I.O.U.S.A.

I.O.U.S.A. is a very good documentary, but it is somewhat dated as it was done in 2007. So take all the horror and double it to understand where we are today. Remember that in just a few short years the horror will grow even worse.

Rate Free Risk

It is generally regarded that short-term government bonds define what the risk-free rate is. In fact as the wags point out, what we have right now is rate free risk.

As I have been pointing out, the risk of increasing interest rates is a lot higher than is commonly understood. As the following chart points out, it is not just that interest rates are low. It is not just that interest rates are very low. Interest rates are as low as they have ever been in history.



A simple road map to successful investment. What is not well understood by the average person is the effect of rising interest rates on investment values. Let’s say that the rate of return on an investment in real estate is 5%, maybe the storage units that Eddie mentioned in the comments recently. If the risk-free rate goes from the current 1% to 3% then the rate of return demanded by potential buyers on your storage units will go up. That means that the price has to go down. Let’s say the new rate of return is 7%. Assuming your rents and your vacancy rates stay the same, that means a decline in market value of almost 30% in what you can get if you decide to sell your property. If your down payment was 20%, well ...

This does not necessarily mean you should not buy. But if you do you need a fixed rate over the full term of your commercial loan so you can hold the property until your loan is paid off. Or you need to pay cash for your rental storage units. If you purchase a REIT, a real estate investment trust, you need to make sure the REIT has no debt or has a good fixed rate of interest on any loan it might have.

Remember that rising interest rates reduce the value of all investments, including stocks.

I do not think I am going out on a limb by saying that interest rates will go up. My guess is that interest rates will drop some more before they rise. It will be a bumpy ride. Prepare as best you can.

This Is Not Capitalism

I remember a story from my philosophy professor in college. He mentioned one of his socialist professors who refused to call the Soviet Union a socialist nation. His reasoning was that he disagreed with the Soviet Union, therefore it could not be socialist. This is a form of the no true Scotsman fallacy.

While I want to avoid this error, I hope you can agree with me that this is not capitalism.

In a survey of 60 central bankers this month by Central Banking Publications and Royal Bank of Scotland Group Plc, 23 percent said they own shares or plan to buy them. The Bank of Japan, holder of the second-biggest reserves, said April 4 it will more than double investments in equity exchange-traded funds to 3.5 trillion yen ($35.2 billion) by 2014. The Bank of Israel bought stocks for the first time last year while the Swiss National Bank and the Czech National Bank have boosted their holdings to at least 10 percent of reserves

If one cannot trust the government measures of GDP or inflation or economic growth how can one invest? In this case if the government is buying stocks, how can you trust the stock prices? If the government is buying bonds and house mortgages then you can't trust their price either. All market prices are of little value as signals for investment. In this situation investment is impossible. One can only be forced to speculate. But first, get out of debt. I am personally in this stage. The current sucker's rally gives us all a little breathing room. Use that time wisely.

GDP Mess

As you probably did not notice the government is changing how it calculates GDP. There have always been some anomalies in GDP. When one of my friends married his nanny, GDP went down by the amount of the salary that he no longer paid. But is it a coincidence that the changes that are being made will increase GDP? Was it a coincidence that the changes that were made to the calculation of CPI made twice over the last 30 years decreased the stated inflation rate? I will leave the answer to you to supply.

If you are interested in the details of this change you can watch this rant from Peter Schiff.

Yogi Berra Was Right

The debate among the "hard money" types about the near future cannot be settled. It is like Yogi Berra said, "It is difficult to make predictions, especially about the future." 

How can one predict with certainty how a future president or Federal Reserve Chairman will act? 

Peter Schiff thinks that they will print money, and then print some more, and then some more. He may be right. Mish Shedlock thinks that they will not do so because this would be stupid and it may not even be possible. John Mauldin thinks that there will be a crisis, but good ol’ American knowhow will prevail. I have no idea and this is the reason I have been talking about the impossibility of making investments. The reason I do not think that Schiff is right is that I cannot see the "powers that be" doing something so against their own self interest as hyperinflation. My thinking is to combine all these viewpoints. Yes, there will be inflation, but it will not be hyperinflation. Yes, there will be a partial repudiation, not of the US debts, but the Social Security and Medicare promises—especially Medicare. There is really no choice. 

Here is an argument between Mauldin and Schiff at the Cambridge House conference I attended in February. I saw it live and it was a lot of fun!