In the midst of the financial crisis in late 2008 I recall feeling like things in the world would never again be the same. I remember wondering if the money printing called Quantitative Easing by the Federal Reserve Bank would cause even the average working person to reject currency as being suitable compensation for their work. Who, I wondered, would accept that green paper anymore and what would that mean for our society? The likelihood of a widespread loss of confidence seemed increasingly possible with each round of money printing, which to me represented a deep threat to our social fabric inasmuch as the government was alerting its citizens that the exchange rate for their time and effort, along with their hard-earned savings, could be devalued on a whim at their discretion.
Then, as I pondered that thought, I realized that this catastrophic situation could not happen. In the end, no matter how terrible or harmful the actions of government, the large majority of citizens would just take the blow, turn the other cheek, move on with their lives and make the necessary adjustments – accepting a degraded quality of life without any thought of revolt. In a society where faith in currency is lost entirely, the ugliness of anarchy is too painful for anyone to even contemplate. Rejecting currency would not be in anyone’s interest, not the richest and most powerful nor the poorest and most fragile within a society. So, even in the face of gross governmental mismanagement (see Venezuela or Brazil as prime recent examples, or Germany pre-WWII as a historic one), the currency, however debased, will remain the primary means of exchanging goods and services.
So, what is the value of this insight that the world will not end, no matter how bleak things may look? The value is that when we plan our investment strategy, we can assess the world’s most troubling situations – the one’s which if they were not resolved could indeed end the world – and we can ask ourselves the question: what must occur to resolve this? And we can know that this is what will happen and then plan our investments accordingly. I am certain that this “World Will Not End” philosophy has been at the core of the investment strategies of the best investor of our time – Mr. Warren Buffett. He consistently proclaimed his deep faith in the long-term success of the U.S. and has always invested accordingly. What I’ve come to realize since 2009 is that what he really believes in is not American greatness, but that the “borrow and spend” economy of the U.S. will naturally lead to continual currency debasement, which will be highly rewarding to those investors who take long-term, leveraged bets on long duration and stable assets, all of which will do very well when measured against the currency that is being debased. Mr. Buffett correctly bets on the incompetence and corruption of government and the concurrent willingness of the masses to play along and see their lives and worth continually degraded. That the rich will get richer and the rest poorer, is the necessary by-product of this process. The world will not end because no one wants it to, and once you accept that, you can plan accordingly.
Today’s investment climate is historically challenging, with stocks and other assets continuing to make all-time highs and yields available to investors very low. Since the 2008 Great Recession, when stocks fell off a cliff, the S&P 500 index has climbed remarkably. An investor who overcame fear, sensed opportunity and invested in January of 2009 and held through the spring of 2017 would have earned a 15.39% annualized return, including the reinvestment of dividends[1]. Even an investor who mistakenly bought just before the crash in January of 2007, near the pre-Great Recession highs, and held on rather than panic and sell would have earned an annualized return of 7.42%, including the reinvestment of dividends[2]. The question on many people’s minds has been – Why are stocks so highly valued in a time when the global economy seems to be stalled? Global economic growth is very low and has been throughout these past years as measured against any other post-recession recovery. While the headline unemployment number is indeed low, it does not accurately portray the weak status of employment inasmuch as wages have been completely stalled and the labor participation rate (those of working age who are employed) remains stuck at historically low numbers, indicating that many have given up trying to find work. Clearly, technology has played a significant and negative role in suppressing wages and diminishing employment opportunities. Forecasts of robots replacing as many as 50% of all jobs in the coming decades portends a frightening continuation of this trend.
I posit that the surging valuations of stocks during this period, along with those of other financial and real assets such as real estate, all bonds, leveraged loans, etc., have very little to do with the resurgence of the economy and say very little positive about circumstances. Instead, the significantly increased valuations have much more, if not entirely to do with the fact that we are measuring these things in dollars in the U.S. and in other fiat currencies elsewhere. But for many, following the narrative of the mainstream economists, who feed their pabulum through to us via the media and politicians, this makes no sense. Hasn’t the dollar been on a tear during this time too? Isn’t it very highly valued today? Well, as measured by its value relative to other, even weaker fiat currencies like the Euro, the Yen, the Yuan, and the Sterling, it is. But, which Americans are busy exchanging their dollars for those other pieces of paper? Practically none, if you reside in the U.S. and do your spending in dollars. The only exchange rates you ought to be focused upon is the exchange rate between dollars and the things you consume, and between dollars and other stores of wealth. When measured that way, the dollar has been crushed[3].
For example, rather than say the S&P 500 is up by 176% since January 2009, one might more correctly say that my 2009 dollar can only buy me 36% the same amount of stock that it used to back in 2009. The dollar that you may have saved in the bank when you were hunkering down in 2009 with justifiable fear that the world may end as you know it and you couldn’t be sure where the next dollar might come from, has now been devalued against stocks by 64%. Your relative wealth, if you were a saver of dollars, which surely seemed like the safe thing to be in 2009, has been decimated. And, the same is true for residents of other countries, who chose to invest in currency.
Yes, cash is an investment and it can gain and lose value just like any other investment. This is a novel thought for those who treasure liquidity. Cash is the king of liquidity and most people hold it without even considering that it is an investment whose value fluctuates with significant volatility and mostly always declines. In fact, cash may very well be the single worst investment of all time. Why is this, you may ask? The answer has to do with politics – where politicians make promises in order to get elected, then must borrow in order to fulfill those promises and get re-elected. The resulting debts, however, don’t belong to the politicians, but instead to us – the citizens. Government borrows in our name, using our collective credit, in order to bribe us for votes. This process, which has been going on forever, results in a need to manufacture inflation, which is just another way of saying that the currency must decline in value in order to right-size for the deficit spending that the world has become addicted to. This situation is one that insures that cash loses its value over time and that, after too many such cycles, as the debts amassed have grown to be too large and borrowing capacity has become constrained, future generations will have a poorer quality of life than their predecessors. With debt levels at all-time highs by any measure and having accelerated at unprecedented rates that has outstripped inflation’s ability to adjust, it is safe to say we have arrived at an interesting inflection point.
Where will we go from here, and what does this mean for investment markets? Will today’s asset valuation peak end in ruins as is predicted almost daily by the many pundits and economists who have their heads buried in regression analyses and are unable or unwilling to consider that today’s bubble is a bit different from past ones? It is entirely possible, and perhaps even probable, that there will be a correction. So much about markets is driven by emotion and herd mentality, so to discount the possibility that high valuations themselves create selling, which magnifies naturally as prices correct, would be silly. Also, it is reasonable to assume that the academicians who run our economy from Washington, D.C., and who have little real world or market experience, will react incorrectly to market downturns and could easily take initial actions that might exacerbate things. However, I believe the long-term trend will continue to point UPWARD for financial asset values and, concurrently, DOWNWARD for fiat currencies, or in other words cash. My brother Joe recently read about a situation with a state police and fire pension fund that has enough money to cover its pension liabilities for two more years, after which it will run out of money entirely. He asked me what I thought would happen, and I put on my “World Won’t End” hat and told him that the federal government will print money and send it to this pension fund. I explained that these retired firefighters and police, many of whom depend upon receiving a pension in order to survive, cannot be left penniless – starving and homeless. He replied that many pension funds in the U.S. are in similarly perilous situations, which to me only meant that even more money would need to be printed and shipped out to support people. What choice will government have? In this world, with debt levels at historic highs and even greater unfunded pension liabilities, continued and even more committed efforts at currency devaluation is a certainty, and thus asset values when measured against a continually weaker currency must climb. Cash has always been a terrible investment in every country, and with debt levels where they are today the decline in the value of cash is poised to be significant.
[1] The annualized return of the S&P 500 Total Return Index from 1/28/2009 to 5/31/2017 according to data accessed from Yahoo Finance.
[2] The annualized return of the S&P 500 Total Return Index from 1/31/2007 to 5/31/2017 according to data accessed from Yahoo Finance.
[3] This argument doesn’t apply to all things that dollars buy, which also are influenced by other variables such as supply/demand and increased efficiency in the cost of production – including gasoline, automobiles, cell phones, and low-end food products.
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