's worth noting that rising volatility hurts the valuations of fixed-income investments.  The VIX is currently trading below its historical average of about 20.  Any rise in the VIX hurts fixed-income securities, with or without hyperinflation.

I'm staying the heck away from fixed-income investments.  I'll keep my eye on only those few types that generate cash flow from hard assets like commodities or real estate.  

Imagining Hyperinflation Wonders

The Fed's indefinite QE of $85B/month gets me thinking about what life will be like for the average American in a hyperinflationary economy.  Ordinary living will quickly become prohibitively expensive.  We can all start wondering about the good aspects of hyperinflation to take our minds off the bad effects.  My imagination is about to run wild . . .

Americans will become much more comfortable with arithmetic.  Store clerks will be forced to recalculate the prices of goods several times each day.  Restaurateurs and their server staff will get to practice their math skills recalculating the daily prices of meals.  I think the baristas at your favorite coffee shop will get to use their overpriced college degrees after all.

Families will get a lot closer.  Retirees who didn't save any money will move in with their grown children once their indexed Social Security COLAs fall behind a rapidly inflating currency.  Three generations under one roof will be able to share cooking and cleaning chores more efficiently.  In low-income neighborhoods this could even mean four generations living together, what with all those unwed teenage baby mamas running around.

Household debts will magically disappear.  That $60K automobile loan your unemployed idiot brother took out to splurge on some high-end wheels will look like a pretty wise move.  He'll pay it off with a $100K swipe of his EBT card.

Daily life will be full of adventure.  Suburban dwellers can hone their survival skills by avoiding roving packs of unemployed youth on their way to the grocery store.  Once they arrive, they can haggle over barter prices for household goods they want to trade away for food while they stand in line waiting to buy rationed food at government-controlled prices.  Is there an app for that?  There will be soon but hardly anyone will be able to afford mobile plan subscriptions that charge by the second.

Becoming a landlord will be easier than ever.  Rent-controlled apartment complexes will go bankrupt as their owners discover they can't raise rents to keep up with inflating maintenance costs, while the residents stay put.  This means aspiring landlords will pick up multi-unit residential properties on the cheap.  They won't have to worry about run-down plumbing or wiring if tenants get fed up and pay for maintenance out of frustration.  What an adrenaline-pumping gamble to make for wanna-be Donald Trumps!

Our culture will blossom with waves of creativity and innovation.  People who can't afford cars or gasoline will stay home, dreaming of the nice things they used to own.  Artisans will create magnificent wallpaper and collages with dollar bills that have been hyperinflated down to nothing.  Entrepreneurs can convert abandoned malls and department stores into workhouses and barracks.

Oh, BTW, there will be one very wonderful outcome after hyperinflation ends.  I'll be sitting on a much larger portfolio after several years of preparation.  This sarcastic article is funny to read but it won't be funny for most people who live through it.  I may laugh all the way to the bank, or I may just snicker a little under my breath.

Retirement Account Cap Will Limit Ability to Hedge Hyperinflation

The Administration's coming budget plan will cap the value of tax-advantaged retirement accounts at $3M.  It's too early to tell how the federal government will enforce this cap without seeing the enabling legislation.   I would have no objection if any excess value in a retirement account after the beneficiary's demise were subject to full taxation as part of an estate.  If the intent is to prevent retirement accounts from being abused as multigenerational tax shelters, this will prevent them from being passed to heirs in a tax-free status.  This idea has more immediate implications for investors than estate taxes.

My readers know that I expect a dollar devaluation and policy overreactions to launch hyperinflation in the U.S. at some point.  A tax-advantaged investment account would in theory allow the preservation of wealth during hyperinflation if its asset mix was heavily weighted toward hard assets.  Any cap on the account's value poses a complication.  If the cap is enforced only when distributions stop at death, it's not much of a concern.  If, however, the cap is enforced annually via a special tax, then the nominal value of the account will not rise above $3M in any given year.  This will pose a huge problem for investors positioning a portfolio for hyperinflation, because the real value of a hyperinflating currency will decline to the point where a nominal value of $3M is meaningless.

This proposed cap will pose a serious dilemma for investors who want to preserve their net worth during and after a currency crisis.  Holding an IRA that is forced to remain below a $3M ceiling will prove disastrous in a hyperinflated economy where a cheeseburger costs $3M.  Investors must now wargame scenarios that include the liquidation of an IRA as it approaches the $3M limit, the payment of a penalty, and the deposit of the remainder into a taxable portfolio (presumably also with a heavy hard asset weight) that so far is not subject to the same ceiling.  The point of such a mitigating move is to allow a hard asset portfolio to continue to keep pace with hyperinflation.

Caps and taxes on private retirement assets are a form of financial repression that keep redistributive entitlement programs fully funded.  Lazy people who did not save for the future think it's fair to take money via taxes from those who did save according to a plan.  This idea will make it much harder for makers and savers to keep their capital away from takers.

Maturing Thoughts on Borrowing for Non-Productive Purchases

I have been a lifelong opponent of assuming personal debts.  I have never maxed out a credit card or applied for a loan.  The handful of times I've been late on a bill payment in my life are some of my gravest mistakes, and the tiny finance charges I paid each time for my oversights are a source of shame.  I hate debt.  That was the mature attitude to have during normal, boom-bust business cycles marked by productivity-driven growth and inventory-derived recessions.

Times have changed.  The historically normal boom-bust model is giving way to its once-in-a-lifetime deformed cousin, the hyperinflationary depression crisis.  An overindulgence in government, business, and household debt is driving the Fed to quantitatively ease away the dollar's value.  This will destroy dollar-based fixed income assets.  That's bad for savers, bondholders, banks, and hedge funds holding fixed-rate notes.  That's good for debtors owing fixed-rate loans, as the devaluing dollar enables them to pay off old debts with dollars of lesser value.

My point is that now is the time for previously debt-averse people like me to seriously consider taking on debt as a time-based arbitrage strategy for a self-destructing currency.  I scoffed for years at consumers who  took out automobile loans.  Owing money on a consumer good that immediately loses half of its book value upon purchase ought to be financial suicide.  Buying a vehicle with debt is good if said vehicle is used as an income-producing asset, i.e., a taxi cab, delivery van, ice cream truck, or urban safari tour bus for the hills of San Francisco.  I thought that way until very recently.  Now I think a loan of any kind, even for something as unproductive as a new car, is a useful way to acquire a hard asset with an increasingly worthless liquid asset.

I've been window shopping for a new car for some time.  My 2003 Ford Mustang still hums but at 80K+ miles it's getting long in the tooth.  When I turn the ignition key on a brand new sports car of some sort (another Ford Mustang or a Porsche are my leading contenders), it will be with the help of a fixed-rate loan that I will be happy to owe.  Watching the loan lose its value in the years ahead as hyperinflation enables me to pay it off in today's equivalent of pennies will be great for my net worth and my stellar credit rating.  Why, I may just pay that five-year loan off a month early as a show of generosity just to ensure I'm not the final nail that drives Ford Credit or its hedge fund syndicate into bankruptcy.

Nah, just kidding on that last count.  I'd never accelerate my payment schedule or do anything else to give a brain-dead counterparty some temporary advantage.  They'd probably assess me a prepayment penalty just to reach for my wallet one last time from beyond the bankruptcy grave.  Don't think a creditor wouldn't resort to that if a post-hyperinflation political regime allows it in one final act of financial repression.

I'll be checking with my local auto dealers soon to see what kind of financing terms they offer on new, flashy sports cars.  I'll also be checking with my bank's loan desk to see if they'll let me max out some one-year consumer loans just before this hyperinflation show gets rolling.  The Godfather of Soul, James Brown, once sang "Papa's Got a Brand New Bag."  Well, Tony here needs a brand new car, paid for by creditors dumb enough to loan me money as the dollar goes down the drain.  

More Alpha-D Option Updates for 09/25/12

The options trades I tried to execute yesterday didn't get accepted.  I have no idea why nothing worked but I tried again today and they went through just fine.

I wrote covered calls on my long GDX position, some of which were very close to at-the-money and others that were farther out.  I do this to gradually whittle down my gold position as inflation ramps up.  This may seem odd to those gold bugs who are convinced that gold is always and everywhere the best possible hedge against inflation.  I am not similarly convinced, and I do not regard gold with religious fervor.  It has its use in an era of generally rising prices but it is of limited use in true hyperinflation.  That's where the U.S. is headed eventually thanks to the Federal Reserve's permanent stimulus and the government's unfunded entitlements.  I'm reducing gold as it rises to make room in my portfolio for other hard asset equities that will keep pace with hyperinflation.

I also renewed my cash-covered short put position under FXF, a currency ETF I wouldn't mind owning.  The Swiss central bank can't hold down the franc's value forever.  Maybe I'll just go ahead and buy some FXF next month.

I did not renew the options positions I've recently had around FXA and FXC.  I'd rather just watch them while the euro's pending self-destruction forces the U.S. dollar higher and plays havoc with other primary trading currencies.  

Alpha-D Update for 09/24/12

Let's make this as quick as possible.  My GDX holdings rose through the strike price of the covered call options I wrote last month.  I bought some back and let some go.  Gold stocks are rising again thanks to QE3 hurting the dollar so I'll be trimming my position as it rises.  Remember, gold and other precious metals  respond positively to the beginning of hyperinflationary periods but they are poor long-term hedges against the entirety of a hyperinflationary period.  That means I'll be looking to buy other hard asset equities pretty soon.

I sold off the last of my FXI, just as I said I would do for the past few weeks or so.  My FXI holdings have greatly diminished since I opened the position a couple of years ago, and they did quite well much of that time.  I have since come to my senses on the China story now that their economic figures are pretty much known to be fabrications.  I won't return to any more non-U.S. indexed equity investments for the foreseeable future.  The world's biggest economies have not decoupled and they'll all head down the slope together, at some point.

Here's how the Alpha-D looks right now.  I'm long GDX, FXA, and FXC.  I tried to renew the short option positions that expired for those two currency ETFs (and also FXF, which I'm not holding right now) but the orders wouldn't execute.  I couldn't even write short options on GDX.  What is up with that?  I'll try again tomorrow.

My pile of cash awaits deployment after the inevitable crash.  If I'm lucky, and the market crashes before the Fed and Uncle Sam launch their coordinated wage-price spiral, I may be able to buy U.S. equities at lifetime low prices.  If I'm unlucky, and hyperinflation hits first, I'll buy a basket of hard asset equities I've been tracking and hang on for the ride.

BTW, you may have seen an excess of haiku and a dearth of analysis on my blog for the past few months.  I am heavily engaged with several other projects that have come to dominate a huge amount of my time.  You'll just have to deal with what I publish until I'm finished doing some important work.  I'll tell you all about it when I'm done.  I promise.  

The Haiku of Finance for 09/17/12

Quant easing won't work
Input prices will spike up
Looming shortages

Rhetoric And Reality In 2012

I've listened to what the major party candidates have said in the past couple of weeks.  They deserve our attention and respect.  I do respect their intentions for America, but understanding their plans requires me to parse the rhetoric from their convention speeches.

The main themes I heard from either party touched the grievances of the middle class in an America increasingly bereft of upward mobility and income security.  The Republicans tout seriousness about balancing the federal budget, but it's easy to find independent analyses of how the numbers don't add up.  The Democrats remind us of the automobile industry's bailout but ignore the financial loss the federal government still incurs.

The rhetoric about saving Medicare for future recipients is necessary for votes but mathematically impossible without serious benefit cuts and cost controls.  The rhetoric about making college affordable is useless in an age when more unqualified students take on crushing debt loads and then settle for low-paying jobs.  This rhetoric will set voters up for inevitable disappointment.

There is no intent at present, in Washington or elsewhere, to resolve the federal government's untenable fiscal condition.  The fiscal cliff at the end of 2012 is the last opportunity for our national leaders to accept the necessary short-term pain that will preserve whatever shreds of credibility that U.S. currency and sovereign debts have in the eyes of the world.  Whoever is President in January 2013 can attempt to navigate the country over that cliff and prepare it for the long, hard slog afterwards that leads to a balanced budget.  The alternative is business as usual, which IMHO will postpone fiscal sanity until after a hyperinflationary depression has made further tricks impossible.  That outcome is an event horizon beyond which something unfamiliar to our national character can emerge, to our collective detriment.

Forget the charges of gender wars and missing birth documentation.  Rhetoric doesn't matter.  Reality is unavoidable.  A balanced budget would be as real as it gets for America.

John T. Reed's Super-Awesome Seminar At The Money Show SF

Okay readers, prepare yourselves for the first of several Money Show seminar reports I've been promising you.  This one's about my idol, John T. Reed, and his seminar on what he's learned after several decades of investing in real estate.  I like this guy because his writing is clear, honest, and extremely well-researched.  That is a rare set of qualities in the broad world of financial commentary.

John briefly recapped his career as a property manager, broker, and author.  Much of his introductory views of real estate are a reflection of what he's written in his free articles online and in his book How to Get Started in Real Estate Investment.  One of his best insights is that real estate investors should follow a strategy comparable to private equity investors by purchasing homes to which they can add value for resale (i.e., turning "disasters into fixers").  Leverage is okay if you can get it on your own terms, with no balloon payments, restrictive terms, or unethical options.

I'm a close reader of John's current articles on the financial crisis and other headline events.  I couldn't pass up the chance to ask him about his endorsement of foreign currency holdings.  He has described in detail his efforts to open accounts in banks domiciled outside the United States, so I asked him what he thought about owning foreign currency ETFs in a U.S. brokerage account.  John was skeptical of the concept on the grounds that even if the ETFs in question (the Guggenheim CurrencyShares ETFs) are held in a custodial account in the UK, that country isn't on his preferred list of safe havens.  John has thought through the legal implications of non-U.S. accounts.  If I were to add one more hedge to my own U.S. dollar exposure, I would hold New Zealand dollars in a bank account domiciled in that country.  John courteously provides his readers with the contact info for a New Zealand banker who is willing to work with us oddball Americans.  I will need a foreign bank account or two if those ETFs don't work as advertised.  Guggenheim has announced the closure of two of its currency ETFs, which means their assets can be forcibly distributed to investors.  That doesn't happen when you hold cash in a foreign bank account.

Aspiring real estate investors will benefit from John's checklist-driven approach to managing risk and hedging against adverse actions.  I suspect his methodology is derived at least in part from the checklists he had to navigate as a West Point cadet and U.S. Army officer.  BTW, John, thank you for your military service, from one who currently serves.  You may not need to hear that, but I needed to say it.  I am very interested in pursuing the investment strategies John identified that fall short of outright ownership of managed property, like liens and easements.

I can't do justice to the enormous wealth of knowledge that awaits real estate investors in John's material.  You folks will just have to buy his books and follow his articles.  I have purchased several of John's books myself:
- How to Get Started in Real Estate Investment
- Succeeding
- How to Protect Your Life Savings From Hyperinflation and Depression
- How to Write, Publish, and Sell Your Own How-To Book

I consider those books to be among the most important I have ever read in my life.  I have read them cover to cover several times and highlighted the passages that I use as active references in my financial decisions.  The starter book on real estate gave me some strategies that I'm actively pursuing.  Succeeding is something I wish I had read as a teenager because its points on matching your career to your natural strengths would have saved me a lot of grief many years ago.  The Hyperinflation book is the kind of tome that comes along once in a lifetime and is worth reading if you intend to survive the years of turmoil that have just begun to afflict the U.S. economy.  I have been following John's admonition to "buy everything you need for the rest of your life, right now" since the summer of 2011.  Check out his description of liquid hard assets if you need to start making a shopping list.  I can now ride out several years of product shortages, logistics bottlenecks, and wage-price spirals in the U.S. thanks to John's suggestions.  I still need to find some "junk silver" for my hard asset portfolio.  I really like the self-publishing book but I plan to use it in a different way than what John intended.  You see, the e-publishing revolution means people can buy e-books on impulse for their Kindles and other electronic book readers.  Having an e-book publishing presence IMHO leaves a much lighter burden for the self-publisher by eliminating physical inventory and other headaches.  Hey John, consider writing an updated version of HTWP for the e-book era.

I will disagree with one of John's chapters in Succeeding.  John is a big advocate of marriage and argues that there's someone for everyone.  I simply do not trust anyone enough to want to share my life with another human being.  I cannot afford to waste one more minute of my life with people who treat me poorly or do not want me around.  Some of us were meant to be alone.

I was absolutely thrilled to hear John T. Reed in person and I even praised him to the Money Show lady who was prepping him for a video interview the next day.  I respect this man's diligence and integrity, and that is why I take his writing very seriously.  Please note that he hasn't paid me anything at all to say this, even though his wisdom is priceless.

Full disclosure:  Long positions in FXA and FXC with covered calls; short position in cash-covered puts under FXF.