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   During the 1970’s there was a significant increase in inflation in the US and the UK which made interest rates rise, thus damaging long term bonds. Gold’s price rose during the 1970’s and was the best asset during that era. Stocks spent the inflationary era of 1966 to 1982 going down 50% and then their prices returned to their starting points after a 16 year bear market, so on a nominal price return basis investors made no gains, however they did get dividends.
Could this time be different where yields are repressed by central banks and not allowed to rise in tandem with inflation? There was a precedent for that in the UK in the 1970’s the real rate of interest was deeply negative instead of being allowed to float up in tandem with inflation. However that was during the rule by the Labour party with currency controls, etc. so that era can’t be compared to modern era of economic freedom, despite today’s era of central bank manipulation.

   Dr. Lacy Hunt, who used to be an economist at the Fed, has repeatedly said that excessive debt acts to suppress consumption and growth, thus dampening inflation. My opinion is that there is an era, a huge generational tidal wave, where EM country workers continue to export low cost goods into Developed countries, causing underemployment and thus disinflation in the U.S. Couple that with excessive debt and it seems likely that inflation will be suppressed. Japan and the EU have been unsuccessful in trying to create inflation in their countries, so this may also happen in the U.S.
If stocks are now high priced at roughly double fair value then they are not a place to protect from inflation, since they need to drop in price 50% to reach fair value. Short term bonds might work the best since the bond market may respond to rising inflation by making the yield on new issues higher so as to reflect rising inflation. However, if the central banks wanted to, they could force rates to be artificially low.
If central banks create artificially low yields then insurance companies, annuities, pensions will all become disfunctional and these institutions could lobby Congress to rein in the Fed. The Fed was created in 1913 to solve and prevent banking crisis. Yet now central banks that have negative yields are creating a new systemic crash risk as they undermine banks and insurance companies with negative yields. At some point Congress may put a stop to this. Nothing lasts forever, eventually central banking’s wrong-headed policies of negative yields and QE will be discredited and the negative yield policies will stop. When people see that QE and low rates mainly helped wealthy stock market investors then the political winds will shift and central banks may become the whipping boy, used as a distraction by politicians. If leftists get elected the tax increases they will institute will be deflationary; if aggressive deficit spending goes out of fashion then there will be less stimulus and thus less inflation.
While waiting for this to stop, what should investors do to protect themselves: diversify into precious metals, which can sometimes go up even during deflation if there is a climate of panic. Avoid risky investments such as average quality stocks. Beware that chasing after dividend yield while losing 50% of the value of one’s stocks is not something that you should seek to do. Avoid junk bonds and instead focus on quality investment grade bonds. Avoid bonds that can be refinanced as you will then lose your bonds with good yields and have to reinvest at lower yields if rates keep dropping. Muni bonds when newly issued often have a 10 year call protection and Treasuries usually can’t be called at all. Commodities may not be a safe haven against inflation if there is also a secular demographic tide of less use of them and a secular economic trend of an ever more efficient, cheaper cost to extract commodities. If society becomes poorer as result of having too much debt then society will have to reduce consumption of commodities and thus I don’t expect a repeat of the 1970’s inflation. The 1970’s inflation was mainly caused by labor markets and a lack globalization. That era has no comparison with the modern era of ruthless U.S. employers destroying union shop jobs and shipping work out to the rural south or offshore. A new era of even cheaper imported goods will occur as the U.S. discourages imports from China then factories will move to cheaper frontier markets like Burma or Ethiopia. As foreign currencies weaken even more against the dollar this will trigger recession in EM countries resulting in even more subsidized make-work export industries exporting cheaper goods to the U.S.
The big future problem for the globe is not inflation but rather it is the disinflationary risk of excess debt, excessive global export competition, along with a demographic tide of lower population growth that is a source of a global low growth economy. Assuming China’s era of high growth is over then global economy will enter an era of lower growth, yet the world has far higher debts than that of 20 years ago.
Investors need independent financial advice about the risks of inflation and the risks of a deflationary stock crash.

The post Will Bonds Perform the Same as in the 1970’s Inflation Era? appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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   The headline new employment rose 224,000 last month, far in excess of the 171,000 three month average. The global economy is reducing its economic activity, so the increase in domestic jobs looks suspicious. Half the jobs gain came from the hypothetical birth-death model. Employment growth in five months from actual data from companies (not from the birth-death model) has been zero. Multiple job holders increased 301,000, if not for them, the jobs number would have been negative. Almost 60% of Household survey employment growth was from self-employed people. So these could be starving rookie independent contractor sales reps, not people with real jobs. The age 25-55 prime aged sector only increased by 29,000 last month and for the past half year it decreased by 168,000.

    The ECRI research company uses a comprehensive coincident Employment index which has fallen to its worse level in 6 years.

   The number of people unemployed dropped by 400,000 since December and the number employed dropped by 200,000. The bottom line is 200,000 less people are working since December. That’s 0.13% less employment or annualized it is 0.26% less. Adding in the population increase that implies employment needs to grow 100,000 a month to keep up with the population (600,000 new jobs needed in a half year) thus the job market is even weaker than the headline suggests. We are missing jobs for the 200,000 reduced number of people working and the 600,000 of new jobs needed for the population increase which is a total of 800,000 needed just to avoid making the percentage of unemployed worse (annualized that’s 1.6million, which is roughly 1.1% of the working population who are worse off).

    The six month Moving Average of  employment (per the Establishment Survey) recently topped out in June, 2018 dropping from 240k to 175k. It had an ever bigger top out in Feb., 2015, thus implying a downward trend for the past four years.
I expect rising unemployment which leads to higher bond prices (lower yields), and which leads to increased gold prices as a fear of QE stimulus and anger at low yields will provoke investors to buy gold. Investors need independent financial advice about the risks of a reversal in the labor market leading to a recession.

The post Surprise Jobs Increase is Misleading appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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   Looking 30 years ahead the growing federal deficit as forecast by a Congressional agency implies the U.S. will become a Banana republic with high interest rates and an unaffordable gigantic budget deficit.
Since people may become alert to this and take steps ahead of time to overcome the problem then I expect the following things to occur:
* Defense spending greatly reduced, resulting in less global stability and greater flight capital into the US and similar countries. The increased flight capital puts downward pressure on interest rates.
* Social Security starting age raised to 72, forcing more workers to delay their retirement, creating a surplus of job seekers, which is deflationary.
* Medicare and Medicaid spending reduced through new laws busting up medical oligopolies and manipulative pricing, thus cutting costs. This is very deflationary, as health care employees with sharply reduced income will have to reduce consumption.
* People respond to the excessive debt and higher taxes (tax increases are deflationary) by reverting to a 1950’s lifestyle where families lived in a 1,000 square foot home instead of the current 2,500 square feet, thus cutting costs, fossil fuel use, and consumption of goods stored in homes, further contributing to a disinflationary climate.
* Higher taxes on the affluent will act to dampen consumption, thus reducing inflation.
* Some of the current high debt balances in the private sector will vanish in a puff of smoke during the next recession as it is “easy” for corporate debtors to file bankruptcy and erase debt. Of course, it is not really “easy” since they would lose everything. This would contribute to a disinflationary climate. Employees seeking to job-hop to pursue a pay raise wouldn’t be able to do so, thus dampening wage inflation, which is the key to suppressing inflation. New corporations with low debts would arise from the ashes of the failed debtor companies and make “job” offers to unemployed low paid Gig economy workers to work as independent contractors.

 

   In the inflationary 1970’s it seemed interest rate and inflation kept rising to ever-higher levels with no hope of a solution. Eventually the Federal Reserve acted to stop it and fortunately Congress and the President didn’t interfere and the program worked. The oil crisis of 1973 and 1979 was scary and at times it seemed hopeless but eventually new solutions were designed and now the U.S. exports oil.  I believe that the U.S. won’t degenerate into a hopelessly indebted Banana republic.

  Interest rates were kept very low by the UK after the 1815 Napoleonic war until 60 years, and even 80 years later, so rates can be amazingly low for an entire lifetime. Investors need independent financial advice about the risks of a debt crisis.

 

The post Will The U.S. Become a Bankrupt Banana Republic? appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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    In the 1997-2007 mortgage housing bubble the enablers of the bubble tried to rationalize using the Gaussian Copula theory that a Mortgage Backed Security holding mortgages from different states would act diversify the risk of a default. But that rationale was wrong because it was assumed that the successful borrowers would offset the damage caused by the losers. Instead the winners, who are borrowers, are not obligated to bail out the loser or to pay extra to the lender to make up for the loss caused by the defaulting borrower, so the “diversification” was bogus.
A similar phenomenon is happening where financial experts assume the central banks can bail out the economy by cutting rates deeply. The problem is rates would have to be cut to negative 3% or even negative 5%. This would mean that insurance companies who need to charge a 2% margin would have to charge their clients 7% (meaning the client would need to pay 7% or “earn” a negative 7% rate!), in an economy where negative 5% yields are normal. This would be such a problem for the clients of insurance companies and banks so that it could cause a massive cancellation of insurance contracts, severely damaging the insurance industry and damaging clients who need insurance. A client who gave up insurance and then suffered a catastrophe would be impoverished. Consumers who are retired would become despondent if their savings account yield went down to negative 5%. From the view of retired consumers and those people who are thinking ahead about future retirement, the effect of QE’s low rates was deflationary (the opposite of what was intended), as it took purchasing power away from retirees holding bonds and savings accounts.
These problems would create a depression, besides destroying the banking and insurance industry, so an attempt to cure a recession by imposing negative interest rates would make things worse. This means that Federal Reserve tools of cutting rates won’t work in the next recession and thus they are going to be trapped in a Japan-style soft depression.
Bernanke claims Quantitative Easing cut rates by 0.5%, but that doesn’t prove it made the economy better. Stocks went up a lot since the start of QE3 in October, 2012 because of low interest rates, but the real economy of corporate earnings was flat from 2012 to present, except for the benefit of the 2017 corporate tax cut.
Cutting rates only fools some of the people (the ones with modest intellect and discipline who soon run out of money). Cutting rates doesn’t fool the captains of industry who are needed to authorize a massive capital outlay by giant corporations. Rate cutting gave the appearance of working during mild recessions of 1945-1979 era because the U.S. economy had tremendous tailwinds from the post-war prosperity before other countries healed from war and competed away this prosperity. The economy would have improved without rate cuts during the economically strong era of 1945-1979. The rate cuts of 2001 to 2003 weren’t as important as the tax cuts.
If the Federal Reserve cuts rates by 0.75%, in three 0.25% increments, during late 2019, that won’t much difference since the borrowers still have to pay principal payments and they will get a smaller tax deduction if interest rates are lower. Cutting the rate 0.75% on a $20,000 car loan saves $12.50 interest a month, hardly enough to motivate a buyer.
Investors need independent financial advice about the risks of being fooled by rate cuts.

The post Complex Theories May Confuse You About The Stock Market’s Hidden Risk appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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    It seems a many financial advisors and financial commentators are making an increasing amount of negative comments about the U.S. dollar and U.S. Treasuries. I disagree with them. I remember the 1970’s when there were many scary headlines about the end of Bretton Woods monetary agreement, Watergate, Nixon’s resignation, the U.S. defeat in Vietnam, the two OPEC oil shortages of 1973 and 1979 that severely damaged the economy, and the US embassy hostage situation in 1979 in Iran, etc.
The dollar went down in value and the economy performed poorly while inflation increased dramatically in the 1970’s. Gold went up from $43 in August, 1971 to a peak of $880 in January, 1980. The inflation-adjusted price return of the Dow Jones average was a decline of 73% from 1965 to 1982 (the nominal price return was negative 15%, about 1% a year). It seemed at times like the end of the world was coming with so much bad news.
Then things greatly improved: the dollar DXY index (after it had a Bretton Woods high of 108 in 1971) went up from a low of 84 in 1979 to 128 in 1984, 20% better than the old Bretton Woods number. Who could have imagined such an increase after the Bretton Woods treaty abrogation?
Gold dropped from $880 to the $400 range in 1984 and stayed there for 15 years before dropping to $250 in 1999.
The current climate of negativity seems incorrect because currently the U.S. economy and dollar are much stronger than in the 1970’s. I’m bearish about stocks because Price-Earnings ratios and similar ratios are too high, but I’m not bearish on the overall economy such as GDP, or employment, etc. Being bearish about stocks doesn’t mean one should be required to be bearish about the dollar.
The reason some are bearish about the dollar is because the nation’s debt load is at record highs and is rising unsustainably, assuming nothing is done to change course. However, on a relative basis, we are better off than the other major regions or nations such as Japan, China, EU, UK. The U.S. has a greater contingent capacity to reduce deficits by privatizing roads, raising taxes, and trimming defense spending than other countries, thus closing the budget deficit. The debt or monetary problems of the EU, Japan and China are far worse than our problems; also we have a better opportunity to recruit skilled immigrants who can add to the tax base.

       Things were much worse in the 1970’s until Volcker’s Federal Reserve tightened in October, 1979.
I anticipate that the EU may disintegrate and China’s debt load and lack of productivity will get worse; meanwhile Japan has not found a solution to its excessive debts and money printing. The U.S. is highly likely to be the last man standing at a drinking party and is the least dirty shirt in the dirty clothes hamper. Central banks are at risk of losing credibility and power if they continue to pursue negative rate policies. Then they could reduce their activism. This could result in a pattern similar to the 1930’s when central banks did nothing to help stimulate the economy.
Since stocks are grossly overpriced (they need to drop about 50% from the peak of 2954 for the SP) then a global weakening of central banks would be deflationary and would contribute to downward pressure on stock prices.

  What may happen is that China may devalue their currency thus inciting Japan and the EU to engage in competitive devaluations, thus making the dollar go higher. In turn this would make it harder for EM borrowers to repay dollar- based loans thus imposing a deflationary outcome onto EM nations.
Investors need independent financial advice about the risks of mistakenly being bearish about the dollar.

The post Negativity About the U.S. Dollar Is Wrong appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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    The Employment report was released by the BLS today showing only 75,000 new jobs created, less than the 100,000 a month needed to keep up with population growth. Thus, on a relative population-adjusted basis, employment shrank by 25,000 jobs. Based on employment to population percentages before the GFC of 2008, the hidden unemployed are roughly 1.0% to 1.5% of the workforce, thus the unemployment rate is close to 5% instead of the official 3.6%.
Many workers are labeled by the BLS as employed even though they have a speculative, high risk self-employment occupation with almost no income or they may have a waiter’s “job” with a $2.50 an hour minimum wage.
The inverted yield curve of bond yields implies a recession is coming in December this year. A downtrend in employment implies the cycle has topped out. The excessively long cycle is so old it seems unlikely to continue.
Bond yields plummeted sharply the past six trading days with the 2 year Treasury Note yield as low as 1.776% today at the low of the day; it was 2.99% at the one year high in 11-9-18. The marketplace is saying that they are taking back half of the Fed’s 2015 to 2018 rate increases.

   The trade dispute with China, in theory, could help those U.S. workers who have the lowest amount of job skills, except in reality those lost jobs that went to China will simply migrate to other EM countries like Vietnam or Ethiopia and thus there won’t be a net employment gain for U.S. workers. The fundamental problem of the era is that blue-collar jobs migrate to low-wage EM countries, leaving our U.S. blue collar workers underemployed. Not everyone is capable of going to college and becoming an engineer or a salesperson when they lose a manufacturing job. Some who lost jobs will become discouraged and refrain from job seeking and become the hidden unemployed. If traditional blue-collar jobs are lost by Developed countries by factories moving to EM countries then deflationary symptoms will appear, thus the Invisible Hand of the marketplace will make bond yields drop to bizarrely low levels.
The deflationary symptoms legitimately result in very low bond yields which then cause investors to incorrectly react in anger and seek out higher “yields” in bogus types of “yield” such as writing put options that are disguised by Wall Street as an exotic high yield investment like “reverse convertible bonds”. In Korea there is a huge demand for a form of this called “auto-callable” securities which basically are put options where the premium from writing a put option makes the naive investor think he’s getting yield, but it is not yield, it is a form of (insufficient) compensation for taking on speculative risk; by contrast, an investment grade bond is supposed to have minimal risk so a bond’s yield is truly yield. See this FT article about “auto-callable” securities.
The global financial markets are trapped in a feedback loop where low bond yields encourage reckless use of speculative trades like writing put options or buying junk bonds, etc. This, in turn, makes it more feasible for stock speculators to take on excessive risk, thus creating a stock bubble. Hungry investors get careless with their cash and send it to Venture Capitalists who fund goofy experimental tech companies that lose money and who run up huge tabs for ads on Google, Facebook, etc., thus stimulating some areas of the economy even while the Venture Capital investor loses money.
Naïve stock investors think Fed rate cuts will boost stocks. They won’t; when the economy heads into recession rate cuts are not a strong enough medicine to rescue the economy or stocks, especially if stocks are ridiculously overpriced, as there now are. During the huge rate cuts of 2007-08 stocks kept crashing down 55%; the cure for the crash was that eventually prices got too low and had to go up, plus in March, 2009 Congress changed the accounting profession’s rules for banks allowing them to avoid marking failed loans to market and thus banks were permitted to make misleading statements about their failed assets.
Investors need independent financial advice about the risks of misunderstanding the employment report.

The post Employment Market Weakens, Recession Coming Soon appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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     Economist Mohamed El Erian wrote that inflation may increase once cost cuts from the gig economy (Uber, Amazon, etc.) have been maxed out and the supply of unemployed people dries up, and corporations get more oligopolistic.
I disagree, I believe: The dominant paradigm of the era is cheap EM labor undermining Developed countries resulting in unemployment, foreclosures, low growth in Developed countries. This force is far more powerful than the inflationary force suggested by Mohamed El-Erian. The fundamentals of EM countries are export subsidies, and excess production funded by local banks under political orders to loan money to companies that are not financially sound, so as to create make-work jobs, etc.
Ironically as the trade dispute with China acts to move jobs from China to smaller EM countries that will increase the forces of disinflation as work is shifted to poorer, hungrier small countries. Undermining China’s debt-laden economy could result in China going into a depression and since the world is used to China as the engine of global growth then a flip over to China being the engine of a more intense version of Japan-style soft-depression could result in greatly disinflationary forces in the global economy.
In another decade the paradigm of the cheap labor benefit of EM countries will be replaced with a new global paradigm in which what matters are quality, complicated, sophisticated goods and services, with excellent consumer rights, made in Developed countries by well educated workers. Since there is a shortage of credentialled workers who are high quality college graduates, then the new secular era a decade away would be less disinflationary than the past 19 years. This would be even more true if the deflationary overhang of the monetary and fiscal errors of Japan and the EU with their huge negative rate debts, etc. could somehow be fixed and they could return to normal.
For the near term investors should avoid overpriced stocks and real estate and focus on bonds as a haven from the next big stock crash. Thus in the near term a crash would be disinflationary. No one knows if the central bank pump priming to be done to get out of the next recession will create inflation (probably not). Thus investors will have to be vigilant against the risks of inflation and be ready to move quickly to liquidate bonds if the evidence accumulates that inflation is coming back. I believe it is difficult for central banks to create inflation by a simple fiat command, instead it takes fundamentals like a massive surge of growth and a forgetting of depression psychology as in the start of the 1965-81 inflation paradigm. The fundamentals of the global economy are that Japan hasn’t fully recovered from their disinflation from the crash of 29 years ago, China is overdue for a big debt bubble crash, and the EU has no solution for their disinflationary debt bubble.
Investors need independent financial advice about the risk of inflation.

The post Will Inflation Return? appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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    When the recession comes, stocks will go down. The Fed can’t cut rates enough to prevent or heal a crash. Typically the Fed needs to cut rates by 5% in a crash; since they are now at 2.4% they would have to go to negative 2.6% which can’t be done without destroying the economy, and thus it won’t be cut to a negative rate.
The intrinsic value of the SP is 1,800 (the peak was 2,954); the intrinsic value of the SP could even be as low as 1,100. If the Fed can only provide about half of the rate cuts needed to heal the next crash then perhaps stocks would get stuck at halfway between intrinsic value and their high water market, perhaps at SP of 2,200, a 25% loss. A possible solution would be for the Fed to buy stocks but this is not allowed by their charter; Congress would need to authorize this but the (sometimes) hard-money Republican senators might oppose this. Perhaps a compromise would allow the Fed to bail out only a privileged “Too Big To Fail” few companies, like in 2008. Perhaps they would be allowed to subsidize failed banks, pension funds, and government agencies that lost money while the Fed ignores the individual owners of stocks.
Japan’s central bank has bought stocks in Japan and made interest rates go negative but the Nikkei index is still 45% below the all-time high of 1989.

  Investors have incorrectly leapt to the conclusion that the Fed has their back and will rescue them, but some aspects of central bank rescues are an unreliable placebo instead of a real cure. Quantitative Easing often buys a bond from a bank and then the bank receives cash from the Fed which it stores in its required reserves and thus the funds can’t be lent out and the Fed pays the bank a lower yield on cash than what can be earned from a bond, so that aspect of QE is explicitly a stupid, worthless placebo. QE is deflationary as it grabs a high yielding bond from retirees and replaces it with lower yields of a bank deposit, thus triggering bad feelings and less consumer confidence in retirees, and pre-retirees. This in turn has a worse effect on consumer behavior than the “Wealth effect” of rising stock prices. The moderate economic status retirees need to get a full degree of yield from their retirement nest egg in order to function properly as a retiree. If they are deprived of yield they may have to sell their home and rent a smaller residence and this will put their economic situation into a mini-depression, thus reducing consumption, and reducing tax revenue.
The huge increase in PE10 ratios for stocks, of double the traditional PE10 metric of 15, was an unsustainable event caused by central bank bubble making, combined with placebo of a myth that the Federal Reserve can magically fix the economy and control stock prices. Eventually the truth will be revealed and stocks will be unable to be fully rescued by the Fed in the next deep crash.

The post If Stocks Crash Can The Federal Reserve Repair The Damage? appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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   The U.S. imports far less than it exports; by contrast some countries are very export dependent, for example Germany exports half of what it produces. We export 12% of our GDP and only 6% to places outside of North America. This allows us to have more leverage since the rest of the world needs us more than we need them. This is even more true due to the growth of domestic oil fracking. The result of a trade war would be skewed in the direction of hurting other countries more than the U.S. will be hurt.
The U.S. also attracts more skilled immigrants than other countries (vital to manufacturing the winning new technology). The “Middle Income Trap” theory that democracies are able to grow past a middle level of income and dictatorships can’t is true, in part, because places like the U.S. and Europe are better place to live and work than a kleptocratic dictatorship.  During WWII a key factor for victory was recruiting nuclear scientists from Italy or Germany like Enrico Fermi and Albert Einstein; there was no flow of scientists in the opposite direction.
The U.S. receives the flight capital funds of foreigners seeking safety, we pay them low yields compared to EM countries, and then U.S. financiers reinvest the proceeds into loans at high interest rates to EM countries, thus making a nice profit margin because of the global desire for security, safety, fair play, trustworthiness, transparency.
When global bad times come, the safe haven nature of the U.S. results in the dollar rising compared to other currencies, making it harder for EM countries to repay their dollar denominated loans, thus further enhancing the tendency for EM flight capital to flee EM countries and go into Developed countries.
The EM countries had a great economic output for several decades due to the desire to extract commodities (partly due to an unsustainable China real estate construction boom) and use the cheap labor of EM countries. However, these are low tech industries that are gradually falling behind the new tech as manufactured by the most Developed country economies. International flight capital will continue to leave Developed countries and go to the U.S. Canada, Australia, New Zealand have all had a commodities boom that triggered a real estate bubble which is now bursting. It won’t be wise for foreigners to park funds or buy real estate in those three countries until their cycle bottoms out in a few years. The EU has so many financial problems it seems like an unwise place to invest in. The UK could be fine once Brexit is fully settled.
The nature of China’s economy is that they have a large amount of resources allocated to real estate which remains empty after construction, thus missing out on collecting net rent. After 20 years the compounded missing rent could be more than double the property’s value, assuming a modest appreciation in rent. This could be taxed and used to reduce government debt. In the U.S. landlords rent out their properties and pay tax on the income which the government uses to moderate the size of the federal deficit.
The U.S. has fundamentally a more sound and solvent economy than the rest of the world. This provides a fundamental basis for why the currency has held its value once Volcker tightened in 1979, after an initial period of devaluation during the Bretton Woods exit of 8-15-1971. I expect the dollar to hold up well during the next global recession. It may be accused of being the least dirty shirt in the dirty clothes hamper; since it is the least bad currency then it is the best.

 

The post How Safe Is The U.S. Dollar? appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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     The 25% tariff against imports from China won’t be inflationary. Consumers in the U.S. will simply buy less goods because they have a limited budget. Thus if they chose to buy imported goods from China, that suddenly cost 25% more because of the tariff, they will simply buy less of other items.
The higher cost will inspire domestic competition and more likely inspire additional competition from other EM countries that have lower wage costs than China. Based on the fact that China devalued by 50% in 1994 a 25% devaluation by China, in response to the tariffs, will occur.
This would trigger a retaliatory devaluation by Japan which has used devaluation to compete and stimulate its economy. This would trigger a global deflationary wave of devaluation with more wealthy people from EM countries exporting their assets into the safety of Developed country bonds, especially the U.S. Treasury bonds. The EU is under severe pressure as they have hit the wall in terms of too much negative interest rates and can’t use those policies any longer and yet they would need to match the devaluation, even if they can’t.

There are plenty of Emerging Markets companies eager to replace China’s lost exports; already many companies are moving out of China to lower cost democratic countries that have a diligent, skilled English language workforce, like India, Ethiopia, etc.
Regarding inflation, of far greater importance than the tariffs is the fact that the EM world is set up as a massive low wage export generating machine where EM banks loan money to EM manufacturing business that lose money because they are set up to create local jobs that pay a tenth of U.S. wages. This deflationary force is far more powerful than a little wimpy tariff tax of 0.6%. The tariff will cost American about $375 per person in taxes, or about the cost of a bottle of beer a day. if we stop drinking beer that fixes the family budget, but no amount of cessation of drinking in China can fix their huge problems such as loss of sales to the U.S. or the huge real estate debt bubble they have. The tariffs of $500Billion of goods are a tax on 2.5% of the U.S. economy. Surely we can handle a 25% increase in 2.5% of the economy, which is an increase of 0.6% of total expenditures. This is slightly smaller than the tax cut of December, 2017, so the tariff tax acts to balance the budget, dampen inflation, and will make the dollar go up, thus creating hardship for EM countries who will be forced to sell more goods at cheaper prices as they will we caught in a trap of repaying dollar denominated debt while their currencies go down against the dollar.
Worry about the world falling into recession, stock crashes, debt defaults, and deflation. Don’t worry about domestic inflation.
If China sells its $1trillion of Treasuries the Federal Reserve can instantly buy them and slowly sell them off to avoid disrupting the market. Meanwhile China will be stuck with an uninsured non-interest bearing checking account holding dollars. If they sell the dollars this will make the dollar go down at a time when they want the dollar to go up so that the Yuan will go down; thus they are unlikely to do this; further they have borrowed $3Trillion in dollars so they are net short $2Trillion in dollars which will cost then an extra $500Billion to pay off if they devalue the Yuan by 25%.

   The possibility of global deflation implies more flight capital coming to the U.S. and thus our rates will go to zero, saving U.S. borrowers hundreds of billions in interest expense, far more than the tariff cost.
Economist Dr. Lacy Hunt said today “in the next 5,10,15 years the US will be relatively stronger when compared to China, Japan, Europe because of marginal productivity per capita. Money supply growth has decelerated sharply; in the lowest quartile historically”.
In the 1950’s and 1960’s the news media ran stories that that the Soviet economy would triumph over the U.S. In the 1980’s it was Japan’s turn to appear to pose the same risk, yet by 1990 they fell into a horrible debt deflation trap and have still not fixed their problems so 29 years later. In 1991 the Soviet Union collapsed and never recovered. Thus China’s risk to the U.S. will likely have the same result.
Since Price Earnings and Price to Sales ratios are too high in the U.S. then one should avoid stocks until they are available at good, low, 50% off prices. For now, one should own investment grade bonds and wait for the stock crash.

 

 

 

The post Will China Tariffs Be Inflationary? appeared first on Independent Investment Advice Blog | Investment Planning | Los Altos.

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