This blog is meant to keep you informed and to educate you regarding money and investment decisions.  For some, it may just be confirmation of what you already know or a supplement to what you already know.  This blog is not really meant to tell you what to do.

With that said, some people want advice on their investment portfolio.  This is a difficult thing to do, as each individual’s situation is so different.  Do you rent?  Do you own a house?  If so, do you own it free and clear (deflation hedge) or do you have a big mortgage (inflation hedge or perhaps just not smart)?  Do you have any other debt?  Do you have any major upcoming expenses?

So let’s assume that you don’t have any debt with the possible exception of a reasonable mortgage.  Let’s also assume that you have an emergency fund.  Let’s also assume that you have an average income with average expenses and you are not retired (although being retired may not necessarily change this).  If you have absolutely no idea on what to do with your money, then you should probably just invest it in Harry Browne’s permanent portfolio, as laid out in his short book “Fail Safe Investing”.  You can also invest in the mutual fund that is similar (symbol: PRPFX).

If you are more experienced and you want a higher risk/reward portfolio, it would still be a good idea to have some in a permanent portfolio fund.  Here is an approximate suggestion for a portfolio in our current environment.  Please note that this could change at any time and it is also not a guarantee to make you money.  There are no guarantees.

Put approximately 15% in stocks (some index funds, some specialized funds like energy).
Put approximately 5% in gold related stocks.
Put approximately 20% in gold and gold related investments (not stocks) like GLD.
Put approximately 20% in long-term U.S. government bonds.
Put approximately 5% in silver and silver related investments like SLV.
Put approximately 35% in cash or other short-term liquid investments like a cd or money market fund.

Although bonds may seem risky, you need some protection in case of another crash.  If you had your entire portfolio in bonds in late 2008, you would have done very well.  Most other investments, other than shorting the market, did not do well.

If the Fed starts to inflate again and the banks start to loan out more money, then you will want to decrease your cash position and increase your gold and silver positions.

Again, this is a very rough estimate and each individual has a different situation.  Use common sense and what you feel comfortable with.  And again, if you have no clue, just stick with the permanent portfolio.

There seems to be a little confusion about excess reserves held by commercial banks.  The Federal Reserve started paying interest on excess reserves right around the time the economic crisis became noticeable.  It has been written by some analysts that the banks started holding excess reserves because the Fed is paying interest.

This is bad analysis, as the reason for the boom in excess reserves is probably not due to the interest paid.  The Fed is only paying one quarter of a percent on excess reserves.  Bernanke, in his recent speech in Jackson Hole, Wyoming, said that reducing the rate paid on excess reserves is a possible future weapon for fighting a bad economy (he may have used the term “disinflation” instead of bad economy).  But even Bernanke admitted that it might not have much effect.

The Fed is only paying .25% interest.  They could lower it to zero and it probably won’t make much difference.  Now, the Fed could charge a fee (a negative interest rate), but this was not discussed by Bernanke.

The most likely reason the banks are holding these large amounts of excess reserves is because of uncertainty.  The uncertainty just happened to coincide with interest paid on excess reserves and a more than doubling of the monetary base.  It is not necessarily all coincidence, but let’s not confuse cause and effect.  Just because the Fed started paying interest on excess reserves around the same time that excess reserves went way up, doesn’t mean that one thing caused the other.  The banks made a lot of bad loans in the past and they are afraid of making loans now.  They are afraid that people will default, so they are being very careful who they lend money to.  Reducing the rate to zero on excess reserves will not change these circumstances.

Here are two charts.  The first chart shows the adjusted monetary base.

http://research.stlouisfed.org/publications/usfd/page3.pdf

The second chart shows the excess reserves held by banks (one year chart).

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=EXCRESNS&s[1][range]=1yr

This tells us two things.  First, the two charts are almost identical.  Money created by the Fed is going to the commercial banks as excess reserves.  This means that the newly created money is not being lent out.  This is keeping price inflation down.

The other thing you will notice is that the Fed has had a policy of stable money for over four months.  This comes after the explosion in the monetary base in late 2008 and 2009.

Until this changes, you will not see massive inflation and you probably won’t see a massive spike in gold.  You should always hold a portion of your portfolio in gold (say 20-25%) or gold related investments, but you will not see it go sky high until we see a change here.  If the economy hits another major downturn (which looks likely), then we may get a change in policy.  You should look for an increase in the monetary base or a decrease in excess reserves (without the same thing happening to the other chart).  Once you see the charts break the correlation, then you should really prepare for high price inflation.

The Federal Reserve has a choice to make, whether it knows it or not.  The choice is inflation or depression.  There is no in between.  The government has created this situation with all of its horrible economic policies.  Bush gave us two wars while continuing to increase domestic spending.  Greenspan helped with creating money out of thin air.  Before Bush left office, he bailed out the car companies and did a massive bailout of the banks.

Obama has continued these policies.  He continued the bailouts and signed a massive “stimulus” package right after taking office.  The federal deficits are huge and the overall debt to GDP is nearing 100%.

There was a lot of malinvestment prior to 2008.  Interest rates were kept artificially low by the Fed and the government spent like crazy.  It caused bubbles in our economy and misallocated resources.  When Bernanke took over at the Fed, he actually stabilized the money supply.  This exposed all of the bad investments and it drove the economy into recession.  This is what needed to be done.  If Bernanke had continued to create new money, it only would have made the problem worse in the future.

Unfortunately, Bernanke and the Fed did not keep this stance for long.  When the fall of 2008 came, the Fed more than doubled the adjusted monetary base.  Most of this new money went to the banks and the banks kept it as excess reserves.  This is why we haven’t seen significant price inflation.

Instead of letting all of the bad investments get cleansed out, the government tried to prop things up with more spending, more bailouts, more money creation, and more debt.  This has only caused more bad investments and a severe misallocation of resources.  At this point, the economy needs to cleanse itself in the form of a severe recession.  This is what the government should let happen.  It will be tough medicine, but it is the right cure.

More likely, the government will continue to spend and create money out of thin air.  If and when the economy shows another recession (did the first one ever end?), the Fed will most likely choose the wrong path of more inflation.  This will make things worse still.  It would be wise to prepare for massive inflation in the next several years.

It is unlikely that we will see hyperinflation.  We probably won’t see price inflation of 100% per year.  We could easily see price inflation of 20% per year.  The future is unpredictable and you never know what will happen, but it is unlikely that the Fed will go to hyperinflation because they will destroy themselves and the banks in the process.  The most likely scenario is high inflation, followed by a severe recession or depression (call it what you want).  It might play out like the 1970’s and early 80’s, but more severe.

Just remember, the damage has already been done.  There are bad investments that need to be liquidated.  There needs to be a shifting of resources and we need people to save and invest, which is the basis of growth.  The government should allow this to take place.  It will probably do a lot more damage before it does.

Rumor has it that Cramer on CNBC is advocating holding some gold positions in your portfolio.  If ever there was a perma-bull, it is Cramer, and even he is concerned and cautious about the stock market.  The Dow is hanging just above 10,000 right now.  If you have any money in stocks that you care about, you should get it out, unless it is balanced with other investments like bonds.  If you have any more than 25% of your portfolio in stocks right now, you are taking a big gamble.  There is a lot of malinvestment in the economy and it is trying to fix itself.  The government is not allowing the fix to take place.

Although we may still see rallies, it is unlikely that stocks are going much higher from here in the short-term.  The only thing that can drive them a lot higher is massive inflation.  In that case, you are better off in other investments anyway.

The future is unpredictable and anything can happen, but stocks are not looking good right now.  When Cramer is cautious about stocks, that means “sell, sell, sell”.

If you pay much attention to the financial news, you will hear how we (meaning Americans) don’t want to end up like Japan of the last 10 or 20 years.  If the American economy, in the next ten years, is like Japan’s economy of the last ten years, we will be lucky.

We hear that Japan has been trapped in a deflationary spiral that it can’t get out of.  First, it is hard to call it deflation.  There have been a few times where the price index reports show a slight drop.  Basically, Japan has experienced stable prices over the last couple of decades.

But even if Japan really did have deflation (monetary or price), it is a myth that it is trapped.  The Japanese government has had some horrible policies in the past.  It has done its fair share of stimulus packages and the debt to GDP ratio is near 200%, bigger than any major country.  The one thing it hasn’t done is gone crazy creating money out of thin air (at least relatively speaking).

Any central bank that wants to avoid a “deflationary spiral” can do so.  The Federal Reserve or any central bank can buy assets at any time.  The Fed could buy more bonds.  That is the most typical method.  It could buy mortgage-backed securities as it did in 2008.  It could buy stocks.  It could buy baseball cards and used furniture.  Bottom line, the Fed can create money out of thin air any time it wants.  It doesn’t do this because it could eventually lead to hyperinflation.  The Fed is walking a tightrope right now, but it can cause high price inflation at any time.  Bernanke has said so himself.  The Fed just has to credibly threaten to dramatically increase the money supply.  It could also force banks to lend.

The purpose of this commentary is not to predict inflation, but just to make you aware that the Fed and any other central bank can inflate at any time.

It ain’t what you don’t know that gets you into trouble.  It’s what you know for sure that just ain’t so.
~Mark Twain

This site is to help you not do things as much as it is to help you do things.  It is always amazing how you can give a set of facts to ten different people and they will all come away with something different.

Investing is difficult.  You should know what you are doing and what your risks are.  There are so many people that will read a particular story or look at some data and think that they have an investment that can’t go wrong.  If you think it is impossible for it to go wrong, it will.

If there is one thing you should take away from this site, it is that you can’t predict the future with certainty.  You can take good guesses and manage your risk accordingly.  If you study the Austrian school of economics, you should know that the market is made up of millions of people acting according to their own wants and needs.  It is impossible to predict the behavior of everybody.  It is almost impossible to predict the behavior of just one person, even yourself.

Remember that economics is really the study of human action.  Perhaps you are certain that interest rates should go up or that gold should go to $5,000 an ounce.  But you can’t be certain and you should realize that it is impossible to predict with absolute certainty.  The rest of the people on this planet may act differently than you expected.  You should take this into account when you invest your hard-earned money.

There is a lot of talk about the Bush tax cuts.  The “Bush tax cuts” has this name for the same reason that “Obamacare” has its name.  Bush spent a lot of time promoting these tax cuts (even though they were only temporary).  It was probably the only significant thing that Bush did during his presidency that libertarians can compliment him on.

The debate now is whether the tax cuts will be extended.  They are set to expire at the end of the year.  The question is whether they will be allowed to expire or perhaps expire for just the “top one percent”.  This will only get more coverage as we get closer to the end of the year.

While the debate is not completely irrelevant, there is too much weight put on it by both sides.  The Republicans act as if the economy will be destroyed if they aren’t extended.  They might be right, but the economy is in ruins due to many other factors, many of which can be blamed on past spending by Republicans.

The Democrats act as if the budget will all of a sudden be in balance if we can tax the rich.  It won’t.  It won’t even be close.  The supply-siders and the Laffer curve have it right on this point.  Raising taxes could actually lead to less taxes collected by the government.

While letting the tax cuts expire (for any group) would be harmful, it is not as significant as it sounds.  Tax rates were higher in the 90’s and it didn’t completely destroy the economy.  The spending levels and the Federal Reserve are far more significant issues.  Tax rates can go up and down like crazy, but as long as the government is spending 4 trillion dollars a year, we are still in trouble.  Anything not collected by taxes will be printed or borrowed.

In conclusion, while the tax rates are not irrelevant and we would certainly rather see them lower, it isn’t the big issue.  Keep your eye on the ball.  Watch overall spending and watch what the Fed does.

While it probably isn’t important to pay too close attention to the political scene, it is important to understand what is going on.  Politics affects how much and in what ways the government will take and spend your money.

It is looking more likely that the Republicans will win the majority in the House of Representatives in the fall election.  Will it have a big impact?  Probably not.

The Republicans will slow things down a bit.  Obama will not be able to hammer through legislation like he did with the “stimulus” or Obamacare.  But we will not see a reduction in spending.  The only things that can reduce spending at this point are economic laws and a citizen revolution (and both seem likely at this point).

Greece was somewhat forced to cut back on spending, although not nearly enough because it was bailed out by other countries.  But Greece is more like a state in the U.S.  It cannot print money.  It could only ask the other countries to print money since it uses the euro.  The federal government of the U.S. can print dollars.  That is why states have been forced to start making some tough decisions and to at least show some kind of concern for spending.  States don’t have a Federal Reserve.

This is why the U.S. government is out of control.  They don’t have to raise taxes directly.  They can keep deficit-spending because they can print money.  Until there are severe consequences imposed by the voters or until the laws of economics really kick in, there will be no significant spending cuts.  The Republicans will oppose Obama, but they will not control spending.  They already proved that from 2001 to 2009.

The U.S. dollar has been down quite a bit over the last several weeks.  It has had the effect of causing the U.S. dollar price of gold to go up.  But gold has not exploded and it will not explode until a major event happens or until price inflation becomes a more obvious threat.

It is always interesting to keep an eye on the dollar.  Just remember that you are comparing it to other fiat currencies.  Everything is relative.

If the U.S. economy hits another major downturn (which looks likely), then don’t be surprised to see the dollar strengthen as it did in the fall of 2008.  There is still a mindset that when there is fear in the economy, the place to go is to the U.S. dollar.  The tide will have turned when fear in the economy causes people to get out of dollars and into something that can’t be created out of thin air, such as gold and silver.