When Is Capital Preservation Not Enough?

Pundit Bill Bonner’s article about our growing government debt grabbed my attention.

“…. When it comes to government debt, the borrower never pays; the feds have no money. The lenders – big banks, investment funds, well-heeled insiders – don’t want to pay.

Generally, they collude with the feds to make sure the real cost is put on innocent third parties – taxpayers and consumers.”

Governments pass the real cost to taxpayers and consumers by creating high inflation. Mr. Bonner lives in Argentina. At the end of February, the official annual inflation rate jumped to 51.3% per year. He estimates it is over 100%.

The next article I picked up quoted Fed Chairman Powell:

“Powell called out the need for the Fed and other central banks to find better ways to deal with pervasive low inflation, and said…it ought to pay serious attention to strategies that would drive inflation higher….” (my emphasis)

That is government lingo, meaning pass the cost of government debt to taxpayers and consumers by devaluing the dollar.

The highest inflation for baby boomers came during the Carter years.

Inflationdata.com provides the inflation data:

The inflation calculator tells us the accumulated inflation was 59.9%.

Investments held in US dollars lost 40% of their buying power. Baby boomers (1946-1964) were still working and could offset some of that loss through wage increases. Today they are retiring at a rate of 10,000 per day.

More Carter type inflation could decimate the life savings of the entire baby boomer generation.

It’s time to go to our inflation expert, Chuck Butler, editor of the Daily Pfennig.

DENNIS: Chuck, readers really appreciate you taking your time for our benefit.

Retirees want to minimize risk with their life savings. When the government sold taxpayers on bank bailouts, low-interest rates were supposed to be temporary. A decade later a 10-year CD pays 3% and probably won’t keep up with inflation.

My parents never recovered from the Carter years. Prices skyrocketed and their income didn’t. If the fed chairman gets his wish and inflation escalates, baby boomers could face some serious problems.

How do boomers balance their need for current income, and protect themselves against inflation at the same time?

CHUCK: Thanks, Dennis. Well, I’ve been preaching this for many years. When I started preaching the Dead Sea wasn’t even sick!

An investor must have a diversified portfolio. By doing so, they reduce the overall risk to their investments. A correct diversification includes an allocation of physical Gold (Or Silver) and a combo of foreign currencies.

Harry Markowitz developed Modern Portfolio Theory. He was the first person to prove that by diversifying one’s investments with different asset classes, you reduce the overall risk of the portfolio. That includes keeping ahead of inflation, protecting the real buying power of your money. I’ve long followed Markowitz. In all of my conference presentations, I made it a point to give credit to Markowitz’s Modern Portfolio Theory.

DENNIS: Let’s start with gold. Hugo Salinas Price tracks the transition from gold back dollars to Federal Reserve Promises in his article, “The Road Ahead for the Dollar”:

“Consider the following table:

  • 1776 to Dec. 1913: Price of gold $20.67/ oz. = 20.67 silver dollars.
  • 1914 to 1933: Price of gold $20.67/ oz. = $20.67 Federal Reserve (FR) dollars.
  • 1934 to 1971: Price of gold $35.00/ oz. = $35.00 FR dollars.
  • 1971 to 2019: Price of gold rises from $35/ oz. to $1300/ oz. = $1300.00 FR dollars.

…. This explains why the Fed dollar is now worth only 0.000769 oz. of gold.”

During the Carter years, gold prices rose higher than inflation.

While gold has offset inflation, retirees also need income. How does an investor hedge their bets and still earn some income?

CHUCK: When interest rates around the world were normal, and not kept low to support stock markets – investing in currencies, usually garnered some additional interest – along with any currency gains that were available. Today, with the exception of Russia and Brazil, there’s very little in interest on currency deposits.

I know you hold some stocks offshore denominated in foreign currency that pays dividends, so that is another alternative. Today we are focusing on the currency itself.

When we look at currencies during the high inflation years, 1976 to 1981…we can see how foreign currencies helped offset the loss of buying power of the US dollar.

I’ll use Swiss francs and Japanese yen. In 1971, very few currencies (no euros at the time) were considered major currencies, which is why I selected francs and yen for illustration. Let’s compare their gains for that period of time VS the dollar. I converted the European price style to American price style, so it’s easier to deal with.

On 1/1/76 the Swiss franc was worth, around 40-cents…on 12/31/81 the franc was worth around 55-cents. When you take it out a couple decimal places, the franc gained 36.8% versus the dollar.

On 1/1/76 the Japanese yen was worth around .0034 cents…. On 12/31/81 the yen was worth around .0045 cents; a 33.3% gain versus the dollar.

Owning these two currencies during the Carter years would have offset much of the loss of buying power in the dollar holdings.

Looking at a longer time period, from 1/1/71-12/31/81, the cumulative rate of US dollar inflation was 138.3%. The Swiss franc gained 243% and the Japanese yen gained 227% versus the dollar.

DENNIS: Wow, it was more than just the Carter years! No wonder my parents struggled.

I want to use your Carter years data to show readers the effect on buying power of the “taxpayers and consumers”.

Let’s assume you had four safety deposit boxes. One contained $100,000 US dollars. The other three contained the equivalent dollar amount denominated in Swiss francs, Japanese yen, and gold. How did the buying power change over the five-year period?

At 12/31/81 you still had your original $100,000. You could sell your gold for $295,539, Swiss francs for $136,879, and yen for $133,439.

What happened to the buying power of the dollar? Assume on 1/1/76 your favorite Buick cost $20,000. Five years, that same new vehicle, (assuming they raised prices at the inflation rate) would cost $31,984.

Five years later:

While the yen or franc didn’t totally keep up with US dollar inflation, they sure outperformed the US dollar.

Chuck, as you tell our readers, currency is sold in pairs. If the dollar goes down in value, another will rise. There are so many to choose from today. What criteria would you use today when selecting currencies for inflation protection?

CHUCK: I tell people that the way to value a currency is to treat it like the “stock of a country”. You use a set of criteria to value a stock before buying it right? Apply your criteria to a country to see if their “stock/currency” is worthy of owning

I use the following criteria:

  1. Does the country have a good balance sheet?
  2. Does the country pay yield/interest?
  3. Does the country have something other countries want?
  4. Does the country have strong leadership/Central Bank?

Using those criteria, I come up with a handful of currencies that make sense to me to own.

Today, I feel that Russian rubles, Swiss francs, euros, Aussie, kiwi, Canadian dollars, along with Norwegian krone are worthy of owning.

Another consideration is that countries that produce oil will also gain when the price of oil rises, due to inflation. I call these countries the “Petrol Currencies” and include: Russian rubles, Norwegian krone, Brazilian real, and Canadian dollars, and to a lesser extent, Mexican pesos, and U.K. sterling.

DENNIS: Thanks again for your time. One final question.

We are regularly warning readers about inflation. I feel it is not a matter of “if” but “when?”

I was frightened a few years ago when speaker Pelosi floated the idea of requiring IRAs and 401k programs to hold “safe” government debt. Much like FDR confiscated gold, the government could soon follow by deflating the value of the currency.

Inflation hedges are like fire insurance. The catastrophic damage could be terrible. The Carter years fire was bad enough.

What do you say to brokers and financial advisors who laugh and minimize those concerns?

CHUCK: Thanks again for the opportunity….

I tell them that they need to go back to school, learn real economics, and study Modern Portfolio Theory…. I learned my economics from some of the greatest economic minds of our time, and I just wish everyone would have had the opportunities like I had in that regard.

I’m a Baby boomer and I worry that many people are not adequately protected against inflation which is why I continue to write the Daily Pfennig. People need to be protected.

Dennis here. When the Fed chair is calling for inflation, that should be a warning to all. Unlike the 1970s, many baby boomers are no longer working. The catastrophic consequences of inflation are scary.