Focus on what is real not what is reified

Kevin Graham, who was recently featured at the Globe & Mail, continues to write about DIY investing at his blog.  Recently, he wrote against oil investing, “Five reasons that oil prices will fail“.   While I agree with some of what he says, I am the sort of investor that he would criticize (and he has done so on this blog).  All of my investments are in oil & gas companies or gold and gold mining companies.  But I am not sure what else to do in the current investment environment.

So I wrote a comment (edited below), that I had the hardest time swallowing this one line from Graham:

“Commodity prices do not reflect reality.”

I don’t disagree that commodities could be in a bubble per se–that could be the case, and the recent rise in the oil price might see a pull back. Rather, I am bemused because it assumes that our current financial markets have anything at all to do with reality. You and I are in fundamental disagreement about fiat currency. Considering that fiat currency is a derivative and has no intrinsic value, it is curious that you could determine value of a commodity based on its nominal dollar value. This is what philosophers call reification. You are trying to determine the value of a concrete object (a commodity) on the basis of an abstraction (the value of the dollar).

In this light, Jim Grant told the story of a letter to the editor of the Financial Times, in which the author said that he finally understands what Quantitative easing is, but now he isn’t clear on what money is anymore.

Commodities are real. Money is not. When high/hyperinflation hits, I will be focussing on what is real, as fiat money will no longer represent anything of value. That is to say, my spam collection, my hoard of wine kits, and my unused toilet paper have intrinsic value, but the dollar, not so much. Commodity prices do not reflect reality, because money itself is not real. When money is debased, it is better to have something that is real than a derivative of a symbol of the collective worth of an insolvent nation.

Do you need an emergency fund? Reflexions on what to do in a high inflation, low interest environment

Tyler and Claire require $85,000 to renovate their house but started saving late and now want some advice.  So the Globe and Mail enlisted the services of TD Waterhouse investment advisor, Eric Davis.  The first thing, he says, is to establish an emergency fund:

Before they begin their renovations, though, Tyler and Claire should build up an emergency fund of anywhere from $15,000 to $30,000, which could be held in a tax-free savings account, he adds.

The standard wisdom today coming from financial advisors is that everybody needs to have an emergency fund.  Usually this consists of up to as much two-years worth of living expenses to tide one over in case of illness, unexpected expenses such as car or home repairs, or loss of a job.  All is good.  Save for rainy day?  Seems like pretty sound advice, right?

But in my mind, it isn’t sound advice in all circumstances.  Why?  Because the spread between the savings interest rates and mortgage rates is usually about 3-5 %.  So you can get 1% interest in your savings account; but you pay 4% on your mortgage.  Why not make an extraordinary payment on the mortgage, and save 3% in the meantime?  The problem is one of liquidity.  The money one uses to pay down a house is illiquid and you can’t access it in an emergency.  So that is why I recommend instead to get a line of credit, preferably a home equity line of credit (HELOC) because they have the lowest interest rate.  As you pay down the house, the bank will increase the HELOC.  Now use the HELOC only for emergencies and any excess cash can pay down the mortgage, saving you 3% interest in the meantime.  Interest earned is taxable, except of course in the TFSA (Canadian Tax Free Savings Account).  The government gets its cut.  Interest saved is not taxable.  So the home owner makes a double win.

I think it is necessary to be extremely wary of the advice from financial advisors because they don’t work for you.  Do you ever wonder why your advisor will make a trip to your house and spend a couple hours working out a financial plan?  Who pays them?  Our broker from Scotia McLeod did that; and Scotia McLeod earned full standard commissions from us: that means 2% or an $80 minimum per transaction.  One time he wanted me to put a stop loss on RSI.un (Rogers Sugar) saying that I’d made some nice gains, I should try to lock them in.  Well I didn’t want to do it because Rogers was paying a tidy dividend every month.  He insisted and finally talked me into it.  When all was said and done, the stop loss evacuated the stock at a $30 dollar after-commission loss to me, my broker got is his fat fee for selling it, and I lost a source of income.  I wanted the long term position for the dividend, but the financial industry made money churning my position.  Today, RSI has continued to pay (now monthly) and it is trading at 25% higher than my stop loss.  I would have won if I held it for the last six years which was my intention.  But the industry doesn’t make any money when you hold, only when you churn.  This incident is one of the reasons that I become a DIY investor.

Eric Davis would probably offer the couple a TFSA account at an anaemic rate of interest at TD Bank. Such a savings account will help the bank, for banks crave savings accounts, needing of capital these days.  But the inflation rate is greater than the interest rate by at least 2 basis points, and so now Tyler and Claire will lose 2% buying power on every dollar in their TFSA; if hyperinflation hits, and in my mind that is certain, then they could lose double digits or higher–food prices are going up like crazy, I know, I do most of the shopping in my family.  But TD Bank wins.  They will use Tyler’s and Claire’s capital earn  money by lending it to someone else at at 4-5%.  They don’t have to worry about inflation because it is not their principal.  The principal belongs to Tyler and Claire!

I think that its better to pay down the mortgage and make your bank hold your available credit in reserve.  Make them hold the money for you rather than the other way around.  If you need it, you’ll pay a little more than the mortgage rate (my HELOC is at 3% compared to my variable rate mortage at 2.1%), but in the meantime, it has reduced your debt, saving you money.

The taxman says, “Heads I win, tails you lose”: On the unfairness of capital gains tax

The following video shows why capital gains taxes are unfair.  The taxman measures capital gains in nominal inflatable dollars.  Inflation robs the investor of gains, but it still looks like a gain. Thus, the investor gets killed by inflation then by capital gains tax and could be left with less than what he had before.  Thus, government robs the investor through inflation or through capital gains taxes: pick your poison.

I notice that the government has its hands out in the good times like 2009-10 when my stocks were going up. But this year, when things are going down, what help or reimbursement do they plan to give me?  Actually nothing.  And you wonder why I hate government?

A Canadian explanation of global monetary policy

One of my kitties decided to stay out all night, and consequently I had trouble sleeping and found myself wide awake in the wee hours of the AM.  So I turned to Market Watch and Bloomberg News to see the latest.  First I turn to John Markman of Market Watch who claims that Timothy (I-forgot-that-I-had-to-pay-taxes) Geitner has cooked up a scheme that will save Europe (Geithner’s plus-sized euro bailout is stealth QE3).  :

The plan, cooked up by U.S. Treasury Secretary Tim Geithner, is to persuade European leaders to vastly expand the size of the emergency bailout fund known as the EFSF, or European Financial Stability Facility. His proposal, and I’m not making this up, would use leverage — i.e., borrowing — to increase the size of the already borrowed money in the fund by up to 10x. … snip

This is a little hard to believe, but it’s the truth. The funds from euro-zone countries in the EFSF have already been borrowed. And now the plan espoused by Geithner is to use that money as collateral to borrow as much as ten times more. The guy does not get enough credit for his evil genius.

Where is Geitner going to get this money?  Apparently, if I understand correctly, from the Federal Reserve Bank.  So Bloomberg says (Euro Crisis Makes Fed Lender of Only Resort),

The ECB said Sept. 15 it will coordinate with the Fed and other central banks to provide three-month dollar loans to banks to ensure they have enough of the currency through the end of the year. The Fed bears no foreign-exchange or credit risk on the swap lines because the Frankfurt-based ECB is its counterparty.

So let’s get this straight:  The Federal Reserve will lend money to the Europeans.  This money will come from where?  It will become a new line on Fed balance sheet and will thus increase the adjusted money base.  This has become known as quantitative easing.  The money won’t be printed, and so nobody will see wheel barrows cash in the market places of Europe as they did in the Weimar Republic.  No, it will just be line in a balance book, electronically created from nothing at all (see Niall Ferguson, The Ascent of Money, 30-31, quoted in this post).

Now the best explanation of global monetary policy is in Corner Gas, season 3, episode 1, which is actually an allegory of banking in our times:  Oscar has made some bad bets in his stock picking game with Hank, who is beating him hands down.  They each started with $10,000 of fictional money, but Oscar’s picks have gone South.  But he’s seen the news about Ark Research’s insider trading, and he believes that knowledge will help him defeat Hank.  He decides to bet big on Ark Research, but he is in desperate need of liquidity.  So Oscar (a.k.a., the European banks) goes to his son Brent (i.e., the Federal Reserve Bank) and asks for $10,000 from his fictional money tree.  Brent says, Why can’t you do it yourself?  Did a fictional hooligan steal your make-believe ladder?  No, Oscar says, that would be against the rules.  Without rules nothing makes sense, he claims.  With rules, this makes no sense, Brent responds.  The monetary policy part of the clip begins at 0:39.  (@7:08 Oscar explains that he lost all the money and he can’t pay Brent back, and that is exactly how the loan to Europe is gonna go down).