Printing Money Is Not The Answer
Emanuel Balarie, September 19th, 2008
While the recent fed action and government intervention might initially bring comfort to many people and rally the stock market in the short-term, it is my opinion that this type of market intervention is ultimately disastrous for the economic fabric of our nation. Instead of focusing on the politics surrounding this market, investors should focus more on what they can do to protect themselves from the ultimate outcomes- inflation and a prolonged bear market.
Inflation
Flooding the market with liquidity is simply robbing Peter and paying Paul. Investors who did not participate in the speculative investments of the last several years are now forced to pay as inflation will continue to erode the purchasing power of their savings. Printing money simply means inflation. Can you imagine the effect that the hundreds of billions of dollars that the fed is printing has on your savings? Your retirement? Your kid's education fund? Suffice it to say, purchasing power is declining with every dollar that the Fed decides to print.
What is the ultimate outcome of printing money? Consider the following excerpt from my book, Commodities For Every Portfolio, where I outlined the several reasons for owning gold. One of the reasons, of course, was that gold is an alternative to fiat money.
Unfortunately, fiat currency does not serve as a way to protect your wealth. Fiat currency is money that is backed strictly by the decree (or declaratory fiat) of the government. The U.S. dollar, the Euro, the British Pound, and most paper money in the world today are fiat money. With fiat money, governments have the power and authority to print more money (and increase the supply of money in circulation) as they deem fit.
As you can imagine, governments often have abused their power to print money. Perhaps the most glaring example occurred in Germany in 1923. In the aftermath of World War I, the government attempted to restructure the economy by printing money. The problem was that it kept on printing. The result was hyperinflation, where citizens had to use wheel barrows of money to buy a load of bread. Individuals who once hoped to pass their wealth down to generations were shocked to find out that it could now only buy a loaf of bread.
"'My father was a lawyer,' says Walter Levy, and internationally known German-born oil consultant in New York, ‘and he had taken out an insurance policy in 1903, and every month he had made the payments faithfully. It was a 20 year policy, and when it came due, he cashed it in and bought a single loaf of bread.' The Berlin publisher Leopold Ullstein wrote that an American visitor tipped the family cook one dollar. The family convened, and it was decided that a trust fund should be set up in a Berlin and with the cook as a beneficiary, the bank to administer and invest the dollar."
While this situation was undoubtedly extreme, it still paints the picture of fiat money at work. At any given moment, the government can crank out the printing press, send more money floating around, and quickly erode the purchasing power of your money. With gold, governments don't have this option. Gold is finite, scarce, and quite simply cannot be duplicated by a simple government decree.
As you can tell from the above excerpt, it is eerily similar to our present situation. Will the US and other western economies replicate the situation of Germany? I don't know. I hope not. But what I do know is that the outcome of excess money printing is a devaluation of paper wealth.
Bear Market & Recession
I do not believe government or Fed intervention can quickly correct a problem that has been several years in the making. Additionally, we cannot forget that the actions of the Fed (keeping interest rates so low for such a long period of time and encouraging exotic mortgages) ultimately contributed to this mess. Economies simply go through periods of growth and periods of contractions. Whenever a speculative bubble is created, there will be a correction that will typically be proportional to the longevity of the bubble. History is full of these types of economic examples. It is also my opinion that this present bubble was created with the start of the dot-com bubble. The economy should have undergone a recession after the dot-com collapse, but the real-estate bubble only delayed the inevitable. I wrote about this in January 2006:
"Without question, the real estate bubble has fueled this US economy in the last several years. I am amazed at the amount of times I have heard about a friend or neighbor who decided to refinance their home, get an adjustable rate mortgage, and take cash out for some type of trivial expenditure. Why not? They would argue. I just made a 200k profit this year. This same irrational exuberance reminds me of the "paper millionaires" in the Dotcom era who pointed to their stock portfolio as a means to justify their spending. Although this spending served to fuel the economy, it also served to further fuel this bubble and send your typical consumer further and further into debt. In the future, those that can afford to pay the additional amount on their higher mortgage will have to "tighten their belt" and not spend as much money in the economy. Consequently, they will hold on to their car a couple of years longer, not frequent their local restaurant as often, and cut back on their overall spending. In turn, this will flow into the economy and we will most likely see a much needed recession as individuals refocus on savings and the re-accumulation of wealth.
The Implications of an Upcoming Recession
Generally speaking, a recession is a prolonged period of time where the economy is contracting. During a recession, you will most likely see consumers spending less money and saving more, a subsequent decline in the stock market, a rise in unemployment, and a decline in real estate prices. The idea is that the economy has to have periods of contraction after years of expansions. From 1991 to today our economy has been constantly growing. Some Economists might argue that we did go through a recession in 2001. I disagree. Although we did have some characteristics that were indicative of a recession, we also had some glaring omissions. How can we have a recession that only lasts one quarter, especially after we just came off a major stock market bubble? Why would real estate prices continue to rise in a time of less spending and more saving? In either case, the recession that is to come will be a multi year recession that will serve to slow down this economy that has been wildly expanding over the last decade and a half."
I want to apologize for posting excerpts from my commentary that is a couple of years old. However, I feel that my analysis and outlook towards the markets have not changed. If anything, I think it is interesting to see how things have turned out. So while the current market volatility is uncomfortable for many gold and commodity bulls, it is important to remember that the current government intervention is simply "putting lipstick on a pig". We must first pay go through a prolonged recession before we can continue on the path of prosperity.
In my last couple postings I have written about managed futures, an asset that can be a valuable tool in adding portfolio diversification, potentially reducing overall volatility and potentially achieving a higher performance than traditional investment portfolios. This past week, Barron's ran a cover story( Retirement: Safety First) in which they asked risk experts- Barton Briggs, Peter Bernstein, Charles Ellis, David Darst, and Jeremy Siegel -what they would do to "keep your nest egg from cracking in a shaky markets. Among other things, David Darst mentioned an allocation to the managed futures funds.
"Within an alternative-investment portfolio, Darst recommends a 50% weighting in hedge funds, which gives investors the potential to benefit from talented money managers who have the freedom to invest where and how they see fit, without constraint.
Some 20% should be in real assets, such as commodities and gold. Both provide a hedge against inflation, and gold in particular has been a historic refuge in times of turmoil in the financial markets, political instability, or other crises.
Another 20% should be directed to managed-futures funds, Darst says. These invest by going long or short futures contracts in a broad basket of commodities and other investments, including metals, grains, sugar, foreign currencies, stocks and bonds.
Managed-futures funds provide a cushion to portfolios in down markets, because they typically are inversely related to the stock market, Darst says.
During the period 2000 to 2002, when the tech bubble burst and the Standard & Poor's 500 cratered 31%, the Barclay CTA Index of Managed Futures Funds was up 20%. In the fourth quarter of 1987, when the U.S. stock market crashed and the S&P 500 lost 22.5%, the Barclay index was up 13.8%. This year through August, the S&P 500 was down 14%, while the Barclay index was up 6.95%." You can read the full Barron's article here.
If you are interested in finding out more about managed futures and would like to receive a free educational brochure, please request one through Balarie Capital Management. You can also request free access to BCM's CTA database.
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. THERE IS SIGNIFICANT RISK OF LOSS WHEN TRADING FUTURES AND OPTIONS. ALWAYS REVIEW A DISCLOSURE DOCUMENT BEFORE INVESTING IN ANY MANAGED FUTURES PROGRAM.
