5/15/2018
In part I, Primer on Fiat currency, I explained how money doesn't have real value only perceived value (it may never and may have never had real value). In part 2, Jesus, take the economic wheel, I explained troubles with creating money whenever you feel like and then just pretend like it doesn't actually matter because money is magic and faith is universal.
If you already knew all that, then this is the perfect place to start!
If the financial world is ending, the next part is easy: Get out of currency, anything valued in currency, and directly into things that maintain their real value.
Step 1) Find something that won't be affected by the change in currency valuation, store value there (in assets of perpetual real value).
Step 2) Consider positions of high liquidity to retain the ability to invest if favorable options are available.
If you already knew all that, then this is the perfect place to start!
If the financial world is ending, the next part is easy: Get out of currency, anything valued in currency, and directly into things that maintain their real value.
Step 1) Find something that won't be affected by the change in currency valuation, store value there (in assets of perpetual real value).
Step 2) Consider positions of high liquidity to retain the ability to invest if favorable options are available.
Step 3) Have a skill or asset that can provide income of real value in the new currency.
As discussed in Jesus, take the economic wheel inflation above 2.5% will likely be explained as growth and a good thing, but the fundamentals won't actually be so clear. I expect real contraction and eventually nominal contraction in a high-interest environment. Positioning is a bit of a challenge then for someone like me, but some amount of cash on hand could prove useful in about a year.
Enter TIPS (Treasury inflation-protected securities) in 5, 10, and 30-year terms. These issues of government debt have a principle that is adjusted to inflation (that is they maintain their real value) and pay interest semi-annually based on the then current principle. They are not readily transactable however and thus best held until maturity unless you're ok at selling them at a discount to their issue principle which in a high inflation period will be at a significant discount indeed. But if you have nothing better to do with that money a Note might be a semi-decent option if high interest rates and limited opportunity is in the future (or just a carefree retirement I suppose). The only real negative is that the principal adjustment is considered taxable income, so if a 1,000 Note is increased by $25.4 in 2018 that $25.4 is taxable income. This downside is completely mitigated in Tax-Differed accounts. TIPS come in another flavor: Treasury Bills, a portion of time on the greater Note.
TIPS Bills are auctioned on these upcoming dates for terms of 4, 13, 26, 52 weeks. With a broker you can place a competitive bid for a specific interest rate, but Treasury Direct only allows you to set the amount you want to buy which will be filled at whatever the market rate is. So while you'd probably need very specific use cases for the 30 year note, I could see a purpose to 10 year notes if the 1970s were coming back and 5 year notes before any recession (issued in April with re-issues in August & December), and Bills seem reasonable anytime you're reasonably sure you're sitting on cash for no reason and inflation is an issue. TIPS are a very poor choice in a deflationary environment or where inflation is low and stable, however, when inflation beats interest rates TIPS will yield more if allowances are made for the gains on principle.
Another related option for a market that might suddenly go on sale would be short-term bonds and short-term bond ETFs or mutual funds. If interest rates are increasing somewhat rapidly these short-term bonds might be better than intermediate and long-term bonds on a basic level but are probably less than ideal until interest rates are over 4 to 6%. A 90-day ladder might prove useful, but both these concepts are beyond the scope of this article. I believe the 90-day decision deferment offered by treasuries to be useful to me personally, but as it's rather complex you should do considerable research on your own and/or consult a professional directly.
Lastly setting up your own bond ladder with the US treasury is apparently very easy. T-Bills can be purchased every Tuesday in increments of $100. If one was to set aside $4,000 and instruct Treasury Direct to purchase a $1000 4 week term T-Bill every week the connected bank account would incrementally increase, at a rate higher than most bank offered interest rates, as the first Bill matures and the 5th is purchased.
Foreign bonds have historically been good options if the investor has a sufficient knowledge and predictive powers. Historically the Japanese hoard money in periods of financial stress creating a deflationary environment which has maintained the real value of invested money, maintaining its nominal value in Yen, and thereby increasing its nominal value in other currencies.
The UK is raising rates less so many may put their investing dollars to work there, probably a terrible idea. The exchange rate has been significantly hit by Brexit and the £ could lose further value nominally against the dollar as that process proceeds. If employment increases but unemployment remains significant it might dodge its own inflation risks for a time and I have no idea what the GBP's float is, if it's small it may suffer from lower inflation than other countries, however if it's comparable then the pound is in for a wild ride down (inflation outpacing interest rates). The dollar could become more valued than the pound. Further, they have shown a strong willingness to quickly devalue their own currency to meet debt obligations - a good move for a nation-state but terrible for anyone buying those bonds.
German bonds have been among the most valuable historically in times of crisis and inflation pressures due to the German's personal knowledge of the horrors of hyperinflation. This will be addressed in a future writing: the Bund.
As discussed in Jesus, take the economic wheel inflation above 2.5% will likely be explained as growth and a good thing, but the fundamentals won't actually be so clear. I expect real contraction and eventually nominal contraction in a high-interest environment. Positioning is a bit of a challenge then for someone like me, but some amount of cash on hand could prove useful in about a year.
Enter TIPS (Treasury inflation-protected securities) in 5, 10, and 30-year terms. These issues of government debt have a principle that is adjusted to inflation (that is they maintain their real value) and pay interest semi-annually based on the then current principle. They are not readily transactable however and thus best held until maturity unless you're ok at selling them at a discount to their issue principle which in a high inflation period will be at a significant discount indeed. But if you have nothing better to do with that money a Note might be a semi-decent option if high interest rates and limited opportunity is in the future (or just a carefree retirement I suppose). The only real negative is that the principal adjustment is considered taxable income, so if a 1,000 Note is increased by $25.4 in 2018 that $25.4 is taxable income. This downside is completely mitigated in Tax-Differed accounts. TIPS come in another flavor: Treasury Bills, a portion of time on the greater Note.
TIPS Bills are auctioned on these upcoming dates for terms of 4, 13, 26, 52 weeks. With a broker you can place a competitive bid for a specific interest rate, but Treasury Direct only allows you to set the amount you want to buy which will be filled at whatever the market rate is. So while you'd probably need very specific use cases for the 30 year note, I could see a purpose to 10 year notes if the 1970s were coming back and 5 year notes before any recession (issued in April with re-issues in August & December), and Bills seem reasonable anytime you're reasonably sure you're sitting on cash for no reason and inflation is an issue. TIPS are a very poor choice in a deflationary environment or where inflation is low and stable, however, when inflation beats interest rates TIPS will yield more if allowances are made for the gains on principle.
Another related option for a market that might suddenly go on sale would be short-term bonds and short-term bond ETFs or mutual funds. If interest rates are increasing somewhat rapidly these short-term bonds might be better than intermediate and long-term bonds on a basic level but are probably less than ideal until interest rates are over 4 to 6%. A 90-day ladder might prove useful, but both these concepts are beyond the scope of this article. I believe the 90-day decision deferment offered by treasuries to be useful to me personally, but as it's rather complex you should do considerable research on your own and/or consult a professional directly.
Lastly setting up your own bond ladder with the US treasury is apparently very easy. T-Bills can be purchased every Tuesday in increments of $100. If one was to set aside $4,000 and instruct Treasury Direct to purchase a $1000 4 week term T-Bill every week the connected bank account would incrementally increase, at a rate higher than most bank offered interest rates, as the first Bill matures and the 5th is purchased.
Foreign bonds have historically been good options if the investor has a sufficient knowledge and predictive powers. Historically the Japanese hoard money in periods of financial stress creating a deflationary environment which has maintained the real value of invested money, maintaining its nominal value in Yen, and thereby increasing its nominal value in other currencies.
The UK is raising rates less so many may put their investing dollars to work there, probably a terrible idea. The exchange rate has been significantly hit by Brexit and the £ could lose further value nominally against the dollar as that process proceeds. If employment increases but unemployment remains significant it might dodge its own inflation risks for a time and I have no idea what the GBP's float is, if it's small it may suffer from lower inflation than other countries, however if it's comparable then the pound is in for a wild ride down (inflation outpacing interest rates). The dollar could become more valued than the pound. Further, they have shown a strong willingness to quickly devalue their own currency to meet debt obligations - a good move for a nation-state but terrible for anyone buying those bonds.
German bonds have been among the most valuable historically in times of crisis and inflation pressures due to the German's personal knowledge of the horrors of hyperinflation. This will be addressed in a future writing: the Bund.
Emerging markets
Financials
Financial stocks nearly always benefit when the general market falls, though not initially. And this will be a little more complicated this go around given expected inflation pressures. However after the collapse of Leaman Brothers all bank stocks were hit, and if you recall the various Federal Bailouts prevented Bank insolvency so I did quite well with BAC and USB while an adventurous co-worker claimed to have made a very rewarding bet that AIG would still exist at a later date when it traded for $0.05 a share. I'm not sure how that works, but if he had bought it at $0.55/share the 1:20 (reverse) split and AIG being worth $53.23 today if he had bought 1,000 shares for $550 those 50 shares would be worth $2661.50 (a 484% increase). I probably would've sold them in 2011 at around 30, but the point is if you know where to look there's always something.
Gold
Gold is not an investment. However, Gold has more than a 5,000-year history of being considered valuable by humans so I believe it's reasonable to believe it will continue to be an object of value and decent hedge. There's only so much on earth, only a certain amount is accessible to humans, and extracting it comes at a cost. Gold is the BitCoin that BitCoin isn't, and delivers in every way BitCoin can't - except for transactability on which they are basically equal. Buying gold is a challenge due to speculators, markups, and ETFs that have often leveraged and lent their Gold to the point that it isn't clear they actually have any gold on hand to back up their claims of being Gold ETFs. However, if there were a magic Gold ETF or a secure way to own bullion, bars, and coins Gold would at least maintain it's real value (as it basically always has) and likely benefit from speculation - provide you sell into the high. This is part of my central plan: Buy now and sell when everything is crumbling at your feet, then buy the choice crumbs. I do think gold drops more before there is a real shake-up, the sky isn't falling after all.
So whatever positioning one takes it should be clear that the water is pretty murky, but picking equities in a down market is fundamentally the same as picking them in a bull market - just with less margin for error. Further, making financial decisions purely on interest rates is probably not a winning strategy. Troubled markets are even more complex than healthy ones and predicting the future is never easy.
Personally, I'm going to get my feet wet with some US Treasury ladders and TIPS as I liquidate my other positions, investigate the Bund, and wait for the Market to declare itself. Whatever ends up happening, it will be clearest at about the time it happens. Also, given Trump's precedent, the Fed could just be telling markets what they want to hear with every intention of acting correctly and raising interest rates despite statements to the contrary. How's that for helpful?