Wealthology

by Akinaw Bulcha

  I also predict our government will make it very difficult, if not impossible to move money abroad. Remember that inflation is the government‘s secret weapon in paying for its expenses. It‘s a secret way of confiscating the wealth of its citizens without their knowledge. But confiscating private wealth is difficult to do if money flees Squirrelmerica‘s borders—money must remain within our borders in order to be taxed.

  This is a major reason why people (baby boomers especially) need to invest in foreign stocks. If people are thinking of retiring comfortably overseas, now‘s the time to do it. They shouldn‘t wait for inflation to devalue the dollar and make living abroad more expensive. We‘d be losing in two ways by waiting: Foreign currencies will be rising while our dollar continues to depreciate.

  By the way, I decided to elaborate a little more on this point in order to show that my approach to forecasting is deductive, that one idea builds on another.

  5. The inflation rate in the U.S. is around 8%. What‘s the secondary effect? Based on this fact, we know that investors who put their money in CDs (certificates of deposit) with a local bank earning a rate of 4% lose 4% per year. People think savings accounts, CDs or long term U.S. treasuries or bonds are safe ways to preserve money. It isn‘t true! They are in fact some of the riskiest investments we can make. People lose anywhere from 2 to 6% every year depending on which of these ―safe‖ options they go with and how much interest each pays.

  There‘s another interesting fact we need to be aware of about government sponsored inflation. This fact explains why inflation is always at least double the official government figures. Even if the inflation rate was 0%, Americans would still be paying an inflation tax.

  Here‘s my reasoning: In free markets, most prices fall year over year (I‘m assuming about 1 to 4% per year). Prices are kept from falling because our government finances its debt by printing money, which in turn, increases costs.

  The government isn‘t just taxing us on the upside (the inflation we do see) but also on the downside (on the deflation/savings we miss out on). Unless we know the natural rate of deflation, we can‘t really calculate the real rate of theft (inflation).

  Inflation is the reason dual income American families today don‘t enjoy the same quality of life single earner families did in prior generations.

  6. More cars are being sold in China than in the United States. What‘s the effect? China is currently the largest car market in the world and growing. What does that mean? It means that China‘s industrialization in general will continue to grow at a rapid pace. As hundreds of millions of Chinese peasants join the middle class, China‘s energy needs will skyrocket. As this economic behemoth wakes up and starts to eat, oil prices will continue to climb. I predict that within a year or two, oil prices will go above $100/barrel.

  China is the largest importer of Saudi Arabian oil, that trend will grow.

  China is expecting prices to rise—they must know something since they recently purchased a Canadian oil company this year at a price that requires a $90/barrel price point for them to be profitable. These are just the beginning signs of a surge in oil prices.

  7. The value of the dollar will depreciate against other currencies. What‘s the effect? This is also a fact of life. As developing economies continue to outpace the growth of the U.S. market, the price of their currencies will rise much faster than ours. As we experience low growth, other nations will grow faster. Some of the secondary effects of this fact are:

  (a) The price of all imports will go up in cost because each dollar will be worth less.

  (b) Foreigners (and Americans who invested in foreign equities) will be able to buy U.S. assets much cheaper than before.

  (c) More foreigners will be able to vacation in the U.S.

  (d) Less Americans will be able to vacation abroad.

  8. The worldwide debt crisis will continue and intensify. What‘s the secondary effect? This is also a fact. Recently, the Greek debt crisis caused a massive selloff of Europe‘s currency—the Euro. Ironically, Greece is a very small economy—too small for investors to get worked up about. What they‘re really concerned with is that the debt virus will spread to other countries that use the Euro.

  However, investors are ignoring the U.S. debt situation which is far worse than what‘s happening in Europe. California, for example, is much bigger than Greece—it‘s the 8th or 9thlargest economy in the world and it‘s on the brink of defaulting on its debts. California‘s not alone.

  Just today I read that the city of Harrisburg (the capital of the state of Pennsylvania) might declare bankruptcy. The city missed its May interest payment of about $450,000. There are many cities, counties and states in worse shape than Harrisburg.

  What does this fact indicate? A first thing this fact suggests is that investors will demand higher interest payments to invest in city, state or county bonds. During the Greek debt crisis, the interest investors demanded to lend Greece money skyrocketed to as much as 20%.

  In the same way, interest charges will rise for states and cities all across the country, thereby increasing taxes and reducing benefits. Investing in state and municipal bonds was once considered a safe bet.

  A second thing we can expect is a dramatic rise in gold prices. When people go for safety, they go for gold. Gold was naturally selected by free people and free markets as the currency of choice because it retained its value. If people had a choice, they‘d always opt for gold—natural money.

  Now as the debt crisis grows in the U.S., more people will seek safety in gold and gold prices will rise to about 1600 an ounce within 12-18 months.

  9. The Federal Government is offering an $8,000 tax credit for new homeowners and $6,500 for existing homeowners. What‘s the secondary effect? The unseen effect is a major tax on non-homeowners and homeowners that have purchased their homes before the credit was available. Renters all across the country should be very upset at this ―bribe buyers out of the recession‖ scheme. Once again, as is the norm in the U.S., poor people are subsidizing wealthier folks (those who can afford a home).

  A privilege for one group of people is always a liability for another because the government has no money. By its very nature, it can‘t give us anything we don‘t already have.

  10. China"s savings rate is 45%. What‘s the secondary effect?

  Such a high savings rate affects different parts of the Chinese economy. Let‘s just look at how it affects their real estate market. There has been speculation that a real estate bubble has formed in China. As I flip between three of my favorite financial networks CNBC, Bloomberg and CNBCW, I‘ll inevitably come across a fund manager who‘s worried about a possible real estate bubble in China.

  I disagree that there‘s a bubble but even if there is, it won‘t be a problem for one reason: Their high savings rate creates a buffer against the consequences of bubbles. A bubble usually forms when everyone is buying on credit. Savings provide economic stability. With so much cash in the bank, Chinese homebuyers are not overleveraged. The Chinese authorities also require homebuyers to put up a cash down payment of between 20 and 50% in order to buy a home.

  Property appreciation in China doesn‘t depend solely on the availability of debt (credit). It also depends on the availability of cash. So there‘s no bubble.

  “I"ve found that when the market"s going down and you buy funds wisely, at some point in the future you will be happy.” ~Peter Lynch.

  Can Anyone Be an Economist? Kidus, I‘ve been accused of having economic ideas that are ―too neat and tidy‖ or ―impossibly deductive.‖ Some financial professionals think that telling people they can manage their own money is irresponsible because the financial markets are complex. But I‘m a populist to the core, a supreme optimist in people‘s ability to achieve what they want if they have the time and energy to put in a little work.

  Obviously, the more complicated the investment, the more facts we need to take into consideration; but if you‘ve listened to anything I‘ve said so f
ar, we should run away from any investment a 12 year old can‘t understand.

  For general investing purposes, and if people have the time, anyone can become a master money mechanic. It may take some time to learn all the parts of the investment vehicle we want to drive, but, it‘s worth the investment. Independent investors can learn how to do it themselves if they have time to do a little homework.

  Even if we don‘t have enough time to actively manage our own money, we still need to know enough to decide whom to trust with our money. We squirrels have to do our best to protect our nuts. After all, brokers are not required by law to act in the best financial interests of their clients.

  So let‘s assume we decide to manage our own money and choose to use the ―neat and tidy‖ system of ideas presented here. In the long term, these ideas will benefit us.

  However, short term market movements may seem to contradict our long term investment strategy. But just because something unexpected happens doesn‘t mean the world of economics isn‘t rational. Logic always retains its force and sooner or later people do come to their senses.

  Warren Buffett‘s mentor, Benjamin Graham, once said that in the short term, the market is a voting machine, but in the long term, it‘s a weighing machine. Longer term predictions are always the safest, and, if they‘re based on sound ideas, eventually they‘ll come true.

  Remember that thinking like a good economist is thinking about longer term effects. Another way to say it is that time is always on the side of a good bet if we can count the cards in the dealer‘s hand.

  Buffett once said that time is always the enemy of a bad business but a friend of a good one. Time may not always feel like a friend. During his 2008 presidential campaign Ron Paul was laughed at. But all his predictions are coming true. Back in 2006, when Peter Schiff predicted almost every facet of the economic collapse (and even wrote a book about it) people thought he was crazy. They laughed at him; but he‘s got the last laugh.

  Remember that unexpected or impossible things occur only in the short term; don‘t worry if you hit a rough patch. Keep studying the thoughts of Austrian economists, commentators and writers. Aristotle once said, ―It‘s possible that the impossible happens.‖ I‘d add that ―it‘s possible that the impossible happens but not for long‖!

  Markets do crazy things like buy up long term U.S. debt—but foolish acts will eventually produce disastrous consequences. Time always tells and its hand cannot be stopped. Either time is working for us or against us.

  We know, for example, that time is working against U.S. fiscal solvency because, even by the government‘s projections (which are always understated), the federal budget deficit will reach $23 trillion dollars by 2019. Some economists have said that the debt can‘t be paid back. That $23 trillion doesn‘t take into account about $70 trillion of unfunded liabilities for Social Security, Medicare and other government programs.

  America‘s growing debt resulted in a steady decline in the value of the dollar; investors made a rational decision to invest somewhere where they could better preserve their wealth. As the dollar is steadily declining to levels our ―neat and tidy‖ philosophy is predicting, an unexpected thing occurs—a Euro selloff is sparked by Greek debt problems. Money that was in the Euro starts to flow back to the U.S. and thereby temporarily increases the price of the dollar beyond its real worth.

  Does this Euro debt crisis or any other crisis change the fact the U.S. is broke? Of course not! In fact we even have short term reasons to believe that holding U.S. treasuries is a bad idea: Credit agencies have been threatening to downgrade the government‘s AAA rating. In short, think about the long term and the short term will make sense. There are no surprises.

  Conclusion These examples show us how to think about economic activity. The financial result of being able to interpret market activity is that when something (anything) happens in the marketplace, that activity becomes an opportunity.

  Of course, we can‘t predict everything with certainty but we can become one of the best predictors in the market by simply using these ideas: (a) What I‘ve called, ―Newtonian method‖ or economic literacy; (b) by sticking with what we know; (c) by experimenting; (d) by following the leaders and, of course, (e) learning from history and mastering luck. Embrace your inner Newton!

  Your Loving Uncle, Akinaw.

  The One Thing You Must Understand

  Dear Kidus, For the last 12 years, something strange has been happening in Orange County, CA. For an unknown reason, residents have witnessed an epidemic of ugly babies being born to the most beautiful women in the world. Doctors were surprised at the frequency of these births. No one knew what was going on. Scientists feared pregnant women were being infected by Asiatic bacteria carried to the O.C. coast in ocean currents.

  Then a researcher at U.C. Irvine found a gas emitting mineral deposit found only in Orange County. Was this the culprit? After further studies, they found that the gas was harmless. So what happened?

  Researchers found that the only other O.C. epidemic on record was a sharp rise in the number of women getting plastic surgery. That craze had begun a little over 12 years ago. It turns out that the ugly baby epidemic was just the result of the false advertising plastic surgery had made available.

  Okay, so the story isn‘t true. I‘m simply advising you it‘s possible to mistakenly marry a bad investment without knowing it. The ugly baby that marriage produces tells you something is wrong.

  Great Expectations The U.S. economy has gone through lots of cosmetic surgeries, allowing it to distort what it really looks like. Understanding what things are really worth takes a little study but it will be worth it. It will save us a lot of heartache in the years to come.

  Most financial mistakes occur because we don"t know what things are really worth when we"re at the altar saying our wedding vows. About 90% of investors falsely believe they know how to value assets. The reason some prices stay irrationally high or low for long periods of time is because enough buyers are acting on false premises.

  Knowing how to value an asset is something every investor must understand extremely well. Real estate investors generally use comparable sales to determine the price of a property but that has obvious limits—there‘s a boom and bust every five years in real estate. That means that comparable sales in up markets will tell us values are higher but those same comparables will tell us prices are lower in down markets. Appraisers just state the obvious, there‘s no real rationale behind their valuations.

  We need a better method of understanding what things are really worth. Comparable sales or our expectations of future value can disappoint us.

  During the run up of real estate prices, I remember how everyone just expected prices to keep going up without ever giving a rational reason for that belief. Real estate was bought and sold on the dogmatic idea that prices just keep going up.

  A lot of people bought into that idea and as a result, have lost their homes, their jobs and their trophy O.C. wives. A great deal of hurt, pain, confusion and anxiety can be avoided by doing some homework (this year alone, there will be 3 million foreclosure filings). If ever there was a time to understand how to value an asset, it is now! Both the banker and homebuyers need to understand this most important skill.

  An investor‘s job is one thing and one thing only: To accurately judge the true value of an asset or an investment. In other words, ―value investing‖ is the only investment methodology that we can use. Warren Buffett has been called a value investor. But there‘s no other way to invest.

  Judging the true value of an asset or investment is made difficult by our Plastic Surgeon in Chief—the Federal Reserve System.

  “I conceive that the great part of the miseries of mankind are brought upon them by false estimates they have made of the value of things.” ~Benjamin Franklin.

  For What it’s Worth

  I took a break from work last night to surf the web for financial news and watched an interview about whether real estate prices
were still overvalued1. The economist being interviewed made some interesting comments on things other than real estate. He said that if we had bought anything in 1982 (bonds, real estate, stocks, etc.), we would‘ve done very well on those investments (we‘ll see why in a minute).

  When the discussion shifted to the arena of politics, he said that ―the Austrians‖ (people with common sense economic views) are gaining popularity even though they have a history of being wrong about economic matters.

  1 http://www.huffingtonpost.com/2010/06/30/barry-ritholtz-housing-pr_n_631190.html Now, I don‘t know what he‘s been smoking to say Austrians have a history of being wrong. Marijuana‘s legal in some states now so maybe he‘s smoking some really good stuff. After all, it‘s easy enough to go on YouTube.com and watch some of the recent predictions from the very mouths of Austrian economists like Peter Schiff he disagrees with. They‘ve been right on just about everything.

  You don‘t need to take my word for it, of course; and you don‘t have to scour the web to find their predictions. Other people have edited and compiled them for you. To see these predictions yourself, search, ―Ron Paul and Peter Schiff were right‖ or ―Peter Schiff Was Right‖ on YouTube.

  Secondly, the reason any investment in 1982 would have done well (as he pointed out) is best explained by the very Austrian economists he mentions have a history of being wrong.

  The reason all asset prices have gone up since 1982 is because credit has increasingly grown since that time. The graph below shows that interest rates have trended lower and lower since about 1982.

  So how does this explain the huge rise of all investments since 1982? Well, if interest rates are lowered, credit is made more available and people go shopping and everything seems to be worth more as a result. People use the available credit to buy up bonds, real estate, stocks, big cars, big homes, bigger lips, slimmer hips and of course, the bling bling. In other words, because more credit is available to more people, they all jointly bid up prices of all assets.