This Youtube video, made by Guardian Films, has been around for awhile. It shows the suffering in Zimbabwe. But it shows that when fiat money fails, gold –that barbarous relic — becomes currency.
hyperinflation
Wine as currency
During difficult economic times, it is often the case that hoarding becomes illegal. It is punishable by severe fines. In Weimar Germany a law was even passed against gluttony. Today, the USA faces a serious threat of hyperinflation. During hyperinflation, paper money becomes worthless and unhelpful in exchange. Therefore, people resort to bartering goods and services. Bartering is a form of commerce that is frowned upon by government because it can’t be taxed. If I fix your plumbing and you fix my roof in exchange, each of us spending three hours to do it, we’ve exchange services but there is no money, no paper trail, and no receipt. Two normally taxable events are reduced to zero tax. So a doctor treats a lawyer’s son and the lawyer draws up the doctor’s will. Neither reports the activity to the government and no money passes hands. It is just a friendly transaction in an underground economy.
I believe that hyperinflation is an inevitability in the US, and unfortunately here in Canada, there is going to be high inflation. In such times, it is useful to build up a store of silver or gold. But personally, I’ve decided to store up something that I could potentially barter. I have been making wine from concentrated juice, grape juice and from grapes since 2004. My wines are pretty good; I’d say the equivalent of at least a $10 CDN per bottle at our local provincially control liquor stores (called the LCBO-the Liquor Control Board of Ontario). Wine is a controlled substance, and so I am not allowed to sell my product without a license. But when times are desperate, and money is worth nothing, I figure that I should be able to barter bottles of wine for food or other goods and services that I might need.
So I’ve decided to stock up on wine kits. These kits are $70 for two at Costco, or $45 for one at my local supplier. Each kit contains concentrated juice that will make 30 bottles. I know that the juice remains usable for at least two years maybe more. Once made into wine, the wine can be aged another two years. It is not certain how long the wine will last after that. So my minimum cost base will be $1.17 per bottle plus my labor (which isn’t worth anything). If I buy 10 kits at Costco at a price of $300, I’ll be able to hoard 300 bottles of wine in reserve. This would give me $3000 worth worth of goods with which to barter, and the product itself has an indefinite shelf life. I estimate that it would be about the same as buying two one-ounce coins of gold, at a cost of $300 CDN.
The great thing about alcoholic beverages is that they do not lose their “currency” in times of depression. Indeed, people feel the need to celebrate or to drown their sorrows even more during economic hardship than during the good times. If the economic crisis never comes to Canada, well I can consume my product or give it away as gifts. Or if the crisis comes and I am unable to barter the product, my wife and I could consume the wine for the calories and it will stave off starvation for a moment.
Deflation or hyperinflation, an investment for both at the same time
During the market crash that began in June 2008 and ended in March of 2009, the TSX lost 50% of its peak value; the US indexes (cf. S&P 500; NASDAQ) experienced similar losses. Other asset classes such as gold and the loonie suffered similar losses against the mighty US dollar, as investors took a flight to “safety”. Arguably this was a period of deflation, when most asset classes plummeted in value while the US dollar itself benefited. It was also deflation caused by a shrinkage of credit, the sub-prime mortgage meltdown, which had the effect of reducing the quantity of money.
Since the beginning of this deflationary crisis, the US Federal Reserve has taken measures to reflate the US dollar through quantitative easing–which is the creation of new fiat currency. Yesterday, Bernanke’s Federal Reserve promised to create another 600 billion greenbacks out of thin air, a spelling out of a promise that occurred already a couple weeks ago, causing the dollar to dive against gold, oil and foreign currencies. This is probably only the beginning of the woes. Some writers, such as Gonzalo Lira (see e.g., “How The Fed Gave Away $1.5 Trillion Through Stealth Monetization“), are predicting serious hyperinflation beginning in the first quarter of the new year.
Yet surprisingly, there remains a large number experts who believe that our biggest fear today is still deflation. David Rosenberg issued another warning which appeared at the Business Insider on November 1: “All This Talk Of Inflation Is Madness, DEFLATION Is Still The Big Threat“.
Clearly the investor needs a flexible strategy that hedges against inflation and deflation at the same time. I personally believe that inflation is the way its going to go down; it is possible to create too much money and the Federal Reserve in its fear of another Great Depression is creating money to prevent it. In my view, it does nothing helpful except to reduce debt by debasing the dollar. All my life inflation has been the major threat and I’ve seen the dollar lose buying power consistently through the decades. So I don’t really believe in deflation, particularly when Bernake has the creation of inflation as his goal. He has no power to improve the economy, but he can destroy the dollar.
Yet because of Rosenberg’s (et al.) warning, I think it prudent to have a plan for deflation. But how does an investor have a working strategy to beat inflation and deflation at the same time? I’m not leaving my money in cash–that’s what you do when you believe that deflation is the only credible threat. If you believe that inflation is the only credible threat, then you put everything into concrete assets like oil companies or real estate. Debt is a marvelous asset class–provided that the debt is invested in a rental real estate (a mortgage) or dividend bearing stocks so that the interest can be paid. So in fighting inflation I’m doing the following:
INFLATION
1. I maintain mortgage debt on a rental property.
2. I maintain a stock portfolio which is 100% invested in Canadian oil and gas or gold-mining companies.
3. I maintain a positive Canadian cash balance and negative US dollar balance in my margin accounts. As a Canadian investor, my total margin is calculated as a composite of the Canadian and US accounts. I may hold Canadian equities in my US account.
4. I occasionally move assets from US dollar account into Canadian funds.
DEFLATION
In order to protect against deflation:
1. I maintain ample margins in my margin accounts.
2. I have my lines of credit which protect against a margin call. In case of a Rosenberg-predicted double dip, I have to have something to fall back on, and that’s where the HELOCs come in (both on the rental property and on the primary residence). Yesterday, I was able to obtain 30% increase in these lines.
3. I will take profits on gains and increase cash positions as market improves (in loonies not greenbacks).
4. In case of market depression, I will use the unused lines of credit to average down on equities.
In many cases, after the 2008 crash, I was able to pick up stocks at well below shareholder’s equity. For example, I was picking up shares of Midway Energy, which had a book value of $3.40, as low as $0.39, which is an astounding .115 price to book ratio. In market downturns, the stocks will be oversold, and bargains will be available. Thus, at least half of the lines of credit must be reserved for purpose of averaging down during a market crash. The other half, of course, is reserved to meet a margin call. No debt or obligation (such as a possible assignment on put option) is covered by the margin alone but by cash or an outside line of credit as well.
This is an unconventional strategy. But these are not conventional times. Most of the investment strategies that I’ve seen continue to call for a balanced portfolio–balanced between stocks and fixed income investments (bonds, savings accounts, treasury notes, gics, etc.). Those who were burned by stocks twice in less than a decade are now being told to ease back into “risky” assets because of the fear of inflation (see for example, Rob Carrick). But I worry that most financial columnists and advisers are not taking the risk of hyperinflation seriously enough, and their readers or clients will be burnt as a result.
Please see my financial disclaimer.
Pecans: a sign of coming hyperinflation
The US and other western countries including Canada, have devalued and are intentionally devaluing their currencies in a vain attempt to remain competitive in the world market.
China is now buying up pecans, about a quarter the North American production, causing the price to shoot up by about 50%. The Globe and Mail reports:
China bought about 100 million pounds (45 million kg) of pecans in 2009. That was about one quarter of the total pecan crop in the U.S. and Mexico, the world’s largest producers. And it compares with less than 5 million pounds roughly five years ago. The strong demand has sent prices for some pecan varieties soaring to $6.50 (U.S.) a pound, from $4.25 in January, according to Mr. Zedan.
Imagine when China raises the value of yuan against the dollar. When that happens all commodities will shoot up in price as there will be suddenly a billion consumers with significantly increased buying power. Meanwhile, forget about those pecan and chocolate cookies we used to eat as kids. That will become a luxury item. Food is skyrocketing in price and the Federal Reserve calls this “deflation”.
What if we made nuts the bellweather of inflation? They are certainly a better indicator than the CPI.
The Chief Export of the United States: the US dollar
A few days ago I had a discussion with Andrew regarding whether money is a commodity. I tended to think of it as an intermediary which made trade possible. It is far more efficient to trade in dollars than it is to determine what the price of oil should be in corn, iron ore, oranges or rubber. Therefore, as a store of intermediary value, the trade between trades, money is not really a commodity–i.e., it is not the goal of trade but the vehicle or means to achieving the goal. So I trade my labor for dollars, and then, my dollars for goods, and so forth.
While reading, “It’s the Money, Stupid: Papering over our economic problems” by Jeffrey Bell and Sean Fieler, it dawned on me something that had puzzled me for many years. I wondered how the United States has been able to maintain 30-year trade deficit with other countries. Bell and Fiehler argue that a paper money system, rather than being able to better smooth out downturns in the debt-based business cycle, has become debt itself:
… there is no viable way to maintain the Fed’s current role as guarantor of short-term financial stability and still reform the paper money system so as to remove its tendency toward the unsustainable accumulation of debt. For the paper money system that the Fed manages not only encourages debt, the system is debt.
They continue:
The self-perpetuating feature that has kept this perverse system alive is the dollar’s position as the world’s reserve currency. Before the dollar assumed this role between the two world wars, gold—something of independent value and no particular country’s liability—was used to settle international payments between central banks and composed their primary reserve asset. But with the dollar performing those functions, its oversupply has often been absorbed abroad. So Bernanke and his predecessors in the paper-dollar era have been able to print a lot of new dollars, over time inevitably driving down the global value of the dollar, without necessarily generating domestic inflation. That is the enabler of, among other things, relatively painless federal budget deficits. For a red-ink-hemorrhaging Greece or California, the specter of default is always on or near the table. For Bernanke and Congress, colossal deficits are just another day at the office.
Clearly, then, the US is able to maintain the trade deficit because the dollar itself has become sought after international intermediary of trade, not only between US citizens within the borders of the United States, but between citizens of diverse countries trading commodities in dollars on international markets. The dollar has thus been a useful product. Furthermore, many countries have vast reserves of US currency and some private citizens living in countries such Russia and Argentina, hold vast sums of US dollars. So I have finally to suggest that Andrew was right and that we can see money as a sought after commodity in and of itself. It is a commodity that facilitates trade and makes it possible to quantify, albeit in relative terms, the market prices of diverse currencies and commodities, as well as thousands of products. The dollar has therefore made the trade deficit possible because the Federal Reserve has had the unique advantage of creating new money as the world’s needs grew. Countries like China and Japan have trade surpluses with the United States and have built up huge dollar reserves which they can now use to buy supplies or invest. The dollar itself has been the chief export, and so therefore, there has never been a real “trade deficit”, but rather, a willingness of trading partners to accept the greenback itself in exchange for the goods that they were peddling. The US has obviously been the winner in this trade since the cost of creating dollars is minimal, especially as compared to the real goods that have been traded from abroad.
Clearly, this is a unique and privileged position that the US dollar enjoys. It is however not carved in stone that the international community will always trade in dollars. The Federal Reserve is squandering this status, because it is determined to keep the US afloat by creating trillions of dollars more. But like any commodity of which there is an oversupply, the value of the dollar will plummet, and then its usefulness as an intermediary of trade will disappear. At that point the privileged status of the dollar as the chief export of the United States will be lost and there will no longer be a “trade deficit”. When that happens, goods from other countries will be difficult to obtain, and hyperinflation in the United States will be the inevitable result.
The Righteous Investor 