Inv101-1 – INTRODUCTION TO INVESTMENT BASICS – broad outline for lay people
Logic flow broadly from oldest (Inv101-1) to most recent
I postulate that “We spend a lifetime accruing money and almost no time learning how to look after our wealth”. This makes no sense, but mostly it is because we glibly claim ignorance about investment and hand over that responsibility to others, few of whom are truly honest & professional and many of whom are outright charlatans.
This is counterintuitive, because: –
“You can delegate a task, but you can never delegate responsibility”
i.e. If it all goes wrong we have no recourse and cannot point fingers. I maintain it is up to us to educate ourselves i.r.o. the basics, until we understand the broad investment concepts, so that we can communicate semi-intelligently with our brokers and agree the ideal diversification strategies for the ruling economic situation. Thereafter, it is up to the brokers to refine it and select the best fund managers.
As with all things in life, true success ultimately lies in the art of getting the basics right. One of the biggest problems with most investment brokers is that they tend to project past performance forwards, which is very dangerous because past performance does not predict future market action. Therefore, your first order of business is to find an investment broker who is properly qualified, informed and uses current market intel to anticipate future market action. This does not mean he will always be right, but he should be able to help you avoid the biggest losses, which is important, because if you lose nothing while everyone around you loses 50%, you are twice as well off. Eg. In 2018 the US markets reached the distinction of “the longest bull market in history”. While records are there to be broken, that statement tells you a major correction or crash is pending. Getting the timing right is nearly impossible, but one can acknowledge that this is probably a time to be careful as “it is no longer about your return on investment, but the return of your investment”. This subtle difference implies that that it would be prudent to suggest a defensive investment strategy to your broker.
The above example illustrates you that you do not need to be an expert to get your investment strategy right, as you can gather a lot from just listening to the news and to other people. Another illustration of this is that “when absolutely everyone is talking about getting into a market or investment, as we saw with Bitcoin, it is probably time to get out” – i.e. when Greed is the dominant emotion. On the flip side of the coin, the famous banker Nathan Rothschild said “the time to buy is when there is blood in the streets” – i.e. when Fear is the dominant emotion. These two statements were summarised by Charles Mackay, a Scottish journalist’s quote in about 1841 “Men, it has been well said, think in herds. It will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”. i.e. The key to successful investment lies in not following the herd, especially when Greed or Fear prevail.
It is important to understand that investment markets move in cycles on all timeframes, moving from overbought peaks to oversold dips, which means they never move in a straight line. The dips manifest as corrections, or crashes, which are good, because they’re needed to eliminate market excesses. While you can choose to ride out the dips, you need to avoid the crashes.
These swings manifest because markets constantly fluctuate between two emotions, namely Fear and Greed, something which can be measured using a range of tools and oscillators. Because of these fluctuations, the basic investment strategy known as “Buy Low and Sell High” is easier said than done. After a crash, there is widespread fear, as people who have lost money are reluctant to get back into the markets, even when they have been rising for a considerable time, because they fear there is more downside to come. After the markets have gone up significantly and everyone is talking about the money to be made, people experience greed and get back into the market – albeit when it is approaching a top, which is actually the time to get out. Major bull markets typically boom to the point where investors experience “irrational exuberance” feeding off widespread greed, which means the markets are driven higher than is justified by rational valuations. This is why they say of any bull market that “when everyone, including housewives, bellhops and waiters” are telling you what shares to buy, it is time to get out. Contrarily, at the end of a bear market, they say the time to buy is when there is widespread fear, nobody wants to buy and people are slitting their wrists, which means markets have been driven lower than justified by rational valuations. The truly clever investors are often referred to as contrarians as their philosophy is “When everyone is out, they get in and when everyone is in, they get out”.
Many of the key economic problems the world faces today arose because of the abandonment of the Gold Standard in favour of Fiat currencies. In principle politicians abandoned the Gold Standard because they wanted to be free of budgetary constraints, choosing instead to indulge in both deficit spending and uncapped escalating debt, facilitated by Fiat money, in order that they would be free to “buy” votes and enrich themselves. The bankers gladly participated as this enriched them and enabled a transfer of wealth from the poor to the greedy rich. This credit facilitated spending spree created numerous economic imbalances, for which we will pay dearly in future. You can read more about this in my various articles starting with Econ1 at https://eelcogold.com/. It is important to note that the introduction of Fiat money also precipitated the need to manipulate official statistics such as inflation, GDP, unemployment, etc. to mask the impact of Fiat money, deficit spending, escalating debt, etc. on society. The consequences included the impoverishment of the masses and a looming pension crisis.
The risks embodied in the current Fiat money regime are best illustrated by these quotes:
- Quote from Alan Greenspan: “The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. Deficit spending is simply a scheme for the hidden confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard”;
- Thomas Jefferson: “I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property – until their children wake-up homeless on the continent their fathers conquered”. … “The issuing power should be taken from the banks and restored to the people, to whom it properly belongs”;
- George Bernard Shaw in 1928: “The most important thing about money is to maintain its stability … You have to choose between trusting the natural stability of gold and the honesty and intelligence of members of government. With due respect to these gentlemen, I advise you, for as long as the capitalist system lasts, to vote for gold”;
- Ludwig von Mises: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved”;
- Ayn Rand: If you see that trading is done, not by consent, but by compulsion – when you see that in order to produce, you need to obtain permission from men who produce nothing – when you see that money is flowing to those who deal, not in goods, but in favours – when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you – when you see corruption being rewarded and honesty becoming a self-sacrifice – you may know that your society is doomed.
There is little doubt that the world is in a mess today and that a major global financial crisis is looming. However, it is unlikely that the world will ever revert to a Gold Standard when it happens, but they will have to adopt some form of prudent monetary management. The important message here is that you need to learn to protect your wealth.
Measuring wealth is a tricky concept in this era of Fiat money, manipulated economic statistics and unlimited credit. This is explained in Econ2. In summary, wealth was created the old-fashioned way when people produced more than they consumed, to create savings for allocation to productive enterprises, also known as capitalism. Contrarily, Fiat Money & Credit facilitated the modern illusion, where wealth is measured in your flashy lifestyle and how much you can consume, while ignoring the amount you borrowed from future income to do so. This critical concept, that “debt is future consumption brought forward”, is explained in Econ3.
All this is further complicated by the disruptive influences of exponential Technology, which are elaborately described in numerous articles on Futurism at https://eelcogold.com/. The transition from the old industrial era to the new multi-tech era will be disruptive and painful.
Broadly, valuations in the investment arena are driven by interest rates, which is why I dedicate a few chapters to the impact of interest rates on the prices of Properties, Resources, Bonds/Treasuries and Shares/Stocks. Accordingly, it is useful to understand interest rate cycles, the link between inflation and interest rates and their influence on each of the asset classes. You can read about this in Econ 5. The chapters that follow progressively explain the most important aspects and considerations of investing. Have fun – I tried to keep it short.
Basics concepts discussed in future chapters include the following:
- Real returns
- Manipulated statistics
- Wealth, Tangibles and Ownership
- Investment cycles
- Various asset classes
- The impact of interest rates and inflation
- Risk and Diversification
- Sell near the top, buy near the bottom
- Blood in the streets
Warning! While I am going to keep this very simple, investment forms a complex matrix of interdependent influences and links, which means that you will be faced with a bit of a chicken and egg situation. i.e. I cannot explain one concept without referring to another that I have not yet introduced. Therefore, one should read through it all before it can be grasped in its entirety and seen as a whole. This probably means that you will want to read it all again until you get the overall picture – bearing in mind that it is your responsibility to protect your wealth.
Broadly speaking you need to understand the investment arena without being an expert. What I mean by this is that you need to have a sense of what is going on in the world, as many things can have a bearing on “safe” investing. Eg. The rate of change of technology can make products, or companies like Kodak & Nokia, obsolete within a year, or reveal emerging technologies where the truly great returns can be made. Similarly, it is always good to understand the degree of manipulation of official statistics as this distorted picture can mask huge risks, or present opportunities.
There is little doubt that the current credit binge is going to unravel as the global economy needs a reset and, when it does, it will dwarf the pain of 2002 and 2009. The only question is “when” this will happen – probably during the decade from 2020 to 2030.
Note! All these reports are educational, free and published weekly.
Free Subscription – if you want to subscribe to this free newsletter, click on this LINK. These, and earlier reports, can all be viewed at https://eelcogold.com/.
Disclaimer! The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests. Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.
Mr Lodewijks is not a qualified Investment Advisor. His investment reports aim to educate and help investors understand investment considerations and strategies. As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.
THE PROBLEM WITH MOST INVESTMENT FUND MANAGERS – Written end 2019
I always maintain one should not highlight problems without presenting solutions. Therefore, this article, that highlights major problems, presents a few solutions. However, it is followed by an absolutely extra-ordinary article, that presents Anthony Deden’s “40 invaluable lessons when investing”, which elaborates on what how investment fund managers should be thinking and what they should be doing. They cannot mimic him exactly, but attitudes need adjusting.
The true purpose of an investment fund manager should be to “Preserve and Grow your capital”, and to do so with your interests in mind and better managed, relatively lower risk, strategies. Regrettably, incentive bonuses have brought about a culture where 95% of fund managers serve their bonus first and their customers last. Therefore, you need to be extremely careful about your selection of a fund manager. Find one who is forward, not backward looking. One who does not presume that the historic bullish trends will project forwards indefinitely. You also need to find one who is prepared to go very defensive when markets are toppish (overbought), such as we see/saw in 2019 after a 10 year bull market run.
The BIGGEST problems with investment fund managers is both Preserving and really Growing your capital
- Recovering from significant corrections or major crashes is a big deal:
Equity markets must gain 100% after a 50% equity market correction/crash, just to break even. Furthermore, such recoveries can take a considerable time. Therefore, significant corrections and crashes should be avoided. A case in point would be the US Equity markets. After the year 2000 peak at 1 550, followed by the 2000/2003 (-50%) and 2007/2009 (50+%) crashes, which were both foreseen by many, it took the S&P 13 years before it broke above 1 550. Worse still, it took at least 17 years for it to break even after adjusting for say average 2.5% inflation and 19 years to beat 3.0% (see below). Therefore, when the markets look toppish, fund managers should progressively start adopting more defensive, lower risk, strategies as a matter of course. i.e. When markets are toppish, it is time to be more concerned with the return OF your capital, than the return ON your capital. However, the attitude of “lazy” fund managers, who are more concerned with their commissions and incentive bonuses, is that eventually the markets recover and, therefore, you should ride out the dips. How stupid. Why would you ever want to risk losing 50% of your capital, especially if you are older?
Therefore, when it is clear that markets are toppish, a better strategy would be to get out of Equities entirely and adopt a more defensive position in the Cash, Money, Bond and Gold markets. Yes, you may only make 2-4% p.a. instead of 4-7% p.a. for the next year or two, but at least you do not lose 30%, 50%, or even 80%. Think about it, if you lose nothing when all about you lose 50%, you are 100% better off than them, in relative terms, after the correction. You can then re-enter the equity markets after the correction/crash.
The Chart below illustrates the performance of the S&P over the past 3 decades. The horizontal dotted line illustrates the 2000 peak level at 1 550, with the two subsequent very significant crashes below that line. The vertical dotted line marks where the nominal 1550 level is broken for the first time in 2013, 13 years after that level was first reached.
The table below the Chart compares the abovementioned defensive/aggressive strategy, with the more conventional buy and hold strategy that is favoured by most fund managers. This strategy yields a compound cumulative return of over 11% per annum over 19 years, compared with the 3.6% p.a. the conventional buy and hold strategy yielded over that time. Now, it is important to remember that this is a theoretical exercise, so your returns may be a bit less, but still far better. I did become defensive about 1.5 to 2.0 years before the peaks, but I got in at the actual bottom, which is not always easy to pick, not a year or two later.
Table of returns, reflecting the “buy and hold” low growth inflation linked targets on left and above “defensive/aggressive” strategy on right.
- Diversification is not properly understood and applied, which increases risk
Diversifying across a lot of shares does not protect you when Equity markets tank or crash. Therefore, one needs to diversify across all asset classes. Traditionally, these are Cash, Bonds, Property and Equities, with the former being the more defensive/conservative and the latter the more aggressive. Ideally, one should also diversify one’s investments internationally, to protect yourself against currency fluctuations, and adverse local regulations and politics. This is particularly essential if you live in an unstable country like Zimbabwe, but also prudent if you live in a developed country like the USA. However, the truly wealthy also diversify across tangibles, which include rarities such as artworks, stamps and coins, and precious metals.
More important, one should continually review this broader diversification strategy and be willing to make minor or major adjustments depending on shifts in market conditions.
The current investment fund manager’s mantra is that a 60/40 strategy has proven effective over the long term. This means they recommend you hold 60% in mostly Equities and some Property funds, and 40% in Bonds and Money Markets. Furthermore, they recommend that one should just ride out the corrections and crashes and your money will, over time, at least hold its value after adjusting for inflation. That does not equate to growing your wealth, it merely equates to preserving your wealth and that only works when you time your entry right.
Bearing in mind that the Equity markets have been in a 10+ year bull run since 2009, which is the longest on record, it would clearly be prudent to urgently adopt a defensive strategy. However, modern convention holds that you then go say 40/60, with less in Equities and more in Bonds, as bonds are the traditional flight to safety destination. Agreed, in the event Equity markets enter a major correction or crash in the next year or two, bonds should again perform better than equities. However, this is more like hedging your bets a bit and not a winning strategy as most sovereign bonds are already delivering negative returns, especially after adjusting for inflation. Therefore, they are arguably not the place to put your money in the longer term, except just before and during a correction/crash. Any significant correction/crash will probably drive even US interest rates into negative nominal territory, global equities into negative returns and global economies into depression. i.e. Negative GDP growth.
Given the fact that Equity markets are long in the tooth and also likely to deliver negative yields in the very near future when markets correct or crash, you have to ask “where do I put my money”? The answer is put some of your money in Physical Gold/Silver and Gold/Silver Equities, as these are the ultimate safe haven, particularly during periods of negative returns.
- “Passive” investing = chasing the dream of capital gains = perpetually rising share price, and it is inherently far riskier than “active” investing, which is based on intrinsic value, established via due diligence studies
Shares either go up because investors are chasing good value, or because investors are chasing the dream of perpetually rising equity prices, or both. Of late, in 2017-2019, investors are mostly chasing the dream of ever higher prices, with little regard to the underlying value, much like they did during the dot.com boom in the late 1990’s. Furthermore, this momentum trade is largely being driven by the belief that “if you are not in, you are missing out on massive profits”, coupled with impetus from High Frequency Traders, Algorithms & ETF’s. This is dangerous, because when the market loses faith in the rising price trend and reverts to inspecting true value, some of these shares can be found to have little or no value. This will, in turn, exacerbate any correction or crash, as it did in 1929 and the 2000 dot.com bust.
Good investment fund managers carefully study the companies they wish to invest in, to establish the underlying value, and the markets those companies operate in. This is called “active” or value investing as one is investing in the intrinsic value of the company and its role in the global economy. These shares typically have a strong asset base, low debt, earn good money and pay considerable dividends, even and especially during tough times.
Contrarily, however, the modern trend of late has been to simply invest in Exchange Traded Funds (ETF’s), which hold a basket of equities and track the index. These are often managed by Artificially Intelligent Algorithms, which focus more on price action and less on intrinsic value. This means that most fund managers do not have to do all that time-consuming due diligence work. This is called “passive” investing. Thanks to momentum trading, passive funds has been outperforming the more conservative active funds, but in the long term, active funds always beat passive funds. So do not to get sucked into this temporary phenomenon.
The problem with passive investing is that it is subject to the vagaries of momentum trading. Momentum trading is trading that is driven by share price performance and not the intrinsic value of the company, and it works well for as long as the stock prices and markets are rising. This is where the share keeps going up and everyone says you better get in before it is too late. This is where everyone focuses on the capital gains, but that only works for as long as the shares are going up. However, such irrational exuberance pushes shares way beyond their intrinsic value and the problem with that is that they come down very quickly and hugely when the markets turn. We saw this after the Dotcom crash, where many shares fell from stellar prices to near zero. For example, we have many technology companies that are persistently making losses, yet their share prices continue upwards as these are “fashionable” stocks to hold. Why would you want to hold onto a company like Netflix, that has publicly stated it will never be cashflow positive as all its money is going to making new films? Why would you want to own WeWork that owns no assets? As at mid 2019, some 15% of companies in the S&P 500, are so called zombie companies that do not make enough profit to cover their debt service costs.
Therefore, in the longer term, it is always better to stay with active investment fund managers.
- Fund Managers are not good at hedging against all that can “unexpectedly” go wrong
A man called Nicholas Taleb wrote a book called Antifragile. The concept is that when things go wrong in nature, only the strong survive. However, they not only survive, they emerge stronger than before. Therefore, one needs to diversify across all asset classes and hedge against every market “quake” eventuality. Accordingly, both you and your investment fund manager need to anticipate all the things that can go wrong with your investments and adopt strategies that will help you emerge financially stronger, not weaker.
He coined the phrase “Black Swan” for unforeseeable events. However, this term is now misused. For example, countless analysts foretold the 2007-2009 Sub-prime Mortgage crash, yet it was labelled a “Black Swan”. The fact that the lazy self-absorbed Fund Managers ignored the warnings and hid behind the unforeseeable “Black Swan” excuse is unforgivable. They should have been gravitating to defensive strategies in 2006, long before the crash.
In this regard, we need to worry about the fact that this 100 year Fiat money experiment, which led to out of control deficit spending, spiralling record debt, negative interest rates and, subsequently, misallocation of investments/assets will one day come to an ugly end. This is why asset classes like Gold and Silver should be on your horizon, because they have held their value for 5000 years and truly withstood the “safe haven” test of time. In fact, Gold and Silver have not gone up in price, it is the currencies have gone down, which is illustrated by the fact that Gold was $20 in the 1930’s and is now over $1500. Similarly, Gold has easily outperformed both the global Equity and Bond Markets since the 2000 Crash.
This is a time to adopt Antifragile strategies. This is a time to convince your investment fund manager to go defensive or change your fund manager. Now, more than ever, it is important to ensure that your diversification strategies are comprehensive and that you are biased in favour of actively managed funds. Having a second passport, having money offshore, having property offshore (if you can afford it), are all important considerations.
Note! All these reports are educational, free and published weekly.
Free Subscription – if you want to subscribe to this free newsletter, click on this LINK. These, and earlier reports, can all be viewed at https://eelcogold.com/
Disclaimer! The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests. Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.
Mr Lodewijks is not a qualified Investment Advisor. His investment reports aim to educate and help investors understand investment considerations and strategies. As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.
ANTHONY DEDEN – 40 INVALUABLE LESSONS WHEN INVESTING
I believe this “investment perspective” gem will enrich and change your life
IT IS ABOUT ANTHONY DEDEN’s EXTRAORDINARY INVESTMENT STRATEGY
This is the way investment advisors should be thinking. This summary encapsulates his philosophies. The result: an investment manager who beats all fund managers.
BELOW IS THE FREQUENLTY PUBLISHED SUMMARY – 20 minutes read.
40 ‘invaluable’ investing lessons from Tony Deden
Who is Anthony ‘Tony’ Deden?
Tony Deden is the Chairman of Edelweiss Holdings, a Bermuda-based investment holding company that he first launched as a fund in 2002. After building a remarkable track record, Tony converted Edelweiss into a holding company with over $300 million in assets and holdings that range from branded dairy products to a fragrance company and a salmon farm. Tony prizes safety of capital above all else and has structured Edelweiss to survive any type of economic situation.
Tony came into the profession of wealth management by accident when in 1985, he was asked to manage the monetary affairs of a family and then one family became two then three and since then he has never looked back. He had never worked in the finance industry prior to that and he learnt everything on the job as he wanted to serve his clients the right way.
Media averse Tony is well known for his old-school investment methodology based on integrity with a supreme focus on the preservation of wealth of his clients. He prefers to spend his time reading and thinking, tries to avoid the spotlight and resides in the Swiss Alps away from the chaotic world of finance. This theme of preferring to stay in seclusion is quite prevalent amongst the super investors as even Warren Buffet prefers to operate out of Omaha instead of Wall Street.
His conscious awareness that its ‘permanent irreplaceable capital’ of his clients that he is handling sets him and his thought process apart from 99% of fund managers today who have become infamous for making imprudent investments with no accountability as they seem to have an undefined, an unlimited amount of capital at their disposal.
If a manager can simply replace the word ‘wealth’ with ‘savings’ when he thinks about his client’s money, he would begin to act and invest differently. Learn to manage money as if it were your own savings.
He believes that for someone who has already earned the fruit of past labour and has significant wealth at hand, the tools with which you protect his wealth are different from the tools that are needed to create it. So, the tools, framework, objectives, methods, language are all different.
Here is the knowledge & thought process of this ‘investing maestro’ distilled into 40 pearls of wisdom;
- At the outset let’s get one thing clear, if you can’t read a balance sheet, you have no business in the stock market or any other market. You will end up deciding on a ‘hunch’ a ‘gut feeling’ or a neighbour’s hot stock tip. You will listen to the crowd from Wall Street that is just as lost or self-serving. You can’t fly an aeroplane on a hunch and neither can you invest money.
- The capital being given to the money managers is a‘lifetime’s worth of savings’ of a family and must be respected, as its hard to make money and even more difficult to keep it. Its hard enough to protect the capital from external factors like inflation, taxation etc. that one mustn’t compound the error by internal factors such as imprudence while choosing investments.
- The real riskwith investing is the idea of losing one’s capital permanently with no ability to ever recover it rather than people’s definition of risk which is actually means uncertainty. Look out for what could go wrong rather than what can go right. It’s better to err on the side of inaction than taking thoughtless action in haste.
- There is no point in having different portfolios for different clients based on their unique special needs and risk perceptionbecause what they really consider risk might not be a risk at all. Instead, it’s better to have all the portfolios aligned to a core principle of capital protection because, in the end, it’s not the money that you make that makes you rich rather it’s the money you get to keep that makes you and keeps you wealthy.
- When you start viewing your investments as a collection of assets in the form of securities, having a purpose, each of the components having a sub-purpose of its own rather than looking at them as a mere portfolio, that’s when you separate yourself from the herd and the opinions of others stops to matter. This collection of assets must endure and withstand the pressures exerted upon them by time and turbulence.
The goal should be to take irreplaceable capital and deploy it to irreplaceable assets
- When you are younger and new to investing, you want to believe the authorities, rating agencies, government statistics etc but as you grow older you realise that they all lie and everything is phoney.This realisation alone will make you look at places where no one is looking and help in developing the courage to acquire the things that everyone has brushed aside.
- Instead of trying to impress your customer, try to protect what he has spent years accumulating.
- In the times of ‘seeming‘ prosperity, always examine the causes to figure out if it’s real or simply an illusionof prosperity. A rising level of consumer spending and elevated lifestyle of the society is simply an illusion if the majority of it is funded by credit.
- As a money manager, one must not participate in an environment in which one has to do things because they were expected rather than doing what’s right. Unfortunately, that’s not how the industry functions these days.
When you start thinking about enriching yourself from the assets of those who participate in your scheme, then you are no longer a custodian rather it becomes a business
- Instead of being on a constant lookout for growth, investors should deliberate upon the idea of endurance and durability of a company.Try to figure out what are the ingredients that have contributed to their survival as a company over so many years. Rather than studying why companies fail, start looking for traits that make companies survive the test of time.
- The first principle to follow while investing is the ‘idea of exclusion’. When you consciously start doing that, you will realise that you are left with a handful of companies that are worth your time let alone owning a piece.
- There is a substantial difference between people who are investors and people who are owners of businesses. No owner of a business wakes up every morning asking himself what he’s worth then why should an investor if he actually believes he is a part owner. And if he believes he is a part owner then his first goal is to make sure the company survives, has a great product, a happy workforce, stable suppliers and a delighted customer.Now to think like that an investor needs to have time preference which is different from other people.
Investors who think like owners don’t indulge in the pseudo-intellectual activity of analysing companies based on how the price of the stock will move the next year or the next
It’s the liquidity you enjoy as an investor that entices you to act more like a price speculator rather than an owner of a business.
- The idea of having a fragile balance sheet for the sake of a higher growth doesn’t lend itself to the idea of ownership, an owner must be really concerned with his balance sheet. The balance sheet should be more important to him than the income statement. A company’s ability to endure and to survive is based on the strength of his balance sheet and the ‘nature’of the assets on it.
- As a wealth manager, you are the captain of a ship and you have passengers on board who wish to go to a destination you all had decided upon before setting sail. They will judge you eventually by having gotten there rather than how long it took as you had to avoid certain weather. Then again, if you had set sail with preservation of capital as the core principle, more often then not you would have a group of satisfied passengers on reaching the promised land.
- Like-mindedness is not just necessary with clients but also with the owner of a business in whose company you are going to invest. The owner should make decisions in the long-term interest of the company rather than next quarter or next year.
Like-mindedness, whether it is in marriage, in a business, or in any enterprise is a principle and important factor in doing the right thing in the right way
- So what should be theright attitude towards investing?
Look to own a participation in a business that is run by owners whose motivation is the same as yours, who are responsible to their family and to their community, and to the capital as much as you would have been if you owned the enterprise. So, instead of owning 100%, you own 2% or 3% of the company. You should be able to sleep well at night
- Here is why the concept of EBITDA is flawed;
- The only reason why EBITDA is around is on account of the ability to finance acquisitions through credit. If it was not for credit creation, there wouldn’t be an EBITDA;
- Real owners do not think of the value of their business as a multiple of the earnings they generate before everything which is EBITDA;
- The word EBITDA owes its very existence and relevance to dishonest money.
- What aboutPE multiple?
- Earnings are important, a company must be profitable and equally important is the cash generated by the company. Profitability can’t just be an accounting entry;
- The price to earnings ratio is meaningful but it’s not really essential in terms of value as profitability over a short term or from one period to another is often times a function of certain temporal events. So an investor mustn’t pay too much attention to that;
- Rather more important is the recapitalization of those earnings and the compounding to those earnings to book value per share which is a far more important indicator of a company’s ability to compound and that’s where the wealth lies.
Wealth is in the compounding of earnings
Basically, a company should be able to re-invest in itself to generate more future earnings which is what compounding of earnings means.
- What about the idea of earnings estimate, forecasts and forward guidance?
- That’s all nonsense. No CEO has a clue as to what is going to happen in future let alone give any precise numbers;
- Secondly, even if a CEO has some idea, the only reason he would share it with you is if he has stock options. The only purpose of asking or giving forward guidance is the stock price. This leads to the price of stock becoming a product and the whole thing turns into a game;
The focus then shifts from making a better product to finding innovative ways to make more money
- Ideally, a business should make money as a result of doing something well. That is the foundational principle, you make money because you add value to somebody’s life for which he is willing to pay you. What these financial tools like ESOPs end up doing is to take the focus away from the business;
- These days more often than not, a listed company’s principal business is their stock. What they do is an unnecessary complication to the idea of the stock going up. If it was owners running such businesses, there would be no disputes overcompensation. An owner of a business doesn’t take options. He owns common stock. He owns the company.
The idea of corporate responsibility is thrown around all the time these days but the truth is owners don’t need to be reminded to be responsible
- Know what can go wrong;
- Try to learn about businesses rather than stocks. When you read about varied industries and the businesses operating in them, you will have a better understanding of what can go wrong. Over time, even a marginally good business will do well if nothing goes wrong;
- To base an investment decision barely on available financial information is a superficial way of investing. But if you are buying simply for the purpose of selling then you don’t need to understand what can go wrong as you are seeing everything in terms of price;
It’s your duty to know, what can potentially go wrong in the businesses you own
- Knowing what can go wrong is more important than what can go right. You can never really know what anything is worth until you understand what can go wrong;
- We value companies differently because we weigh various components differently. There is no such thing as valuation metrics based on some standardized formula unless you see it in conjunction with other issues;
- In a world where there is a distortion of the economy and the cost of money is nearly zero, it’s important to have your own subjective way of measuring and accessing value;
- Always include an element of risk in your valuations based on the risks that are particular to a business, particular geography and so on.
- Scarcity, Permanence and Independenceare the three components that make investments endure the test of time.
- Scarcity is the most important law of economics. It is an important ingredient in any action that deploys capital in future. Anything that is scarce accrues in value over time, be it savings, resources (tangible and intangible) or the human character traits that help in building great businesses that last. The oligopoly of a business in an industry is an example of scarcity;
- Scarcity can be seen not only in quantifiable and material considerations but also in a company’s culture and ability to endure, survive and adapt. Or it could be its competitive advantage or the aggregate technical skill in some particular field of endeavour that is difficult to duplicate;
- Scarcity element reigns supreme when it comes to people running the company;
There are far more original multi-million-dollar Picasso artworks out there than there are company CEOs in whose enterprises you would be willing to deploy your savings
- Permanence is the idea of creating a framework that makes you invest in a company and people whose practices and behaviour is designed to endure rather than just grow. A company can grow but become fragile at the same time and die;
- Dependence makes a system fragile. If its a company then dependence on suppliers, a single customer, government subsidy etc can reduce a company’s ability to endure in the long run. A company independent of external factors is more likely to adapt and endure in tough times than the one which is a lot of dependence on the system.
- Liquidity can be a curse;
- When you invest in something that isn’t quoted on exchanges, you are excited about the idea of being a part of a real business. You make the extra effort to study the intricacies of the business and try to figure out what can go wrong. But when it comes to investing in listed companies, you tend to throw money based on tips as they can always be sold the next day.
The liquidity gives you an excuse to not want to know or understand anything about a business
- Build a habit of re-visiting your decisions, good or bad, and ask yourself;
- What is it that I should have seen that I didn’t?
- What was possible to see which was overlooked?
- What did I see and how did I focus on those that others didn’t;
The idea behind this exercise is to be able to separate an element of luck and happenstance from skill
- The unseen and unmeasurable are more important than the other kind. Things that kill you are often things that you cannot measure or cannot see;
- Understanding just the notion of risk isn’t enough, you need to know the nature of risk and the possible places from which risks to an investment can emerge.
- There are companies where the owners have a mindset to protect, preserve and enhance what they have been handed over by the previous generation and pass on the baton to the future generation when the time is right. These are the kind of owners you would want to partner with.
- The time horizon of such owners is not in years but in generations. When you partner with owners with such ideology, rest assured that the company will continue to do well for decades to come and your capital is secured.
- More frequently you look at the price of something, more frequently you start to second guess why you own it. So frequent checking of the portfolio can be dangerous to long term compounding and having so much liquidity in the system doesn’t help either.
- One of the greatest abilities that one must have as an investment manager is the ability to judge people in order to associate with like-minded clients and also the owners of the companies you’ve invested in.
- This can only be achieved by practice and observing things. A single sentence uttered by a CEO or CFO can completely change your decision on whether or not you should be investing in that company;
- When you hear them say something that is not aligned to your philosophy of business then you mustn’t rationalise staying invested only on the basis of good financial performance, you simply get out;
- A great question to ask yourself in such situations is that if you owned this entire business would you hire the current managers to run your company. If the answer is no, then why would you even want to hold a 1000 shares?
- One way to develop this judgement is by meeting the management but sometimes you don’t even need to meet them. If you can see that over the last 20-50 years, they have made the right decisions at the right time and they have been consistently doing this all their lives then you don’t need to meet them to invest with them.
- Any good investment operation, particularly when it deals with irreplaceable capital, must have embedded in it a source of continuity, substance and reservethat can be deployed when a favourable investment opportunity presents itself.
- This reserve can be in the form of treasury bills, commercial papers, short term bonds or time deposits. The problem with these so-called ‘paper assets’ is that they are actually debt. So, you do not want your liquidity to be somebody else’s liability.
- Physical Gold solves that problem. Gold gives scarcity, permanence and independence from the financial system. It is something that;
- you can hold see, touch and hold in a vault;
- can be sold to anybody, anywhere in the world at a moment’s notice;
- no one actually owes you anything when you hold gold. It’s not a claim on anything;
- has a sense of peace to it as it possesses a financial strength that even some financial institutions can’t boast about.
- Don’t own something you don’t understand.If it is going up, it makes no difference.
- Commodity-based businesses have a low barrier to entry. The acceptance of their product is subject to whims of the public, the buyers;
- Similarly, the companies that provide any sort of transport like aerial, trains or trucks have no operating leverage. They are subject to inputs and costs that are beyond their control, subject to government regulation. So they lack substance.
- While deciding where the probable investible company should be in the structure/hierarchy of production;
- It doesn’t matter where the company stands in the structure of production rather it should have natural barriers to entry based on various factors that make it difficult to compete with;
- Nothing is permanent, so this advantage and these barriers need to be cultivated and the company needs to adapt in order to keep its competition at bay;
- But you don’t want to be partnering in a company that makes something the nature of which is so large as a component of something so as to subject to the seasonal demand or subject to external risks through government intervention, regulation or competition. You want that element of independence to be there.
- Don’t just make an investment because you want to make a quick buck from it, rather have a strong framework and a set of questions that you ask yourself before making an investment.
- Do you like this business?
- Do you understand it?
- Do you want to be in this business?
- What is the history of this firm?
- What is the competitive advantage that this company has?
- What is the larger environment in which it operates?
- Where does the demand for the product come from? In essence, does it come as a result of government policy, subsidy, regulation or does it result from a choice on the part of the consumer, customer etc?
- What are the components that go into this business and how are they regulated?
- What risks are there?
- What is the market for this company’s product?
- How honest are the revenues?
- How permanent are they?
- What are the factors that influence their operating margins or unit growth?
- How have they deployed their earnings in the past?
- How have they grown? A company growing purely on acquisitions or financial engineering is an accident waiting to happen;
- What is the ownership structure of the company, who owns it, for how long and what have they done with it?
- Who are the people involved and how long have they been there?
More often than not when you start answering these questions, you will come across something significant that makes you disinterested in the company.
In a handful of cases, at the very end of your analysis, you will realize that you are onto something substantive, valuable, enduring, scarce, extraordinary, beautiful. It is then that you ask yourself, well what is it worth? Understand that there is a difference between what a company is worth and what it’s selling for.
- What are the components that add to value?
- What are the risks inherent in the business that you would want to take haircuts against?
- How do other people think it’s worth and under what circumstances over a period of time?
- Is it something that’s neglected?
- Is it something that is followed by every mutual fund and ETF in the world? Because if it is then that makes a company uninteresting.
Then ask yourself some broader yet critical questions before you actually make an investment;
- If you could, would you want to own the entire company? Is this something you would want in your collection of assets? – If the answer is no, then why would you want to buy a piece of it?
- If you could own the whole company, would you want the same people to run it?
- Is this business likely to be around 20 years from now? You can get an idea of that by looking at some decision that the owners have taken over the past decades. By looking at the decisions you understand the motivations of those who own the firm and understand whether or not they are sowing the seeds for the next decade or two.
- Investing is not a science. There is no one size fits all or there are no fixed checklistsyou can adhere to. It is a subjective process;
- . Sometimes you come to a quick conclusion to the attractiveness of something. Love at first sight actually happens in investing as well;
- At other times, you don’t love something right away rather you take your time and slowly start seeing value in the company.
- The price is important no matter how good the company.No one can predict earnings accurately and consistently. So, don’t base your investment decisions on ‘potential’ earnings.
Try to develop some mental tools with which to think about the economic value of a business endeavour rather than its financial value. It’s easy to say, ‘ this company sells for X number of dollars a year’ but what’s difficult to say is, ‘what is this company worth and why?‘.
- What is ‘intrinsic value’?
- In its essence, it is a sounds like a necessary idea. Yet, to the extent we wish to quantify it, we end up excluding what is unquantifiable and unseen—the very essence of what concerned the prudent man of olden times;
- We conjure unknown future flows of money, that is, something we guess, from a business whose results are subject to interventions and distortions, or from one that is being hollowed out and sacrificed at the altar of shareholder value, and run by persons who don’t quite care if the company is likely to be around in twenty years’ time;
- We then discount it all by a number—a rate of interest that bears no relationship to anything. We get a number and we compare it to the monetary value of an investment instrument. The math can be impressive to the customer, but what does it really mean?
It means absolutely nothing
- Instead of looking at the stock price fluctuations on a daily or weekly basis, look for the seeds that are being sown today in the company, good or bad, that are likely to bear fruit a year, two, three or four years down the road.
- When you find something that looks very nice in the first instance, ask yourself the question that there is something wrong here. Seek out the reasons why you shouldn’t add something to your collection of assets.
Always be a ‘doubting Thomas’ while analysing investments
- Once you are in a participation with a company, there will be times when you will have doubtsabout something. Here you can create a decision-making framework based on your comfort level with the past actions of the owners of the company.
- Some managements have shown extraordinary faithfulness to their companies, families and shareholders over many years that it’s not worth second guessing them in case it’s a one-off ‘perceived’ anomaly that you have noticed. You need to trust their judgement and decision-making abilities;
- There will be other companies where you would need to second-guess, in that case, seek to get some answers by politely writing to the management;
- If a company has a series of errors and actions that you are not sure are in the best interest of the company long-term, it’s better to quietly exit. As that’s really the only thing you can do, being a minority shareholder.
- It’s not important to be looking for opportunities.What is important is to acquire an understanding so you can recognize the opportunities when you see them. If there is an opportunity, it comes across for everyone to see it but very few people recognize it. So, the people who recognize it are the ones who are prepared to recognise it.
So, what are the tools that will help you recognize opportunities that others don’t;
- Understand the business;
- Understand the sector;
- Understand what the market needs;
- When you go through hundreds of probable investment ideas, you invest a lot of time and effort working on them and in the meantime, you learn something about the process;
- This time spent is never wasted, you keep making mental notes as you go on researching company after company and industry after industry. And the next time the situation comes, you have the tools with which to think;
- In the process, you develop a third or fourth sense of things which sets you apart from the crowd.
- There is no value in reading the financial press.
- The news is not news, it’s fake and it always has been;
- A lot of reports for news are poorly disguised promotions or written by people who have no clue;
- People who are involved in real economic endeavour don’t have the time to indulge in meaningless activities;
- The reason why people are looking at the press constantly and seeing, what do other people do is because their investment decisions are largely based on other people’s decisions. Instead, you should figure out what’s right for you by yourself because you don’t know what the real motivation of the person behind the news is.
- Remember that a play on words can change the whole perspective on how your brain processes things. Over the years, the gambling business has changed its name to the gaming business. This is not by accident. They want to infer to you that there is an element of fun in giving money to the house when all odds are against you.
If you can simply replace the words ‘shareholder/stakeholder in a company’ with ‘participation/partnership/ownership in a company’ in your investing vocabulary, you will start looking at your investments differently especially in terms of your time preferences
- What does the economy or money in the modern day world actually means, is it real or simply an illusion?
- we look at prices on an exchange to reckon value, having failed to see that wealth creation via the stock market does not create resources in the economy. We don’t see that booming markets without savings is not an accumulation of resources but an accumulation of claims on existing resources;
- We hail growth by looking at a meaningless aggregate such as GDP and we hope for higher prices, dismissing the fact that such aggregate growth in money terms more often than not comes from debt creation and the consumption of our capital. Yet we reckon all this as a modern financial miracle;
- We have abolished the idea of failure—nature’s cleansing mechanism. As a consequence, we’ve lost real economic vitality. We’ve substituted finance for an industry as the locomotive of economic growth. In GDP terms, it looks terrific. But it is neither enduring nor real;
- A promise to pay is not money. We dress it up as a bank deposit, a treasury bill or some variation thereto and insist on calling it an asset. But we also laugh at the man who chooses to keep his cash in gold. The price of something becomes our value determinant rather than its characteristics in being real, enduring, or suitable as a means to our objective;
- Dishonest money begets dishonest statistics, dishonest accounting, dishonest balance sheets, dishonest means, dishonest objectives, dishonest compensation policies, and dishonest relationships; that it begets ambiguousness and corruption in every aspect of life—from the loftiest of boardrooms down to the lowliest economic agent;
- We need to appreciate the fact that our own claims, promises and debts are nothing but a false reckoning of wealth. We trade instruments on financial exchanges that possess no inherent economic value. We trust there will always be a bid or a greater fool as they say;
- One of the most nefarious consequences of dishonest money is to destroy our ability and willingness to act responsibly in light of our own judgments. It has led us to replace common sense by compliance;
- We have substituted the law for what is moral and what is right. We have substituted audit checklists for an auditor’s judgment about what is true and fair. And we have substituted phoney mathematics for the judgment we once possessed in understanding the nature of value and that of risk.
- Tony believes that;
Wealth in created on the main street and not on wall street. Our job as custodians of that wealth is to understand the irreplaceability of that capital created over generations of hard work and savings. It must be respected
- The history of business and money is replete with stories of companies like Xerox where fortunes made over a lifetime were lost due to some inappropriate decisions. So, we need to view the financial process with some humility. For unless you inherit it or win the lottery, creating great wealth is quite difficult and, keeping it, is substantially harder.
‘Humility’ and ‘Judgment’ are two foundational traits they don’t teach in Business School. They are impossible to identify or quantify
A little arrogance, over-confidence or lack of judgment results in disaster. Be it money or life in general
- More importantly,
The best thing you can pass onto your children is not money, it’s the way of doing things
END OF ANTHONY DEDEN’s 40 LESSONS
I dedicate this to my daughter Carla Lodewijks Davie, who wanted to save aggressively and so expressed a desire to better understand “Investment”, so that she could better manage, preserve and grow her wealth.
It has always been my contention that
“We spend a lifetime accruing wealth and no time learning how to look after it”,
which is illogical.
When it comes to their investments, most people say: “I find it all confusing and/or I am not interested in all this”, so they can hardly wait to hand the entire responsibility over to some investment broker. However, that is risky, because many brokers are outright charlatans, few “truly” understand their role and/or know what they are doing, and very few are “truly” and “honestly” trying to serve your best interests. Regardless, handing over the responsibility for preserving your wealth is counterintuitive, since
“you can delegate a task, but you can never delegate a responsibility”
Therefore, when your portfolio loses money you cannot entirely blame your fund manager, as it is arguably your fault for not understanding the big picture and participating in the decision-making process. Contrarily, you pay him and so you should be able to trust him to do “everything in his power” to preserve your wealth.
Accordingly, the purpose of this book is not to make you an expert, but to give you an overview of the investment arena, which is remarkably simple, so that you can intelligently engage with your broker. However, while the each of the individual concepts and the overall picture are simple and easily understood, their interactions in the marketplace form a complex matrix of interdependent influences and links, which nobody fully understands. It is important to ignore this complexity and stick with the simple concepts conveyed in this writ, as these will be sufficient. Regardless, I have a problem in that we are faced with a bit of a chicken and egg situation. If I introduce countless basic concepts first, I may lose you to boredom, whereas if I start with the bigger picture first, I will confuse you because you will not understand the terminology and basic concepts. Therefore, I have chosen to go with basic concepts first and hope I do not lose you, as these concepts lay a foundation that will help you better understand the bigger picture. Having said all that, I appeal to you to stick with the overall picture and not get too side-tracked by the plethora of market complexities. To assist you, I have named most individual chapters after each of these concepts, and tried to keep these short, so that you can refer to them if you so wish.
Economics is all about humans, because it is merely a reflection of human activity, decisions and behaviour in the marketplace and business arena. That is, without humans, there is no economy, so it is important to understand how human behaviour in government, corporate and commercial space is impacting on the economy. In fact, it is human interference that introduces much of the complexity and uncertainty. Similarly, it is always good to understand the degree of manipulation of official statistics as this distorted picture can mask huge risks, or present opportunities.
Unfortunately, our world is also becoming increasingly complex as new technologies are facilitating new ways of doing business. These are upsetting conventional economic models and business practices. What I mean by this is that you also need to have a sense of what is going on in the world, as that also has a bearing on “safe” investing. For example: The rate of change of technology can make products or companies (like Kodak and Nokia) obsolete within a year, or birth emerging technologies where the truly great returns can be made. That said, the basics of good business remain the same. For example: Every business must provide good value at the right price. Your revenue should exceed your costs. Good service is critical, etc.
Remember, the primary objective of all this is to preserve and grow your wealth, to ensure that you have enough so that you are not eating dog or cat food in your latter years. Therefore, you and your broker should strive to adopt strategies that will reliably achieve this in the long term. In the process, small, short term losses cannot be avoided, but big and longer-term losses should be avoided at all cost.
It is important to understand the investment markets are dominated by two emotions, namely Fear and Greed. Broadly, when markets are rising significantly and rapidly, they are frequently being driven higher by Greed as people are fearful of missing out. Contrarily, when markets are falling significantly and rapidly, they are frequently being driven lower by Fear as people are fearful of losing more. Because of this, the basic investment strategy known as “Buy Low and Sell High” is easier said than done, because the right time to get in is mostly when everyone says “stay out” and the right time to get out is when everyone says “buy, buy, buy”. After a crash, there is usually widespread fear, as people have lost money and are reluctant to get back into the markets, even when they have been rising for a considerable time, because they fear there is more downside to come. After the markets have gone up significantly and when everyone is talking about the money to be made, people experience greed and get back into the market, albeit when it is approaching a top, which is actually often the time to get out. Markets typically boom to the point where investors experience “irrational exuberance” feeding of greed, which means the markets have risen higher than is justified by rational valuations. This is why they say of any big generational bull market that “when the financially ignorant, especially the bellhops and waiters” are telling you what shares to buy, it is time to get out. This is also why Baron Rothschild said: “the time to buy is when there’s blood in the streets“, i.e. when people are slitting their wrists. This is also why the truly clever investors are often referred to as contrarians as their philosophy is “When everyone is getting out, they get in and when everyone is getting in, they get out”.
It is important to remember that each of us has his/her own biases and preferences. Therefore, the purpose of this “book” is to give you insights, not answers, to make you think whether, or not, you agree with everything I say. Once you truly understand the basic concepts properly, do not dwell on any single aspect. Rather allow your intuition to assimilate the big picture and guide you.
The chapters that follow progressively explain the most important aspects and considerations of investing. Bear with me as you need to grasp every concept, before we can progress to the bigger picture. Have fun – I tried to keep it short.
MOST IMPORTANT: I think it should be something you really want to do willingly!!!
I say this because it should be a positive process with an optimistic purpose, like that you are expecting to live long and are investing now so that you can enjoy a good lifestyle in later life. It should not be a grudge obligation you do now out of fear, because you are scared you will end up eating dog food in your old day. If you do it reluctantly, you never put away enough, whereas you do if you do it willingly.
MOST IMPORTANT: Financial Planning is the process of securing your future financial freedom with immediate effect. It is about ensuring you can maintain your lifestyle from today onward into your retirement in the distant future, no matter what!!!
That means you are taking the necessary precautions to ensure you are able to maintain your lifestyle, even in the event of a life changing event, which means you are going to strategically consider, and properly address the following:
- Death – which means insurance, preferably taken out at a young age. This is particularly important once you are married with kids, to help your spouse cover costs in the event of your death.
- Disability – which means income protection and/or lump sum disability insurance.
- Retrenchment – which suggests it is prudent to operate with minimum debt, maximum savings reserves, income producing hobbies, passive sources of income, etc.
- Un/Self-Employed – the technologies of the future suggest you are more likely to be self-employed in the future. Foster the skills needed to secure your future in the self-employed space. For self-employed people, saving becomes more essential, difficult and requires greater discipline.
- Economic crisis – ensure you adopt defensive strategies and hedge against crises. A book called Antifragile, helps put this into perspective.
- Marriage and Divorce – starts with a good antenuptial contract but is more about planning that both parties will be well provided for, in the eventuality.
- Retirement – this is the costly biggie, presuming none of the others come to pass.
How much should you be putting away. At least 15% of your after-tax income, but preferably between 20%-25%. This is easier to do before you have children and after they have left the house. More about all this later.
It is not clever to hope you will have enough money later. Most people live beyond their means. You may think you do not have enough money, but then you have to figure out how to “MAKE DO WITH LESS”. Once you have made that decision, it is amazing how many ways there are to save a bit here and save a bit there. More important, while these sacrifices may impact on an opulent lifestyle, they do not have to rob you of a wonderful life.
Here are some tips:
- Decide how much you need to save for your retirement, presuming you will live to the ripe old age of at least 100, which is increasingly likely as medical technology advances favour longevity. Put that away first and adjust your lifestyle to live off the rest;
- Set aside some money for emergencies.
- Set aside some money for holidays.
- Where possible, take out insurance to protect yourself in the event of crises.
There are many books that deal with this sort of thing. One of the best, although it is a bit Australia centric, is The Barefoot Investor. Done with considerable humour, it is the perfect book for those who are struggling to keep their heads above water, as it provides a step by step guide on how to recover, find your feet and then prosper.
This chapter reveals the matrix/framework within which all investment strategies fall.
As with all things in life, true success ultimately lies in the art of getting the basics right. The basics are not rocket science, so you do not need to be an investment expert to grasp them adequately. While you mostly need to use brokers, because the public cannot deal directly with funds, it is important that you understand the gist of what they are saying and participate in the selection of the optimal strategy. Ideally you should arrive at their offices with a broad strategy that you refine with them. If you’re able to shuffle your own investments without a broker, understanding all this becomes critical.
The first important thing to understand is the broad risk reward concept, that higher returns/rewards usually come with higher risk. The slide below perfectly illustrates the conventional, albeit simplistic investment strategy map. There are times when it is justified to pursue a more aggressive strategy, such as when you are young, equity markets are undervalued and/or equity markets are growing strongly. Contrarily, there are times when it is better to adopt a more conservative/defensive strategy, such as when you are older, or the markets are overvalued and/or toppish.
This brilliant slide by Chris Hart, a South African economist tells the story
The conventional investment strategies below, illustrates that you are continually trading off Risk and the Reward. i.e. The higher the risk, the higher the reward, and, the lower the risk, the lower the reward.
I explain and elaborate on each of these asset classes in subsequent chapters. However, before I do, I highlight some matters in the next three chapters, that have a bearing on our evaluation of each of these asset classes. This is because they illustrate that Government intervention and Greed have skewed the investment playing field. Thereafter, I highlight the role of interest rates in pricing these asset classes, which is needed to enable us to compare these when selecting our optimal portfolio.
Bear with me as we will encounter a few minor chicken and egg situations henceforth.
Before we discuss investment, you need to understand Fiat money. Statement:
- The Gold Standard, which prevailed until the early 1900’s, provided a stable currency, which held its value and fostered an honest and just society; Contrarily,
- Fiat money allows for the continual debasement of the currency to the point where you end up with a corrupt and unjust society.
The word “FIAT” means “by Government Decree”, or just “because the Government says so”. Therefore, Fiat money means that the money only has value “because the Government says so”. It is critically important that every person on the planet, especially the youth understands the concept of Fiat money and the role of money. This is because that which we call money today is not really money, in the sense that it is no longer a store of value as it was under the Gold Standard. Instead it is merely a medium of exchange that will “progressively” become worthless. In fact, most currencies have lost more than 99% of their value in the past 100 years, as evidenced by the fact that things were far cheaper in the old day, before inflation eroded the value of the currencies. You could buy a loaf of bread for a penny. So, what does this have to do with you and your investments.
Back in the 1800’s and early 1900’s, the Gold Standard prevailed. For example, on the Gold Standard, one could exchange a USA $20 note for 1 oz of Gold. This meant that money served as an actual store of value and its value remained constant or appreciated. Under the Gold Standard, new money could only be created whenever new Gold/Silver was extracted from mines. This meant money was not plentiful and that Governments had to balance their budgets. Politicians did not like this, as it “cramped” their freedom to spend frivolously. More specifically, it restricted their ability to buy votes to remain in power, and to enrich themselves and their cronies at the expense of 95% of the population. Therefore, they conspired to abandon the Gold Standard. The next brief paragraph reveals a very important piece of US history that negatively influenced the entire world – trust me, this is fact, you can google it.
From October 1910 until December 1913, US politicians and corporate bank executives conspired, in a series of secret meetings on Jekyll Island, to create a US Central Bank. Remarkably, the US Federal Reserve bank is owned by big US and International banks, not by Government. Then, on 5 April 1933, President FD Roosevelt signed an order prohibiting public ownership of Bullion coins, which were confiscated in exchange for paper money which could not be converted back to Gold. This meant the US was off the Gold Standard and had adopted a Fiat Currency at domestic level. Finally, in August 1971, the US Dollar became a fully-fledged Fiat currency when Nixon declined to pay France “Gold” to settle their trade surplus in terms of the Bretton Woods agreement. During the next two decades, the rest of the world also abandoned the Gold Standard in favour of Fiat currencies.
NB! The absence of the Gold Standard is not a problem if Governments continue to practice fiscal discipline with balanced budgets. However, the entire point of the conversion to Fiat currencies was so that governments could print at will and indulge in deficit spending.
Subsequently, the USA, UK, EU, Japan, China, and the rest of the world have all increasingly indulged in deficit spending to the point where the cumulative debt of these great countries now far exceeds their GDP. In smaller countries, this is usually the tipping point at which they are deemed bankrupt and can no longer borrow internationally. However, because the above countries are big, print their own money and have “international” currencies they can continue to print, and their debt continues to spiral out of control. In addition to this ever-increasing pile of debt, these governments have made generous promises to public servants and the electorate relating to future pension and other benefits. Now it is important to realise that this translates into future payment obligations that should be added to current debt. These “unfunded liabilities” typically push the national debt to levels in excess of 300%, and even 400% of GDP. The bottom line is that this debt, that continues to increase exponentially, can and will never be repaid. Therefore, they are burdening future generations, including their children and grandchildren, with the repayments of these debts that arose due to their lack of fiscal prudence. Remember, any entity that cannot repay its debt is effectively bankrupt. This is obviously a problem because politicians today are kicking the can down the road, because they will no longer be in office when the problem manifests.
However, there is a second problem. As the debt escalated, Governments’ debt service costs escalated, and as these debts escalated, Governments had an increasingly vested interest in keeping these debt service costs low. Accordingly, they started to buy their own bonds and, in so doing, were able to artificially suppress interest rates. This created a host of problems for the free market system, because the market was no longer able to evaluate risk and was increasingly mispricing assets. I elaborate on this in a subsequent chapter. It should also be noted that, in the longer term, interest rates and inflation tend to move in lockstep.
Essentially, all this means that money can no longer be deemed a store of value, because it is now merely a rapidly depreciating tool for facilitating transactions. Fiat money is merely a piece of paper, which has no value, beyond that which the Government decrees. More specifically, such money no longer has any value once people lose faith in it, which usually happens during hyperinflationary periods. If you think about it, that bill you get in exchange for goods you sell is a worthless piece of paper unless you spend it. One day when people lose faith in that currency, as they did in Weimar Germany, Zimbabwe and Venezuela, to name but a few, nobody will want it. It is like musical chairs. You are fine, until you are not.
Today all the currencies currently in use, are printed virtually at will, at the behest of politicians and bankers, which accelerates this loss of value. This excessive printing of Fiat money both precipitated and exacerbated the recent global economic crises of 2000/2003, 2007/2009 and the current CV crisis of 2020 to say 2025?
Understanding all this is important as it will enable you to better evaluate the investment arena and climate. This will become clearer as we progress from chapter to chapter.
In the next “sub chapter”, which you may skip, I provide a detailed explanation of Fiat money for those who still do not understand it, or for those who want to understand it better. It is long. However, even if you think you know it, it is worth reading so you “understand” it WELL!!.
MODERN FIAT FRAUD MONEY vs GOLD – THE ONLY REAL MONEY
Explanation of Fiat Currency (paper money – not on the Gold Standard)
Only to be read by those who truly do not understand Fiat money, or those who want to understand it better.
How did our money become worthless and what are the consequences?
This is of necessity lengthy to uncomplicate it.
To make it easier, I will explain why – in very basic and detailed stages:
- Before Coins and Paper Money, Barter Trade Barter of farm produce, manufactured goods, jewellery and, obviously, precious metals such as Gold and Silver. The latter have been treasured by all civilizations for millennia. The essence of this “Barter” system was that you could not buy something if you did not produce or have something to exchange. You always had to make a product or offer a service in exchange for the product or service you wanted. As civilization and the complexity of products and services on offer progressed, Gold and Silver played an increasingly critical role in this barter system. This was because people often wanted a product and did not have any products or services that the supplier wanted at that moment!, so they paid the supplier with Gold or Silver, which served as a universal unit of exchange. Gold and Silver also solved any problems that arose if the products the two parties wanted to exchange were of disparate value as they were divisible. Essentially the Barter System comprises the exchange of effort, typically priced in “Man Hours” – remember this;
- Next came coins. The need for coins arose because not every trader had a scale to weigh raw gold or silver or the means to test its purity. Therefore, coins were minted that had a specific weight and an implicit authenticated purity (alloy assay). However, with time, some people would shave bits of Gold or Silver off the edges of each of the coins they handled, and hoard this until they had a fair bit of Gold or Silver. The result was that with time, coins were no longer round and no longer complied with their original specified weight, which defeated the purpose. To counter this, the next generation of coins had “reeded” (riffled edges) and laws were passed making it a punishable offence to deface coins. NOTE! – each and every coin was a Gold or Silver asset that could be exchanged for goods in the Barter Trade Tradition;
- Next came transport companies and then “banks”. Moving large amounts of Gold and Silver was problematic due to the risks posed by highwaymen. In response, transport companies such as Wells Fargo originated that used mule trains, wagons or stage coaches that were accompanied by security personnel to transport the Gold and Silver. Since these companies needed safe secure offices at the start and end points of their run, where the Gold and Silver could be stored, they also became custodians of money. Sometimes the Gold and Silver were moved from the transport companies to storage “Banks” in the city. So the first banks were custodians of money for a fee;
- Note! For ease of reference I may sometimes use Gold as a generic for Gold and Silver.
- Next came promissory notes. Any person who had Gold at the bank would hand write a note to the bank instructing it to “pay to the bearer” i.e. “on demand” a specific amount of his gold as payment for the goods received during their barter transaction. NOTE! – at this stage, the banks were holding Gold, not money. The notes merely served as confirmations of transfer of ownership of the Gold held in custody by the bank, from one person to another. These hand written effectively functioned like a modern day cheque;
- Next came Bank Notes. Effectively, the abovementioned personalised notes were often passed from one person to another or won in a poker game, so the person presenting the note to the bank was not necessarily the original holder. As a result, the banks started issuing notes with standard values, partially since these were far lighter and easier to carry. So if a person put – say 50 ounces of Gold on deposit, he would get fifty Twenty Dollar notes as each ounce was worth Twenty US Dollars until 1931. Each bank issued its own Bank Notes and each Twenty Dollar note had words such as “I promise to pay the bearer on demand – 1 ounce of gold” or for lesser value notes – “I promise to pay the bearer on demand – 1 ounce of sterling silver” (this is where the UK’s “Sterling” originated – Sterling is 92.5% pure silver alloy). NOTE! Each bank would hold an amount of Gold and Silver exactly equal to the amount of Bank Notes issued and if someone withdrew his Gold or Silver, he would exchange the Bank Notes for the metal and the Bank Notes would be removed from circulation, torn up and/or burned. It is critical to understand that each note represented real Gold or Silver that was being held in custody for the owner. The banks were not the owners of the Gold or Silver, they were merely holding it in safe keeping for the owner for a fee. Therefore, when a man was holding a bank note, he was – in effect – holding “proof of ownership of Gold” and when he gave it to another in exchange for goods, the seller of those goods would now be the owner of that Gold. Note furthermore, that there was no such thing as credit or interest, there were only bank custody/storage fees. Instead of credit, people with money used to grubstake entrepreneurs, meaning they used to advance them money for food and equipment, or invest in their business venture. In return, they usually became part owners – ie. shareholders – in the venture with the promise of a pro-rata profit share if the venture succeeded. Note! Their capital and income were at risk. Broadly speaking credit and “interest” are a more modern habit that was encouraged to facilitate growth. Sadly, it also facilitates insolvency of banks, corporations and/or individuals. So it was that the banks were owned by private individuals and, if they did well, from custody fees and were not robbed, the owners of the bank used to become wealthy and grubstake entrepreneurs. Equally, if the banker knew of a good investment prospect, he might encourage a few of his wealthy clients to invest money in the venture as they would be indebted to the banker if the investment paid off. Note, there was no guarantee of a return of or on investment as the lender would get nothing if the venture failed. This investment vs credit approach is how the Muslim Sharia banking system works to this day – although they are “getting creative”. Remember, this was an era where a man’s word was as good as his bond and bankers were mostly honest trusted individuals;
- Now for the sad news – bankers increasingly became dishonest. First, some banks started realizing that their bank notes were being passed from one person to the next without the Gold being withdrawn. They then printed more money than they had Gold on deposit on the assumption that not all the depositors would show up simultaneously to withdraw their Gold and, therefore, no one would ever know. They then invested this additional “non-gold backed” money in diverse projects. This was effectively theft, as it meant that if all the owners of their bank notes arrived simultaneously to collect their Gold, that the bank would not have enough to cover all the bank notes and many people would not get the Gold or Silver that was rightfully theirs. Naturally, all these extra notes enriched the bankers and this system would work for as long as no one became aware of what the banker was doing and for as long as all the depositors did not arrive at the same time to withdraw their metal. Effectively this was hugely dishonest as the bankers were creating wealth out of thin air, investing that money and earning profits that they were not legally entitled to. Naturally, some bankers became greedy, took this too far and issued notes in many multiples of the Gold or Silver they had on deposit. This fraudulent practice became known as fractional reserve banking, as the banks only held a fraction of the Gold reserves they were supposed to in relation to the money they had in circulation. NOTE! It is theft, whether or not the depositors arrive to collect their Gold and it is dishonest since the bankers are enriching themselves at the expense of others;
- Next came Government Central Banks. Initially, Municipalities and Governments collected money, comprising Gold and Silver coins and later convertible bank notes, by way of taxes. They stored this money in privately owned banks and spent it on community projects creating the necessary infrastructure for the citizens to share. However, eventually there came a time when the dishonesty of private banks had to be addressed and Governments created Central Banks. They confiscated the Gold and Silver from the privately owned banks, thereby becoming the custodians of the public’s Gold and Silver, and issued Government Currency Bills in exchange. Remember, as explained previously, the Government was now the custodian of the Gold or Silver of its citizens – it was not the owner of that Gold or Silver. Again, the notes were endorsed with the words “promise to pay the bearer on demand X ounces of Gold or Silver”. NOTE! – This system is known as The Gold Standard as paper bank notes could be converted to Gold and/or Silver). However, when countries are on the Gold Standard, there has to be strict fiscal discipline for a number of reasons:
- Firstly new money can only be printed either when the miners have mined new Gold or Silver, or when the country has exported more than it imports and earns foreign currency that they can exchange for the Gold or Silver held by the other country’s central bank;
- Secondly, if the country’s trade deficit is too big, its foreign trading partners can demand that the deficit is settled in Gold. In this way Gold (Wealth) is transferred from the importer to the country that is able to produce more efficiently or cost effectively. This transfer of wealth leaves the importer country poorer, which causes its currency to weaken, which, in turn, improves its competitiveness and enables it to grow its exports. Contrarily, the exporter becomes richer as it “earns Gold” and so its currency becomes stronger. So you see that purchasing power parity is maintained by the exchange of Gold Wealth and improved Manufacturing Efficiency reflected in Export Competitiveness;
- Thirdly, because there is a specific amount of money, and not an ever-growing unlimited supply, there is virtually no inflation and so, Municipalities & Governments have to stick to their budgets.
- This puts massive pressure on Governments to properly manage their economies and maintain strict fiscal discipline and this did not suit modern politicians who are using the media, tax breaks, manipulated inflation statistics, social subsidies etc to garner votes, stay in power and enrich themselves. As a result, elected officials started bending the rules for their personal convenience;
- In time, this brought about seriously distressing dishonest practices by Governments that included three major aspects;
- First, Governments adopted Fractional Reserve Banking (explained above) and pushed this to the point where Central Banks only held “at most” 10% Gold in relation to the amount of money in circulation. This meant that if all the nation’s citizens were to ask for their Gold simultaneously, only 10% would get their Gold. Remember – “This is effectively theft, since the Gold originally belonged to the citizens, who would now no longer be able to get the Gold that was legally theirs”. “This was also dishonest since the Government created wealth that did not actually exist”, which enabled the politicians and bankers to enrich themselves. Initially this progressive fractionalisation is inflationary as it increases the money in circulation despite the fact that the output of the country remains fairly constant;
- Secondly, the Central banks subsequently abandoned the Gold Standard, thereby disenfranchising the public of any right to claim the remaining 10% of their Gold. Again this is theft of the wealth of the very citizens the government officials are supposed to be serving. I stress, this meant that citizens were no longer entitled to claim the Gold that was legally theirs as it had effectively been confiscated by the Government. In the USA, this happened on a national level in 1933. However, for the period from 1933 until 1971, there was a sovereign Gold Standard, meaning that foreign countries could still claim payment in Gold. In 1971, France came to the USA and demanded payment in Gold to settle the USA’s huge trade deficit with France. Nixon then became famous because he declined, effectively declaring that the USA was bankrupt. The USA had frittered away its 21 000 ton Gold reserves of the 1950’s and owed more than 38 000 tons – Google “Frank Veneroso’s Gold Book”. At this point, the US Dollar and subsequently all currencies in the World abandoned the Bretton Woods system and the Gold Standard and became “Fiat Currencies”. The Latin word Fiat means “let it be done” and paper money is called Fiat currency as it was created by no more than Government Decree. Fiat Currency is the term for paper money that is not backed by Gold or Silver and in the history of mankind, every attempt at sustaining a Fiat Currency has failed and there have been countless attempts. NOTE!- I quote the USA, but all currencies are now Fiat with Switzerland the last to abandon the Gold Standard in 1998;
- In the same way that paper money is now worthless, all coins used to be made of Gold, Silver, Nickel and Copper, metals that had intrinsic value – Eg. a Silver Crown that was worth 50c in 1950 would contain almost R250 of Silver today (1/5/11). Today, all coins are made of plated steel and are worthless.
- Finally, the ultimate dishonesty of this whole system is illustrated by these two sentences:
- Originally, with “Real Money”, when you sold something and someone gave you money, you could take that paper money and go to the bank to get your gold – which represented your due -THE OTHER HALF OF THE BARTER TRANSACTION; but
- Today, with “Fiat Money”, when you sell something and someone gives you money, he has actually given you a worthless piece of paper. This piece of paper only serves as money for the purpose of facilitating another trade and for as long as people believe in it, as it actually has ZERO value. Worse still, due to the fact that Governments print more at will, it constantly loses value until it is worthless like it was in Zimbabwe, etc. Currently, it is like global musical chairs, as when the music stops i.e. currencies collapse, those holding paper money will have nothing.
- There used to be a joke that Paddy got an overdraft at the bank and he was given a cheque book. After a month or so, the bank manager called to tell him his account was overdrawn, to which Paddy cheerfully replied “no problem, I will come in and pay you with a cheque”. This is exactly what the US Fed and other central banks are doing, more blatantly than ever before in the history of mankind, with their “Fiat Money System” as they openly buying back Bonds/Treasuries with newly printed “costless” paper money. Confirmation? – Read this really excellent and revealing article by Ty Andros
Read this article by Bill Gross, the MD of the world’s biggest bond fund
THIS IS THE TURNING POINT.
Up to this point, paper money on a Gold Standard represented a “REAL ASSET” that could be accumulated as that represented an increase in “REAL WEALTH”. The day Central Banks abandoned the Gold Standard, paper money became nothing more than a medium of exchange, a piece of paper that facilitated trade and a record that a barter transaction had taken place. For as long as Governments exercised fiscal discipline, this system worked, but greed intervened, fiscal profligacy prevailed, and staggering amounts of paper money were created. Accordingly, paper money could no longer be relied on as a store of wealth or value as inflation was constantly eroding its value and it could become “TOTALLY” worthless at any time. The proof of this is that the Dollar and most other hard currencies have effectively lost 98% of their value in the past 100 years. The evidence is that prices today are astronomically higher than they were 100 years ago. This is what happened in Weimar Germany, Argentina, Zimbabwe, Venezuela, etc, except on a hyperinflationary scale. It is important to note, that we need paper money as a medium of exchange as the big problem with pure barter trade is that each person has to want exactly what the other person has to offer. Furthermore, in barter trade the values of the items traded have to match approximately as you cannot get half a car as change if the price of the house is equal to the price of 2.5 cars. Paper money is also more convenient as it is light, transportable and more easily divisible than an ounce of Gold.
Essentially the initial requirement of money was that a) it must not tarnish and degrade over time, b) that it should have a high value to weight ratio to make it easily transportable and c) that is should be easily divisible. This is why coins were made of Gold, Silver, Nickel and Copper in days gone by. Paper money backed by Gold and/or Silver was preferred as it was light to transport and easily divisible – Gold and even Silver coins could not be easily used to buy low cost items, whereas Nickel and Copper coins could. Personally, I can live with metal plated coins, as these represent a small percentage of our wealth, but I cannot accept Fiat paper money in the absence of some system of absolute control over Government statistics and money printing activities. The primary trouble with Fiat paper money is the irresistible temptation to print and, in so doing, to create inflation – i.e. devalue the paper money.
- FINALLY – THE UGLY TRUTH OF FIAT MONEY. Throughout history, no Fiat Currency has ever survived. On the other hand, from Daily Reckoning comes the appropriate contrary question: But if gold is the best money, how come we don’t use it rather than dollars? Lord Rees-Mogg explains: “The problem for gold is not that it doesn’t work, but that it works too well…it imposes limits on human behaviour, and those limits can be resented and rejected. Indeed, it can become impossible for a government to maintain the discipline of gold…”. For as long as countries maintain fiscal discipline, by balancing their budgets, and trade deficits remain low, the “Fiat” currency system works. This is because the books can be balanced. ie. The amount spent by Government equals the amount gathered in taxes and/or the amount of goods sold and the amount of goods bought cancel each other out and the countries have been “Paid” in imported goods in exchange for their exported goods. However, under a Fiat Money Regime, it is too tempting and too easy for a country to run up huge budget and/or trade deficits and simply print money at will & low cost to cover budget and trade shortfalls. e. Governments (read Politicians) can spend more than they earn in taxes, usually to fund their own agendas and line their own pockets. This is especially true since the consequences of deficits incurred today are transferred to future generations so it is unlikely that the current government can or will bear the consequences or be held accountable. Bottom line, in the absence of balanced budgets, deficits will increase to the point where the accumulated debts can no longer be paid. This practice of creating money that is not backed by Gold, Silver or Other Assets is classically called Monetisation or more recently Quantitative Easing, which is exactly what Weimar Germany, Yugoslavia and Zimbabwe did. The problem is that once Governments start printing, it is too tempting and too easy to do so again and, then it inevitably spirals out of control in ever increasing amounts as the currency weakens. The USA has over the last decade printed massive amounts of Fiat currency, lived beyond its means and run up huge budget and trade deficits. In fact, the USA trade deficit with the rest of the world is in excess of $20 Trillion (2020) – that is a pile of $100 bills over 20 000 / twenty thousand Km high. NOTE! That means the USA has imported $15t more than it exported or that the rest of the world has given the USA $15t of goods in exchange for worthless paper. Today the USA, UK, EU, Japan etc are all printing money to the point where it can no longer be accounted for and is probably being “Taken” by those in power to enrich themselves. The perfect modern day illustration of where this rabid printing of money leads is the Zimbabwe Dollar. They printed Zimbabwe Dollars to the point where no-one wanted them and only Gold, Silver or “harder” foreign currencies were deemed acceptable, albeit as an illegal black-market currency. This same scenario is currently in the fairly early stages of unfolding in our modern global monetary system. The more money the USA prints, the cheaper their currency becomes and that makes USA products cheaper into the EU and the rest of the world, which gives the USA an unfair advantage. To combat this, the rest of the Central Banks of the world have commenced printing extra money to make their currency weaker and regain their competitive advantage. This has led to a spiral where Central Banks are printing more and more money in a never ending cycle of competitive devaluations that is currently being referred to as a “currency war”. This could make all paper money worthless if it is allowed to go too far. The consequence of printing excess money is inflation, which is best explained by a simple example as follows:
- When you print too much money, you eventually get inflation and actually weaken your currency. It works like this – say two countries each produce a million units of goods and have a million units of currency. That means that one unit of Good is worth one unit of Currency. One country then doubles the currency in circulation overnight without increasing the total goods produced – obviously people will be willing to pay two units of Currency per unit of Good instead of one – which is inflation. Now the other countries that did not increase their currency are still operating on one unit of currency per good, therefore, your currency is now worth half what it used to be, as good for good, we would now be exchanging two units of your currency for one of theirs. That is why, when your currency loses value, you become poorer relative to everyone else in the world and you get inflation down the road when you print too much money. However, the magnitude of the inflation is difficult to control if you continue to print too much money, as there is a lag before higher prices filter through to the economy and a distorting factor called velocity. Velocity is the rate at which money changes hands and lower velocity = lower inflation, whereas higher velocity = higher inflation. So, as is currently the case in the USA 2000 – 2020, lower velocity can temporarily offset higher money supply. This latent inflation is being further offset by deflation is being imported from China in the form of lower prices and automation is bringing down costs. In essence, the more you print the greater the risk of things getting out of control, at which point you get sucked into a never ending inflation spiral that leads you to the situation Zimbabwe was in. Contrarily, for deflation to manifest, there has to be a contraction of the money supply, with central banks raising commercial banks fractional reserve limits on the one hand and literally collecting money and burning/ destroying it on the other;
- The fact that the increase in money supply has been countered by the reduction of the velocity of money is beautifully illustrated in the following two charts:
The Money Supply Stock virtually quadrupled since 2000.
The velocity of money has virtually halved since 1995.
Today the world has been printing excessive paper money for decades, but particularly since 2008/2009 and even creating it by computer. In September 2012 the US engaged in QE-infinity, because the USA waved any limit. Initially, QE benefited the banks and stayed in the banking circles, which meant it did not get out in the public domain where it would create inflation. However, banks have realised that the Federal Reserve in the USA will not allow a major collapse of the economy, so they are increasingly finding ways to strongarm the US into opening the spigots. However, in time, this money will leak out into circulation. This will inevitably lead to inflation, which will, in turn, lead to greater amounts being printed (Currently the inflation figures are manipulated lower to obscure the rising prices, but we all know food, fuel and medical costs have more than doubled of late). However, if all countries are printing money to devalue their currencies relative to the others, there could be no relative weakening of one against the other and therefore no differential price inflation between one country and the next. If this is the case, the deteriorating value of the global currencies will only be reflected in the rising prices of Gold and Silver which are the only Real money and represent Real value. This situation where money is printed in such excess will, almost certainly, spiral out of control as the global currencies approach a Zimbabwe Dollar situation, especially the if velocity of money increases and the lag effect comes into play. I believe the situation will not be allowed to get totally out of control as it did in Zimbabwe before some fiscal sanity prevails and some fiscal discipline is re-introduced by way of a return to some pseudo Gold Standard. By virtue of the fact that the US Dollar is still the world’s reserve currency, countries with huge trade surpluses, like China, India and Russia will put a stop to it before the value of their surpluses is eroded excessively. But until then, investors are going to flee depreciating currencies and “Go for Gold and Silver” as the ultimate, time tested, store of wealth in troubled times.
To summarise the “inflation” issue, I leave you with this quote by Greenspan:
In 1966/67, long before he was elected to the Federal Reserve, Alan Greenspan wrote a piece in which he said: http://www.constitution.org/mon/greenspan_gold.htm
The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. Deficit spending is simply a scheme for the hidden confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard. Alan Greenspan
Subsequently, after he was elected, he was asked about this quote and he said
“I stand by every word of it”.
In October 2013, Greenspan said: “Gold is a good place to put your money these days, given its value as a currency outside of the policies conducted by Governments” and Greenspan characterized the job of Fed chairman as one “subject to the heavy dictate of the federal government”,
THE USA AND THE WEST ARE FOR SALE
Because the USA has imported $20 Trillion more than it exported, this means the USA has effectively been paying others for imports with worthless paper dollars and running up huge trade deficits. ie. In a fiat currency regime, the greater their trade deficit, the more products and services they have managed to get for free (contrarily, if there is no trade deficit, the imports would have cancelled out exports and each party would have exchanged products and services of equal value). Therefore, for as long as their creditors do not spend these dollars in the USA, the USA got their imports for free. The USA knows this and is blocking China from purchasing huge US organisations, because they are supposedly “strategic assets”. Furthermore, for as long as these creditors like China and India spend their US Dollars buying the assets of other countries, they have transferred the problem of these potentially worthless dollars to those countries. Ideally no country should hold onto the dollars as they are rapidly losing value (purchasing power). It is important to note at this point that the USA has commenced monetising its debt, which means it is printing money like Zimbabwe and the faster they print money the faster it loses value, until finally it becomes truly worthless even for buying assets. The only way justice would be served would be if everyone spent their dollars buying the assets of the USA, failing which it is musical chairs and some poor sucker is left holding the worthless dollars. Remember, I refer to the USA as a proxy for the rest of the World, as Japan, the EU, UK etc. are all engaged in rabid printing.
As Thomas Palley, a Washington-based economist wrote last year, – “Printing a $100 bill is almost costless to the US government, but foreigners must give more than $100 of resources to get the bill. That’s a tidy profit for US taxpayers.” Similarly, John Connally Governor of Texas said to a bunch of European politicians – “The US Dollar is our currency, but it is your problem”.
It is important to note that a Fiat Currency system will only survive for as long as all the people believe in it. When that belief was suspended in Zimbabwe, people reverted to barter trade and trade in safe currencies like Dollars, Euros and Gold. If this belief is suspended on a Global basis and all Fiat currencies collapse, people will revert to barter trade and/or trade with Gold and Silver as it was in the first paragraph at the start of this article, since there will be no currency that will be perceived as safe and certainly not one that is big enough to replace the Dollar and/or the Euro. And so the whole cycle will start again. Remember, essentially “barter trade” means that people are exchanging “Man Hours” i.e. the value of all products in any new currency will once again revert to the “Effort or Man Hours” required to produce that good – which will be the cumulative labour cost embodied in the production of each product. Eg. The value of a house is the value of the labour cost of taking iron ore out of the ground, plus the labour to create the steel, plus the labour cost to manufacture the skill saw, plus the labour cost to cut the timber, plus the labour cost to build the house etc. Therefore, when all currencies collapse and a new currency is introduced, all tangible assets will have a value that will once again be determined by the cumulative labour cost of the product expressed in the new currency. For this reason, during this period of insane “FIAT” printing, I favour tangible assets like Gold, Silver and Property, which can never lose their “labour” value, over intangible assets like cash, bonds or derivatives. For this reason I stay away from banks.
So now that we understand that “Money”, which used to represent “Real Wealth” is now an “Empty Fraudulent Promise”, we need to better understand Wealth and, more importantly, the difference between “Real Wealth and Nominal Wealth”. This is covered in the next chapters.
Due to the fiscal imprudence of this era, it is a time to own Gold and Silver until the Fiat Currencies have been exposed for what they really are and that is in the process of happening now. This statement is truer now than it was 20-30 years ago, because the amount of Fiat Money being created is totally out of hand and all economies are experiencing negative growth together. The USA, EU and Japan have just announced (2019) that they will print as much as is needed indefinitely i.e. printing to infinity. Remember, “ALL” modern currencies are Fiat and the proposed new benchmark currency, the IMF’s Special Drawing Rights (SDR’s), is merely another Fiat currency that will have a value represented by the “Weighted average of the world’s biggest Fiat currencies”. Already it is impossible to say how much money major economies have in circulation due to manipulation and the fact that money is generated by computer at the stroke of a key, so how are they going to monitor the basket. Imagine a basket that has to be reset every week or month because the US, UK or EU continued to print money at a rabid pace – what a joke – as it completely defeats the purpose, which is exchange rate stability. Furthermore, as the IMF is managed by the Fiat culprits, namely the USA, EU, UK and Japan, its SDR’s will also be open to manipulation for political expediency and, therefore, in no way represent future stability or absolute fiscal discipline. Imagine if they all agree to increase their money supply by an equal percentage, that would keep the SDR constant but effectively devalue it against all other currencies. This excellent article by Richard Mills explains a proposal by Maynard Keynes that could have provided an elegant solution to the above dilemma http://www.marketoracle.co.uk/Article34000.html. However, US Self Interest prevailed over Global Community Interest and this proposal never saw the light of day – until now that is, as the Chinese have tabled it and favour its adoption. Therefore, eventually there will have to be a reversion to some sort of Gold Standard (see below). China is accumulating Gold at a pace and has hinted that it will revert to a Gold Standard. Many other BRIC, Middle and Far East countries are doing the same. Utah just approved a Gold Standard (31/3/2011), albeit only for Gold coins at face value, which is perfect if the US currency collapses as goods will then be re-priced any way http://www.mineweb.com/mineweb/view/mineweb/en/page72068?oid=124156&sn=Detail . Eleven other states are considering similar steps. I think this is a big deal. The question is – will this spread to other states listed and then to the rest of the world, or is this a once off?
Read this remarkable article exploring Global Political and Economic Governance – http://www.marketoracle.co.uk/Article23789.html.
The following remark extracted from
http://www.gold-eagle.com/editorials_08/kosares012411.html almost puts it in a nutshell. Benn Steil too echoed the thinking of Robert Mundell in his speech delivered in 2008: “. . .if you go down the line of currencies around the world, you don’t find many attractive opportunities. And that’s why I say if the world were to give up on Dollars and give up on Euros, they’d probably go back to the old standby, which is gold. And I don’t mean by gold, government run gold standard, like we had in the late 19th century. That’s politically impossible. Governments will never be willing to subordinate their policies to the constraints of a hard commodity ever again… So how could gold make a revival as a sort of international money? Well, we don’t actually need a government run gold standard anymore…since people have always had confidence in gold as a long-term store of value, there’s no reason why it couldn’t play that role.”
Today – End 2020, we are in a situation where the rest of the world is increasingly Dollar averse, the US is in crisis, Europe and the Euro are in crisis, the UK is in a mess and Japan has the highest “official” debt of any country in the world so the Yen is going nowhere. In fact, today all the countries are engaged in currency wars comprising competitive devaluations aimed at protecting each country’s trade advantages (current accounts/trade balances). The latest G20 meeting attempted to stop this currency war, but consensus could not be reached, especially with the USA for whom cessation of its money printing would mean financial disaster in the form of default i.e. bankruptcy. It is only a matter of time before it all collapses. Note! The total Debt including future social obligations of the USA, the UK, Japan and many EU countries exceeds 400% of their Gross National Product, whereas the normal bankruptcy threshold is 100% as evidenced by countries like Argentina (100%) and Greece (113%). Iran and India have just agreed to exchange Oil for Gold – outright barter – and other countries are commencing trading in currencies other than the traditional Dollar/Euro/Pound.
It is equally important to realise that the barter analogy makes it clear that “a country should always be producing something of value that can be exchanged, even if it is only tourism, in order to ensure that that country’s exports balance out its imports”. After all, you should always have “something” to exchange, otherwise there is no trade – and paper currency is definitely not “something”. The something could be intellectual consultancy services or labour, but Export Revenue should balance Import Expense. Any imbalance is unsustainable in the long term, as demonstrated by the USA which manufactured less and less, imported $15 Trillion more than it exported over the past two decades and is now effectively unable to repay that debt. Now it is only fair that a country like China can get value for its Surplus, whereas currently it is stuck with a depreciating $2Trillion lemon. This imbalance would not have been possible in the days of the Gold standard as their creditors would have demanded payment in Gold far sooner. This would have weakened the payee’s currency as they’d have the same amount of dollars covering less gold, which would have rebalanced the county’s purchasing power parity. Instead, the imbalance that was facilitated by modern “Fiat” money could be extended almost indefinitely as the currency devalued to the point where payment in Fiat money makes payment a meaningless exercise.
Ultimately, the new money has to be based on a Gold Standard. Although there is much talk of a standard comprising a basket of commodities, such as Gold, Silver, Oil etc, this is not practical. Gold is the only practical benchmark since it has a high value to weight ratio that facilitates payment of national deficits (such as the one Richard Nixon reneged on). Imagine the transport and other logistics of settling a huge trade deficit with another country in equivalent value of Sheep, Cattle or even Oil, especially if “the country that owes has nothing to give that the owed country wants”. So! I believe the anticipated currency crisis or collapse will eventually precipitate a resumption of a pure Gold Standard at international level, if only to provide a mechanism for settling trade deficits. In fact, I believe China, India, Russia, Indonesia, the Middle East, Mexico etc have anticipated this and are already making preparations to that end as their Central Banks are buying Gold at a pace.
Another way of explaining why the Gold Standard has to return is that in its absence, foreign countries are lending money without collateral, which is not fiscally responsible. In fact, in the modern era, it is patently clear that any sovereign loans to “de facto bankrupt” countries and most are bankrupt, WILL NEVER BE REPAID, so they are merely window dressing to paper over the truth and defer the pain. After all, in the same way that banks lend money against collateral, tax payers are entitled to demand that their country lends to other countries with some form of security/collateral that their money will not be lost. That collateral has historically always been and should once again be GOLD!!
GOLD – THE ULTIMATE CURRENCY – THE CURRENCY OF THE FUTURE
THE RECENT FLIGHT FROM PAPER CURRENCIES TO GOLD IS PROOF THAT GOLD IS THE ULTIMATE CURRENCY. i.e. THE FUTURE CURRENCY HAS TO BE ONE THAT PEOPLE CAN TRUST, LIKE GOLD, AND NOT A CURRENCY THAT CAN BE CREATED/PRINTED AT WILL.
A final question is what about the banks. Banks used to store our monetary wealth and now they do not even want cash. In the absence of the Gold Standard, they only have two primary functions:
- They record numerical balances and transfer numerical amounts from one account, bank or country to another. Imagine a scenario where some password driven global internet software manages all account balances and transfers (as we do on internet banking). e. Essentially, if money used in day to day transactions is merely a medium of exchange, the e-bucks concept can work, where one exchanges the word money for value credits. Some computer software like Google can keep track of all our Plusses (value credits/money in) and Minuses (value credits/money out), with the Balance amount of value credits standing against our name. If you do not have a positive credits balance, you cannot buy – Debt is Dead. Currently a number of digital currencies like Bitcoin are enjoying a lot of attention. While these are again merely a Fiat medium of exchange, they do have the added benefit that they bypass exchange controls. In Countries like China and Chile, they are widely accepted;
- They provide loans for asset based purchases and this investment role could easily be taken over by internet based investment forums or investment houses like current private equity placement houses. Crowd funding is also becoming popular, where you post your project on the internet and anyone who likes the idea can buy in for a fraction of the equity with a few dollars. If a million like your idea, you easily get a Million Dollars. e. Effectively this internet based broking site would introduce investors to investment opportunities, whether those be funding for projects, buildings, equipment or working capital. Personally I would like all this to be on an equity type basis where the investor gets a profit share for a normal equity investment or a fixed return for Preferential Shares. i.e. I would like all this credit and interest nonsense to stop as this is what gets most people into trouble. They must learn to use debit cards and for the rest they must save for what they need, with the exclusion of a house and maybe a car;
YOU HAVE BEEN ROBBED and ARE BEING SCREWED – EXPLANATION
It is official. You and your forefathers have been robbed for the past 40-50 years, unless you belong to the super wealthy. Gradually, 95% of people in the US, EU, UK and the rest of the world, have been impoverished. The proof is outlined below, after these two famous quotes.
ALAN GREENSPAN: Former chairman of the US Federal Reserve Bank said in 50’s:
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. … Deficit spending is simply a scheme for the hidden confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard”. MY NOTES! At the end of his term in office, Greenspan confirmed that he stood by every word of this quote. Today Fiat money, deficit spending and escalating debt at are the sovereign norm.
THOMAS JEFFERSON: Former president of the USA: 4 March 1801 – 4 March 1809.
“I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property – until their children wake-up homeless on the continent their fathers conquered”. And: ”The issuing power should be taken from the banks and restored to the people, to whom it properly belongs”. MY NOTES! These reflect the Fiat reality today, as the Federal Reserve is owned by the bigger private banks. However, if the “people’s” governments owned the central banks, that would only work if politicians were honest, which they are not.
In the early 1900’s, the Gold Standard prevailed. It was abandoned worldwide during the course of the century, in favour of Fiat money that could be printed at will, to facilitate deficit spending. This resulted in rising inflation, which Governments covered up by manipulating the figures, which led to the impoverishment of the masses as explained below. I quote statistics from the US, but all countries have engaged in these blatantly criminal practices.
First, let us look at the “actual” cost of living increases. If you Google “Chapwood Index”, you will find that the actual inflation rate experienced by the US working and middle class, these past few decades, was closer to 10% as shown below. One can find similar conclusions, that are based on historic formulae and not as current, if you Google “Shadowstats Alternate Data”. Although the rest of the world does not have similarly accurate statistics, this is universally true.
However, the Politicians have a vested interest in suppressing inflation for reasons outlined further below. Accordingly, Governments, at the behest of politicians, use countless blatantly dishonest tactics to supress inflation statistics. For more on this, see “Shadowstats Alternate Data”. Here we see that the official US Core inflation rate, as depicted by the red line below, averaged closer to 2% for the past 25 years, a full 8% lower than actual cost of living increases.
Now you may ask why Governments would choose to manipulate inflation figures, and what are the consequences? Politicians, adopted Fiat money and manipulate official statistics for a wide range of extremely selfish reasons, including the following:
1. Politicians were impatient of the Gold Standard, which imposed fiscal discipline in the form of properly balanced budgets. Accordingly, they abandoned the Gold Standard in favour of Fiat money, which allowed them to print money and spend “virtually” at will. This allowed Politicians to perpetually spend more than the fiscus collected, in order to make themselves look good, while enriching themselves and their cronies, which gave rise to words like Crony Capitalism and the Corporatocracy. They did this because deficit spending allowed them to buy votes by increasing entitlement spending for public servants and voters. Unfortunately, this led to rising Government debt to the point where it will never be paid, effectively burdening future generations (our children’s children);
2. However, rampant printing inevitably leads to rising inflation, which they suppressed by manipulating the statistics. Lower inflation had numerous advantages and consequences, as illustrated below:
a. It made GDP growth look better than it was, which increased the chance of their re-election. This was because “Real” GDP is the nominal growth in economic activity, after adjusting for any reduction to compensate for inflation. Consequently, GDP growth has actually been negative since 2000, despite what Governments tell us, as reflected in this chart from “Shadowstats Alternate Data” at http://www.shadowstats.com/alternate_data
b. This, in turn, made budget deficits less severe, because wage, salary and pension increases were lower than they should have been if people got the correct “cost of living” adjustments. On the Chapwood Index website they state “the inaccuracy of the CPI began in 1983, during a time of rampant inflation, when the U.S. Bureau of Labour Statistics began to cook the books on its calculation in order to curb the increase in Social Security and federal pension payments”;
c. This, in turn, impoverished the masses, since they got a 2% increase, instead of a 10% cost of living adjustment. Consequently, most people became as much as 8% poorer every year. Over time, the cumulative effect of this was that single parent labourers could no longer properly support their families as they could in the past. Accordingly, over time, the spouse was sent to work and frequently both partners were compelled to work two jobs. Today even families with double+ incomes are struggling to make ends meet. This, in turn, also limited parental supervision of children with many negative consequences, particularly on the discipline front. There are numerous articles, charts and websites that highlight the fact that people earn are “at least” 50% less well off than their forefathers, in real terms. In fact, they are probably closer to 75% less well off;
d. Worse still, these sub-par increases also meant that people on social security and pensioners were increasingly unable to make ends meet. Accordingly, they had to work longer, which precluded their jobs from becoming available to the younger generation.
3. It is important to remember that, the increase in people who could not make ends meet increased the demand for welfare. This worked in the favour of Politicians, because more people on entitlements meant more votes from those who were beholden to the Politicians:
4. So now we are back to the statements of Alan Greenspan and Thomas Jefferson. This hidden but actual inflation has impoverished the masses while enriching the wealthy to the point where fewer and fewer people own ever more of the world’s assets and property;
5. However, it all gets worse. Due to rising Government Debt, Governments have a vested interest in supressing debt service costs, namely the interest they have to pay. Accordingly, they are now buying their own bonds in order to artificially suppress interest rates, which is why interest rates are now at or near historic lows. In fact, many countries now have negative interest rates and the amount of Bonds yielding negative returns will easily double to 50% of global GDP when next the markets correct;
6. This, in turn, means that pensioners cannot survive on their lifelong savings and the public at large have no incentive to save. Meanwhile, Politicians keep suppressing interest rates, while encouraging us to keep consuming and getting further into debt, to keep their illusion of growth going;
7. Worse still, the super low and negative interest rates meant that pension funds could no longer earn adequate returns without adopting increasingly risky investment strategies in a search for higher returns, failing which they become actuarially insolvent. This can only end badly, as pension funds are supposed to adopt conservative strategies and now, if markets crash, they could end up losing massively. Most pension funds are already actuarially insolvent, as evidenced by the fact that they are already either reducing pension pay-outs or raising the age of retirement. Imagine what will happen this time around if markets crash and pension funds lose excessively;
8. Investment funds in general are also engaged in adopting riskier strategies in a search for higher yields. This too cannot end well;
9. Finally, there is an insidious relationship between the big Banks and Corporations, and the Politicians, aka the Corporatocracy, that enables them to lobby politicians to pass anti-competitive legislation. This makes it increasingly difficult for capitalism to function as small competitors who could rebalance the market pricing mechanism, are prevented from doing so. Again, this pushes up the costs to all but the rich, at the expense of the majority.
It is my contention that Incentive Bonuses are one of the greatest evils around. In the past, people’s loyalty to the company and desire to serve their customers was unquestioned. If they worked well, they earned a bonus comprising a 13th or 14th cheque. Today, incentive bonuses are linked to profitability and share performance, to name but a few. Accordingly, senior banking and corporate executives increasingly adopt short term strategies and dishonest practices, that enhance their bonuses at the expense of both their customers and their shareholders. Goldman Sachs was fined when it was found that they were round tripping shares between in-house policies in order to boost administrative commissions. Morgan Stanley and Deutsche Bank were fined for holding futures contracts instead of physical gold, as promised, while charging storage and insurance, which re-introduced third party risk just when customers were trying to avoid it. There are literally hundreds of such examples of banks manipulating prices and interest rates for their own advantage and to the detriment of the man in the street. Similarly, companies give their employees 2% increases in line with official CPI figures, while hiking prices by considerably more thanks to anti-competitive practices, which again enriches management.
The working class and the middle class are being impoverished, for the benefit of politicians and those in the upper 2-3% income bracket. In addition, the Politicians, Banking and Corporate Executives of the biggest corporations are screwing you while they entrench and enrich themselves.
I would love any comments, feedback and especially suggestions of new topics.
My book Technology Tsunami Alert will be published mid-2020. It didn’t start as a book, but as I wrote, I had a growing urge to warn as many people as possible about the breadth and depth of disruption in the near future, so that they become aware of the risks and opportunities and are able to choose a better future. See website at https://technologytsunamialert.com/, or, you can contact me via my website at https://eelcogold.com/, which is more about investment.
Disclaimer! The content of this report represents the opinions of Mr Lodewijks, who is a retired Civil Engineer with diverse interests. Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.
Mr Lodewijks is not a qualified Investment Advisor. His investment reports aim to educate and help investors understand investment considerations and strategies. As trading and investing in any financial markets may involve serious risk of loss, Mr. Lodewijks recommends that you consult with a qualified investment advisor.
DEMOCRACY and CAPITALISM vs CURRENT REGRESSIVE TRENDS
It is important to realise that Capitalism is not a political ideology, it is a term that is applied to a free market system. This system is a self-balancing system that eventually becomes corrupted by self-serving politicians and by collusion between greedy politicians and corporate executives. As they erode the “free” in the free market system by adding or removing regulatory constraints, it becomes unbalanced. We could describe this as the shift from a Capitalist Democracy to a Socialist Democracy. This deliberate insidious destructive process is inevitably to the detriment of, and at the expense of the majority, and in favour of and for the enrichment of the minority. I know there are many who believe that capitalism is evil, but that is only and increasingly true as the system becomes progressively more corrupted. It is that gradual impoverishment of the masses, to the point where they can no longer make ends meet, which eventually brings about that eventual tipping point where the entire free market system breaks down. At that point the entire system will inevitably reset, and I believe we face such a Great Reset in the mid to late 2020’s. The various stages of this very evil impoverishment process will be revealed in this and the next few chapters. Because it has a considerable bearing on your investment decisions, it is worth understanding the process and bigger picture.
Aside! Currently a wave of socialism is engulfing the world. In Europe it is the Yellow Jackets. In the USA it is being spearheaded by presidential hopefuls like Alexandria Ocasio-Cortez, Elizabeth Warrant, Kamala Harris and Bernie Sanders, to name but a few. Most have adopted a campaign strategy aimed at taxing the rich in order to give to the poor, who are now clearly in the majority as you will see as we progress. This will inevitably lead to the downfall of our current socialist democratic system over time, in favour of outright Statism, Fascism, or Communism. This is all part of a huge circular trend that has played out repeatedly over the millennia, where power shifts from the Commercial Traders, to the People, to the Military, and then the Sages & Theologians, and back to the traders. This downfall of democracy is illustrated by examples below:
Every time a group of pioneers established a new settlement in the past, they always opted for democracy, never socialism, statism or communism, to govern their fledgling community. When say 100 pioneers settled in the wilderness, the “natural order” that they would adopt would inevitably be Democracy as their order of governance, coupled with Capitalism as their chosen order of commerce. This was because each of them had an equal voice and right to vote on the important choices that shaped the development of their community, which could only survive if all stood together against the challenges it faced. The core values that they embraced always included honesty, integrity, consideration for each other and a sense of community. In such a small community, any aberrant behaviour would immediately be noticed and dealt with.
I know this brief paragraph is elementary, but it leads up to the key conclusions: Initially some would hunt for food while others helped each other build shelters or houses. Subsequently some “worked” to hunt for food or establish crops, while others used their skills or aptitude to make things they needed to help them and/or their community survive or be comfortable. Immediately they had produced anything in sufficient quantity, they produced more of the same to exchange with others in their community, which heralded the introduction of the barter exchange of goods. Subsequently the community would set up core services like schools, which heralded the exchange of goods for services as the parents could only pay for this service by way of produce or items they produced, such as food, clothes or furniture. As the community grew, a farmer might also elicit the services of another to work his fields, in exchange for produce, accommodation, etc. Their system of barter sufficed, so they had no need for money which is merely serves as a medium of exchange to facilitate barter. At this point it is worth noting the following:
Every person was productive, and it would never have occurred to anybody that they did not have to work. More important, nobody would expect to, or get away with, being rewarded for “doing nothing”. If they shirked, the elders would set them right;
The more productive any person was, the more land he/she could till and/or things he/she could produce, and the more he/she had to exchange for other things he/she needed. Consequently, those who worked the hardest progressively became the “wealthiest” and, by virtue of the amount of effort they put in, often the most respected members of that community. Note! It is the growth in this cumulative productive effort that translates into the growth in the cumulative wealth, or Gross Domestic Product (GDP), of this community;
- It is normal that some people are more productive and driven than others. However, nobody would ever believe that they had the “right” to take away that for which another had worked hard, or that they deserved a share of his wealth. In other words, that argument that is used to promote socialism “what gives him the right to have so much when I have so little”;
- At the end of the day, every man’s “honest” physical or intellectual productive effort was and always is the only driver of “honest” and “REAL” growth in his/her wealth and the only contributor to “honest” and “REAL” economic growth. Later in this book I will talk about the financialization of the economy, which effectively split it into those who honestly produce, and those who almost deviously skim.
When such a group of settlers is small, it is easy to maintain a sense of community as everyone knows everyone and peer pressure ensures that there are no slackers. Furthermore, the elected leaders served the community in their spare time without payment, because major decisions were few and far between and everyone knew what the community wanted.
However, as the community progressively grows ever bigger, certain detrimental trends manifest. Firstly, the whole “thing” becomes increasingly impersonal and it becomes easier for faceless slackers and thieves to fly under the radar. Secondly, the elected representatives are paid a salary, which is fair since it becomes a full-time job. However, those senior politicians eventually become “professional” career politicians who would do almost anything to buy votes to hold onto their jobs and so, over the years, one saw:
- A gradual shift of tax allocations away from development and infrastructure spending in favour of increased welfare spending. These vote buying entitlements took the form of things like increased benefits for public officials; welfare grants for the unemployed to the point where they no longer had an incentive to work; and grants for pensioners who did not put away enough for their retirement, to name but a few. However, budgetary constraints imposed a limit to the above re-allocation of monies they could get away with;
- That politicians became impatient of the budgetary constraints imposed on them by the Gold Standard. Accordingly, US politicians conspired with big banks to create the Federal Reserve Bank, which is owned by the big banks. Their goal was to introduce Fiat currencies, which would allow them to engage in deficit spending in order to buy votes with increased welfare spending and higher salaries for themselves and their subordinates;
- Collusion with lobby artists, with the result that anti-competitive laws are passed, which give large corporations and financial institutions advantages they would otherwise not enjoy, at the expense of smaller players. This was particularly evident during the 2008/9 collapse in the US, when big banks were bailed out and their losses were socialised (covered using future tax revenues). i.e. The wealthy made profits when all was well but did not lose when markets crashed, as the public’s tax revenues bailed out the big boys;
- Manipulation of government statistics to hide the detrimental effects of the Fiat regime and, instead, paint a “false” but more favourable picture of economic growth, to make the leaders look good. Two huge consequences are that. I later devote a chapter to properly explain all this:
- Inflation is understated, with the result that the 95% majority are not adequately compensated for cost of living adjustments, which means they are gradually impoverished by cumulative under-compensation. Consequently, during the 1971-2017 period, the “REAL” income of the labour force has been more than halved;
- This also meant that GDP growth was overstated as lower inflation begets higher “inflation adjusted” GDP growth; and
- Unemployment is understated, which means it is not timeously identified and/or properly addressed.
- The employment of “spin doctors”, whose sole purpose was to put a positive spin on patently wrong policies to sell the electorate policy changes they would otherwise never agree to. Donald Trump’s spin doctor Kellyanne Conway called these “alternative facts”. This is about misleading you by exploiting your lack of in-depth information, analysis and insights;
- Suppression of the right to protest. The combination of deficit spending and inflation suppression greatly increased the poverty of the majority. However, the minute they protested, as they did during occupy Wall Street, they were labelled economic terrorists and arrested or harassed.
The rest of the cycle would play out as follows:
Gradually, corruption within Government, Government interference in commerce due to lobby groups and the growing demands of the self-appointed “entitled”, who use false morality to convince the world that it owes them something, causes both democracy and, through that, capitalism to unravel. Subsequently, as entitlement spending increases, Democracy gravitates to Socialism, which increasingly employs deficit spending until debt bankrupts the system. Margaret Thatcher once said: “The problem with Socialism is that eventually you run out of other people’s money”.
Progressively, all this leads to mass impoverishment which makes the majority restless and inclined to protest. At this point Government is compelled to exert increasingly dramatic “centralised controls” to subdue the people, as we saw with “Occupy Wall Street”, and prevent uprisings, and so our Socialistic Democracy gradually devolves into Statism, Fascism and/or possibly even Communism. Since Communism is not a sustainable system, it inevitably breaks down decades later. At this point Capitalism again gradually comes into its own, as we see in China today.
Optional but interesting reading:
This cycle of power shifts is well explained in Sarkar’s “Law of Social Cycles”, which is explained below – Google it. What it illustrates is that after a few centuries of power shifts, we are inevitably back where we started. South Africa is merely a bit further down the road than the USA, UK and many countries in the EU. For those of you who are interested, this process is described below:
Sarkar’s “Law of Social Cycles”
Law of Social Cycles, also known as Social Cycle Theory, is a theory of human historical motivity based on “the ancient spiritual ideas of the Vedas”. The theory was propounded by the Indian philosopher and spiritual leader Prabhat Rainjan Sarkar in the 1950s and expanded by Ravi Batra since the 1970s. Using this a man called Ravi Batra predicted the fall of the USSR, amongst others.
Four Types of People
The Law of Social Cycles is a theory of Varna, arising out of the Indian episteme (Inayatullah, 2002). This law states that while people in any society are all relatively similar, they have generally the same goals, desires and ambitions but differ in the way they go about achieving their goals. An individual’s specific methods for achieving success depend on his physical and psychological makeup. Essentially, there are four different psychological types of people, warriors, intellectuals, acquisitors and labourers, who find basic fulfillment in four different kinds of ways.
Warriors, or Kshatriya in Sanskrit, have strong bodies, vigorous physical energy and a sharp intellect. Warriors tend to develop the skills that take advantage of their inherent gifts of stamina, courage and vigor. Their mentality is one that is not averse to taking physical risks. Examples of people in our society with the warrior mentality include: policemen, firemen, soldiers, professional athletes, skilled carpenters and tradesmen, etc. They all achieve success through their physical skills and a deep understanding of their profession.
Intellectuals, or Vipra, have a more developed intellect than the warriors, but generally lack the physical strength and vigor. Intellectuals are happiest when they try to achieve success by developing and expressing their intellectual skills and talents. Examples would be: Teachers, writers, professors, scientists, artists, musicians, philosophers, doctors and lawyers, and above all, priests.
Acquisitors, or Vaishya, have a penchant for acquiring money. If money can be made the acquisitors will find a way to make it. They are not considered as bright as the intellectuals, nor as strong as the warriors, but they are keen when it comes to making and accumulating money and material possessions. Such people are the traders, businessmen, managers, entrepreneurs, bankers, brokers, and landlords in our society.
Laborers, or Shudra, are altogether different from the first three groups. Laborers lack the energy and vigor of the warriors, the keen intellect of the intellectuals, or the ambition and drive of the accumulators. In spite of the fact that their contribution to society is profound – in fact, society could not function without them – the other groups generally look down upon and tend to exploit them. The laborers are the peasants, serfs, clerks, short order cooks, waiters, janitors, doormen, cabdrivers, garbage collectors, truck drivers, night watchmen and factory workers who keep society running smoothly by working diligently and without complaint.
Epochs of Social Classes
My explanation for lay people. Please note that this plays out over decades or even centuries. We have had a few good centuries in the age of the “Acquisitors”. However, eventually greed and other forces prevail that impoverish and suppress the majority, where-after there are protests leading to social upheaval. However, those “Labourers” who inevitably overthrow the government have no suitable leaders who could introduce or govern the new regime, with the result that chaos persists. Accordingly, the military “Warriors” step in and bring order. However, while they may have leadership, they have nobody who can properly govern the country. Consequently, eventually the “Intellectuals” are drawn in to bring about law and order. Gradually things settle down and orderly commerce re-establishes itself as the “Acquisitors” are allowed back in the game. And so we are back where we started until greed again gradually unbalances the system.
Schematic representation of P.R. Sarkar’s Law of Social Cycle
Groups of each type of people make up the social classes in society. Sarkar simplifies society into four classes, divided by inherent traits:
• Warriors defend the nation and keep the peace;
• Intellectuals develop our ideas about the world, in the form of religion, art, law and new inventions;
• Acquisitors manage the practical aspects of life, including farms, factories, financial institutions and stores;
• Laborers do the routine work, waiting tables, collecting trash, and other low-tech, low skill jobs.
Social cycle theory and modern social development
According to Batra (1978), the West is currently in the age of acquisitors, also known as Capitalism. This age succeeded the ‘age of intellectuals’, which gave birth to the Enlightenment and the British parliamentary system. Before that the West went through the ‘age of warriors’ and the age of discovery. Feudalism, an earlier ‘age of acquisitors’, reigned before that. It had replaced the ‘age of intellectuals’, with restrictions on religious thought and also gave birth to the Renaissance period. Before that, Rome ruled the West under the aegis of warriors.
Exploitation and breakdown
To Sarkar, each age would run its course, with the social motivity going too far, causing much grief to the majority of people (Sarkar, 1967). The situation could go on unchecked for a long time, before things got so bad that a spontaneous revolution and overthrow of the system took place. In fact, as this was the reason for social change, it was clear that no single class of people could remain dominant indefinitely. Social power was destined to pass from one class to next in the prescribed order, or cycle. The ‘age of warriors’, which brings strict order to society and a return to fundamental values, essentially leads to excessive focus on strong man rule and warfare. It is followed by an ‘age of intellectuals’, which bring a sense of liberation in the mental sphere but soon replace that freedom with the yoke of newer ideas. Over time this age merges into an ‘age of acquisitors’, which brings progress in the material sphere, but this is soon replaced by increased physical and mental exploitation. The Servile Wars spelled the doom of the Roman Republic. Labour conflict could be the undoing of Capitalism, according to this theory. And so the cycle moves on its endless round, until the civilisation ceases to exist or is taken over by a superior or more powerful civilisation.
Preventing the misery of exploitation
Sarkar’s essential view on the implications of each age was to develop a way to avoid the dynamic of exploitation, when the social motivity of one class goes unchecked and too far (Sarkar, 1967). In such cases, it falls on moralists to accelerate the movement to the next age to shorten the exploitative phase of each age.
Lay explanation of “How interest rates impact on Equity, Bond & Property prices”
Ideally, the interest rates the public earn on savings should be at a level that enables lay investors, and particularly pensioners, to earn a positive return on their investments after adjusting for tax and inflation. When this is not true, people have little or no incentive to save in the normal course of events. This is detrimental to the economy, since it is precisely those savings that provide the capital for economic growth. Please remember this whenever you consider your investment strategies, because low savings equals or predicts low economic growth. More about this later.
If you are going to understand the process of choosing your portfolio mix, it is critical that you understand the role of interest rates in the markets. That is because interest rates serve as the benchmark used to determine the prices investors are prepared to pay for the different asset classes. Broadly speaking, falling interest rates cause Equities, Bonds and Property to rise, whereas rising interest rates cause them to fall. Below I explain how and why, where-after I discuss the merits of each asset class separately in subsequent chapters. a
Next it is important to understand that Interest rates, coupled with risk, provide the mechanism that enables one to compare the returns offered by one asset and/or asset class, with another. If one asset class offers a markedly better risk weighted return than the rest, people will buy that asset/asset class until the Risk/Reward weighted return, is normalised.
Finally, you should know that when I speak of interest rates to price or compare asset classes, I am always referring to 10-year Bond Yields (interest rate paid on Bonds), which vary from country to country. This is because 10-year Bonds have always been deemed by the market to be “risk free” investments on the assumption that Governments cannot go bankrupt. Accordingly, yields on 10-year Sovereign Bonds, which vary from one country to the next, have always been used for pricing in the market risks of each country.
NOTE! The following explanations relate to LONGER- and not Shorter-term perspectives.
EXPLANATION OF THE INVERSE RELATIONSHIP BETWEEN EQUITIES AND YIELDS
Interest rates inversely impact on Equities in the longer term, in that Equities go up when 10 Year Yields go down and vice versa. The explanation is as follows:
- Let us imagine that the US 10-year Bond Yield is 3% (Feb ‘18) and that inflation is 2.5% (Feb ‘18). This means an investor is not beating inflation, especially after deducting bank charges and tax, so the investor decides he needs to invest in say Equities to get a return that beats inflation. However, because Equities are risk than Bonds, the investor demands a risk premium of say 2%, which means he wants to invest in a company that yields a 3% + 2% = 5% Return on Investment (ROI). The Earnings per Share (EPS) divided by the price of that share represents the ROI, or the yield of that share;
- Now let us imagine that company X’s Shares are valued at $100 and that its Earnings Per Share is $5 per share, which means it yields the required 5% ROI sought by the investor, so he buys the shares. NB! The 5% should give him a return after costs and taxes that beats inflation;
- Now for the sake of this exercise, let us imagine that the Risk-Free Rate jumps from 3% to 6% “OVERNIGHT”. Suddenly the investor can get a better yield from Risk free bonds and considers selling his shares. However, the new buyer re-values the return he wants from Company X as follows:- the revised Risk Free Rate of 6% + 2% Risk premium = 8%. Therefore, he says he is prepared to pay at most $5.00/0.08) = $62.50 per share, which you bought for $R100 per share. In fact, he would probably look at the impact the higher interest rates are going to have on the company’s earnings and, let us suggest, he concludes that the earnings are going to fall to $4.50, in which event he would only be prepared to pay $4.50/0.08 = $56.25 per share;
- Conclusion: Company X’s share price almost halved when the Risk-Free Rate doubled, which confirms that share prices go down when interest rates rise. This approach, which sometimes allows for future improvements in earnings, is broadly known as Value Investing, because you are valuing arithmetically.
- It should be noted that when markets rise rapidly, investors are often prepared to pay considerably higher prices for shares purely based on the expectation of higher Capital Appreciation. However, this is frequently speculative, rather than value-based investing. Beware, because the greater this speculation is, the greater the “irrational” exuberance driving the markets up. Usually this is correlated to riskier toppish markets, which may be a sign that it is time to get out.
EXPLANATION OF THE INVERSE RELATIONSHIP BETWEEN BONDS AND YIELDS
The pricing mechanism for Bonds works exactly the same as for Equities, in that Bond Prices go up when Bond Yields go down and vice versa, because you are paying a sum of money for an asset that has to yield a market related return. However, the determination of the appropriate yield has two scenarios, one of which is tied to short term factors and the other of which is tied to long term trends as follows:
- Short term factor: When markets correct “materially” and there is a flight to the safety of Risk-Free Bonds, that surge in demand causes Bond prices to rise. This, in turn, causes Yields to fall, regardless of any long-term trend bias. This is because traditionally Bonds have been the “safe haven” / ”flight to safety” destination for capital when Equity markets are overpriced or correcting. i.e. Investors would rather have a slightly negative after-tax return in the short term, than a significant loss as and when markets correct/crash;
- Long term trend: In the longer term there is a strong correlation between Interest rates and Inflation, mainly because investors always want to earn at least as much as the inflation rate, after tax;
- Regardless of the above scenarios, if we pay the Government $1 000 for a Bond that yields 3% ($300 per annum) and that yield goes up to 6% overnight, we would only be able to sell if for $500 – i.e. $300/6% as that is the revised return investors would expect. The opposite is also true; if we pay the Government $1 000 for a Bond that yields 6% ($600 per annum) and overnight that yield goes down to 3%, we would be able to sell if for $2 000 – i.e. $600/3% as that is the revised return investors expect. Although this confirms the inverse relationship between Bond yields and the prices, it is a pretty simplistic example because aspects like time to maturity change the pricing.
EXPLANATION OF INVERSE RELATIONSHIP BETWEEN PROPERTY & YIELDS
I think we all understand that rising interest rates translate into rising mortgage payment and vice versa, because it hits closer to home. Therefore, when interest rates fall, considerably, property becomes more affordable and when interest rates rise considerably property becomes less affordable. However, what normally happens is that there is a lag, in that property prices do not respond immediately to the upside when interest rates peak and start to decline, nor do they respond immediately to the downside when interest rates bottom and start to rise. The reason for the lag after the peak is twofold, namely the fear that they will continue to rise and the fact that they have to fall materially before the high mortgage payments that stretched owners, once again become affordable to the point where they have disposable income. Contrarily, the reason for the lag after the bottom is twofold, namely the expectation that they may go lower and the fact that people’s disposable income and ability to pay their mortgages gets squeezed gradually as interest rates rise. Therefore, property prices only really started to rise a few years after interest rates start to fall and only start to stagnate/fall a few years after interest rates start to rise. Simultaneously, the cost of replacement (building costs), will impact on property prices, in that there are times when it is cheaper to build than to buy and vice versa. Finally, the capital gains affect the market. By this I mean that during periods of high inflation the property price is implicitly rising, although you would only really be able to reap that benefit by selling when interest rates/inflation begin to fall materially, as that suddenly makes the mortgage repayments and the property affordable.
CORRELATION BETWEEN INFLATION AND INTEREST RATES
There is a definite correlation between interest rates and inflation, although it is not instantaneous, merely a long-term phenomenon. The big question is, which comes first? My sense is that interest rates lag when inflation is rising rapidly and inflation lags when interest rates are falling rapidly.