The FOMC has released its latest statement.  Nothing much has changed from its previous statement.  The Fed will continue to buy $40 billion in mortgage-backed securities per month and $45 billion in longer-term treasuries per month.

If the Fed follows through with these statements, then it will mean an additional $85 billion per month will be added to the adjusted monetary base.  The FOMC statement says that it is maintaining its policy of rolling over the maturing debt, including the mortgage-backed securities.  In other words, it will not allow expiring debt to decrease the monetary base at all.  It will keep reinvesting the principal amounts, while adding an additional $85 billion per month to its holdings.  Over the course of a year, this will add up to about $1 trillion.

The FOMC announcement came in the afternoon, which was preceded that morning by news that the 4th quarter GDP in 2012 (annualized) is being estimated at negative 0.1%.  So with all of the talk about seeing signs of improvement in the economy, there was actually a slight retraction in the last quarter.  While I have my issues with the GDP as an indicator of economic growth, there is some validity to it.  It is quite telling that the politicians can’t even get their own statistics to tell a positive story at this point.

The FOMC statement also said that it would keep the federal funds rate at between 0 and a quarter of a percent.  This is basically meaningless, especially when commercial banks are sitting on huge piles of excess reserves.

The new GDP estimate is actually being taken as some as good news, because it means that the Fed will keep pumping new money.  Of course, these people have their heads screwed on the wrong way, at least when it comes to economics.  The continuation of Fed pumping means that they are kicking the can down the road further.  It is delaying the inevitable and making it worse.  It is allowing the government to spend vastly more than it could without the Fed’s help.  This higher spending is misallocating resources and hurting savings and production.  It is making us all poorer.

Since the Fed’s policies are unlikely to change any time soon, we can expect more monetary inflation.  While it is impossible to know how long this will take to lead to significantly higher consumer prices, it will happen eventually if the Fed doesn’t stop.  There will also be asset bubbles.  This could be stocks, real estate, oil, or gold.  It could be all of them.  I think gold investments are the safest bet right now, but some exposure to all of these assets may not be a bad idea at this point.

While there is no way that anyone can predict the future, and Austrian school economists, of all people, should know this, it does not stop many Austrians from making predictions.  A couple of common predictions amongst Austrians is that we will eventually see higher interest rates and higher consumer prices.  There is certainly disagreement about the timing and about the severity, but there seems to be general agreement that both are likely to go up in the future.

Of course, there are many factors that will affect the overall economy, and in particular interest rates and price inflation.  It matters a great deal on what Fed policy will be going forward.  It matters on what banks decide to do and how much they lend.  It also matters what billions of people in the marketplace decide to do, including their habits of saving and spending.

With that said, I tend to agree with the consensus that interest rates and price inflation are both likely to rise in the somewhat near future (probably less than 5 years, although I hate giving predictions with time frames).  However, I have been against the idea of shorting bonds, which would be betting on higher interest rates.

As I write this, the 10-year yield is near 2%.  While this is really low, it is up a little bit from where it was.  So is this the start of rising interest rates?

I still don’t think so and here is my main reason.  The price of gold and the consumer price index are both signaling that imminent price inflation is not a problem.  This could certainly change very quickly at any time, but there just isn’t high consumer price inflation right now.  Prices at the grocery store may be going up, but the average prices are probably not going up at double digit rates (on an annual basis).

While I can’t predict the Fed’s actions with certainty, I can take a pretty good guess.  My guess is that the Fed will continue its money creation in one form or another, as long as price inflation is seen as relatively tame, although there may be short periods where it stops.  And as long as the Fed is buying government debt and mortgage-backed securities while price inflation is low, then interest rates are not likely to rise significantly.

For that reason, I believe that we will not see significantly higher interest rates until we see more signs of price inflation.  This means that we will have to see signs in the way of a higher consumer price index or a significantly higher price in gold (and probably silver too).

Once higher price inflation does become more evident (assuming that happens), then it will be time to take a look at shorting the bond market.  At that point, there are two factors that could drive interest rates higher.  One reason is that the marketplace will demand higher rates to compensate for the threat of inflation.  The other reason is that the Fed may have to scale back or stop its buying of government debt (to save the dollar), thus reducing demand for bonds and causing higher rates.

In conclusion, watch the price of precious metals and watch for changes in the consumer price index.  These are likely to be your best indicator of when you can expect higher interest rates.

As I write this, one ounce of platinum is going for approximately $1,669.  One ounce of gold is going for approximately $1,656.  While platinum has historically been worth more than gold, that has not been the case in the last couple of years.  It has just been in the last couple of weeks that platinum has been trying to overtake gold.  I actually wrote a couple of posts on this back in 2011, saying that it might be a good time to look into platinum, although the price would have been slightly higher then than it is today.

I much prefer gold over platinum in an investment portfolio.  I also prefer silver over platinum, although to a much lesser extent than gold.  With that said, I am not against a little speculation in platinum.  It is still basically on par with gold, so if the price adjusts to more historic norms, then platinum could pay off.

Of course, there is no magical ratio that has to hold.  If you are familiar with precious metals, then you may hear about the ratio of the gold price to the silver price.  While it can be a useful tool, there is no guarantee that some particular ratio has to come into effect in the future.  There is no guarantee that the ratio has to return to its historic average.  So the same goes for gold and platinum.  But again, it can be a useful tool and tell us that perhaps platinum is undervalued as compared to gold, if the price ratio returns to more of an historical average.

While gold and silver tend to move in tandem (with silver having more volatility), there is less correlation with platinum and gold.  Platinum has more industrial uses.  Gold has a history of being used as money.  Central banks do not accumulate platinum, at least to my knowledge.  This has actually favored gold in the last few years because governments and central banks are buying gold more than they are selling.

If you want to speculate in platinum, here is my recommendation.  With the price where it is right now, I would say it is reasonable to own one ounce of platinum for every $100,000 you have in net worth (excluding equity in real estate).  That would put your platinum holdings between 1 and 2 percent.  If you don’t want to actually hold the metal, you can buy PPLT.

Although gold and platinum are not as highly correlated as gold and silver, I don’t expect platinum to do poorly in the future, especially if we don’t have a deep recession.  One thing that platinum and gold do have in common is that they cannot be made on a printing press.  As more Fed dollars flood the system, the nominal price of platinum and gold are both likely to go up.

There is a report out that households in Greece suffered an annual drop of 10.6 percent in disposable income in the third quarter of 2012.  This article says that “Greek austerity policies cut Q3 household incomes”.

Greece is now a symbol of the end result of a welfare state.  The people of the country allowed a government that promised big benefits to people, while trying to pay for it with high taxes.  In the long run, the promises just couldn’t be kept.  They were not possible.  Now their day of reckoning has come.

In America, we sometimes hear people say that we need to fix our spending and debt problems or else we will end up like Greece.  Actually, it is a reasonable statement, although there are major differences between the countries.  Unfortunately, the U.S. has its own central bank to print money and can therefore make the game go on longer.  But it can also make the problems bigger.

The U.S. also has far more wealth than Greece to start with, so there are more resources to be consumed.  Hopefully America will not get to this point of consuming most of its resources.  The good news is that the American people are much more entrepreneurial and individualistic than the average Greek.  And while many Americans look for government handouts, it is not nearly to the same extent as in many European countries such as Greece.

People can blame “austerity” all day long on Greece’s problems, but they simply don’t understand what they are talking about, unless they are outright lying.  Austerity is not causing Greece’s problems any more than a wet sidewalk is causing it to rain.  The so-called austerity in Greece is essentially being forced on the people there because of the situation there.  They have consumed their resources and have almost nothing left to consume.

This is why today’s Keynesians are a joke.  They think we just need stronger demand to drive the economy.  You don’t think that the Greek people are demanding enough?  Many people in Greece are living in virtual poverty, barely being able to put food on the table.  Is this due to a lack of demand?

It is obvious that the people there have consumed their resources and their productivity has diminished dramatically.  Once you have consumed your previously saved resources, then there are no more resources to consume anymore, other than those currently being produced.  The low production is due to government policies, which in many ways reflect the mentality of the general population.

The majority of the population, while they are not necessarily getting what they deserve, are getting what they asked for.  Actually, they asked for the impossible of endless benefits.  But they are getting the government that they asked for.  And at this point, it doesn’t matter who is elected or who is in power.  There simply are not many resources to go around any longer.  Politicians can’t magically create food and clothing for the population out of thin air.

The one other point here is that a big government debt is not the most harmful to future generations.  It is the most harmful to people here and now.  It reflects big spending by government, which means a massive misallocation of resources.  It means less production.  It means a lower standard of living.  It can mean major poverty, as we are seeing in Greece right now.

If the Greek people want to recover, they must end their government welfare state.  They must get back to free markets, which will encourage production and savings.  It will set a base for future economic growth.  Until this happens, I’m afraid that the Greek people will suffer greatly, at least for those who don’t move away.

The Republicans caved in once again, agreeing to suspend the debt limit until mid-May.  They are kicking the can now so that they can kick it again in a few months.  Perhaps they will end up agreeing to some future spending cuts that are not binding and are not even actual decreases in spending.

In any case, I know there is a lot of talk about the massive debt.  It is certainly a major concern, but I think it is more of a symptom than the actual illness.  In some ways, the debt itself is even more symbolic than anything.  The true problems ahead will not be because of the massive debt.  The problem is the dependency on government.

While Mitt Romney talked about 47%, there is actually a far greater percentage who are dependent on government.  I am not saying anything negative about these people.  It is most of us.  Most people have been dragged into the situation, especially since they are forced to turn over a good portion of their money.

People dependent on government include Social Security recipients, food stamp recipients, farmers, government contractors, people on Medicare and Medicaid, parents who send their kids to government schools, military personnel, and millions of other government workers.  These are just a few of the major categories, but there could be a list of hundreds of categories of people dependent on government in some way.

The politicians have made it this way on purpose.  It helps perpetuate big government.  Most people say we need to get to a balanced budget, but they also don’t want their favorite programs cut.  It is impossible to do both, so the politicians choose the side of big government, which is to keep spending.

While Americans will tolerate big deficits (even if they say otherwise), they don’t generally tolerate extremely high taxes.  It seems like the federal government is unable to go past a certain threshold, which is approximately 20% of GDP.  Beyond this, Americans will revolt.

When the can can’t be kicked any longer, Congress will have to cut spending.  This will probably only happen when we see higher price inflation and the Fed is forced to save the dollar and stop buying additional government debt.  When Congress is essentially forced to cut spending, it will be very painful for a lot of people.  It will be painful because of their dependency on government funding.

You can tell people all day long that they will be better off in the long run, but they do not want to feel immediate pain.  Most people try to defer the pain, even though that can make it worse.

If people were not so dependent on government, it would be easier to cut spending.  Then the debt wouldn’t be much of a problem.  But the debt can be dealt with anyway.  Default is always an option, even if it is a painful one.

The only way we are going to see significant improvements in the economy, barring some technological miracle, is for spending to go down.  The government has to stop spending and misallocating resources on a giant scale.  The government bubble must pop.  Only then can we have real and sustainable growth that leads to a significant increase in our standard of living.  It is not a matter of reducing the debt as much as it is a matter of reducing spending.

Looking at America, or perhaps the whole planet, I feel like I’m watching a bad movie.  Or perhaps a frustrating movie is a better description.

The government makes life so much harder for virtually everyone than it needs to be.  We have more pain and suffering because people have allowed governments to have such extensive powers.  We are poorer because of it.  Even most government employees, while seemingly benefiting in the short run, are much worse off in the long run with big government.

It is frustrating because there is a small (albeit growing) group of people who see it.  They are trying to tell the other innocent people that they are being taken advantage of, but the people do not want to listen.  It is like a frustrating movie because the villain (the government) is wearing a mask and pretending to be a good guy.

Imagine a Superman movie where Lex Luthor has dressed up as Superman.  He is manipulating Lois Lane into doing all kinds of evil things.  He keeps reassuring her on how caring he is and what a good guy he is.  Meanwhile, Lex Luthor has changed Superman’s identity and made him powerless.  He is trying to tell Lois that he is the real Superman.  He is trying to tell Lois not to listen to Lex.  But this just aggravates Lois more and makes the real Superman look like a bad guy.

It is frustrating for me to watch Americans (and people throughout the world) support the very people who are bringing misery to their lives, and in so many different ways.  Even most people who say they are mad or fed up with the politicians, are still supportive of the government.  They will say bad things about the politicians, but they will keep re-electing them.  And worse, they will keep supporting many government programs, thinking that we would all be in trouble if not for certain government expenditures (when in fact the opposite is true).

It is frustrating for me when I tell someone that we need to drastically cut government spending and they think I am the bad person.  They think I am the one who doesn’t care.  Just because I am against government education, I must be against all education.  Just because I want to end the drug war, I must be in favor of everyone taking drugs.  Just because I don’t believe in government welfare, I must be against all forms of welfare and charity.

Meanwhile, most people don’t understand that when they are supporting government, they are supporting the initiation of violence.  They do not understand that they are supporting their own demise.

How do I know that most people support government, even if they don’t say so explicitly?  It is because there are only 535 people in Congress, 1 president, and 9 people on the U.S. Supreme Court.  Meanwhile, there are over 300 million people living in the U.S.  Even if you count all of the government agencies, the people still outnumber the government employees by a massive margin.

This being the case, there is no way that so few people could rule over so many without the consent of the many.  The government’s power rests on this consent.

I am screaming at the top of my lungs to the masses that they are being swindled.  They can easily throw off the politicians and live free, but only if they desire it.  I try to tell them, but they laugh at me and make fun of me.  They tell me I’m wrong.  Certainly not all people, but enough of them.

What more am I supposed to do?  All I can do is keep repeating the truth and hope that more people listen.  It may be frustrating, but that is all I can do.  That is all that any libertarian can do.

I recently received a comment from a post I wrote last month called “Real Estate in an Inflationary Environment”.  That post was in response to a different question.  Occasionally I’ll get a good question that I think others might find interesting, so I turn them into a post.  This is one of them.

The comment was as follows:

“I came across this (http://goo.gl/vBtxt) website while doing some real estate research online. The case is made that the real threat we face is deflation rather than inflation because the vast majority of money in circulation is actually credit which cannot possibly be paid back in full by everyone. So if I understand it at all, the claim is that eventually a great deal of this “money” will implode as people foreclose, default, etc. This makes sense to me. 

It would seem that it would take enormous amounts of monetary inflation just to offset that, which is what the intent it now I would assume. 

If this thesis holds any water that would make buying a home right now quite risky. I always appreciate your take on this topic, so I’m curious what you think about this view. Is there anything to this? How does this threat factor into buying a home now? I am considering buying a second home as a single family and moving out of the duplex I own and occupy now, and renting both units out. 

Thanks.“

Someone who expects deflation in the short run is taking a different view from what I have.  I am not saying that person is wrong.  It is just that I give a higher probability to inflation in the near future, given the analysis I have done.

One area that I often disagree with deflationists is the inevitability of it.  The comment above says that “the vast majority of money in circulation is actually credit which cannot possibly be paid back in full by everyone.”  I think it is playing technical word games to say that most of the money in circulation is credit.  If this were the case, why has there been virtually no deflation for the last 70 years?

Again, I’m not saying a deflationary situation is impossible or won’t happen.  I just believe that we will see much higher price inflation before we see anything resembling a serious deflation.

There is one thing that Ben Bernanke understands.  He said in a speech back in 2002 the following:

“But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.“

The Fed can always prevent deflation.

The problem for the Fed is if it hits recession/ depression conditions at the same time as high price inflation.  We saw that back in the late 1970’s and the Fed was forced to save the dollar and bring on a deep recession.  While this could certainly happen again, we haven’t hit high price inflation yet, so I would expect the Fed to keep creating new money out of thin air until it is forced to stop by high price inflation.

So how does all of this fit into real estate?

I recommend buying investment property that you can rent out.  It is best to buy something where you have positive cash flow.  If you don’t have to sell it, then deflation does not matter to you in the short run as far as housing prices go.  Your only worry is about the rent.  But if you have positive cash flow, then it gives you a little bit of a cushion for lower rents.  The good thing is, your costs should also be lower with deflationary conditions.  Taxes should be lower and maintenance costs should be lower.  The one thing that won’t go down is your fixed rate loan, or at least until you pay it off.

I am not one of these people who advocates that you leverage everything you can.  While I am not against taking out a mortgage, I am also not against paying off your loans.  If you buy and hold a property for long enough, you will eventually pay off your loan (or hopefully your renter will), assuming you don’t refinance to longer terms.  I actually think this should be the ultimate goal of every real estate investor.  Once your loan is paid off, then your cash flow will increase dramatically.

If you are concerned about deflation and you still want to invest in real estate, then paying off your mortgage should be your primary goal.  If you have a mortgage rate of 4%, then every extra penny you put into your principal balance is the equivalent of a 4% return on your money.  This is a hedge against deflation.

In conclusion, I don’t think a major deflation is likely, at least not in the next several years.  But even if you disagree with me and think deflation is likely, it doesn’t automatically mean that you shouldn’t look at real estate investing.  It just means that you should try more aggressively to pay down your mortgage before the deflation hits.

Monetary inflation caused by a central bank or government (and not by the free market) is harmful to the overall economy and is harmful to the average person’s standard of living.  While inflation could be harmful in a free market too (let’s say a gold miner discovers a huge quantity of gold that was previously unknown), the market can also adjust and even switch to another form of money if necessary.

Monetary inflation is harmful in many ways.  It misallocates resources and causes artificial business cycles (booms and busts).  Inflation allows the government to spend more and accumulate more debt than it could have without a monopoly over money.  Inflation also redistributes wealth.  While it is a net loss overall to society, it does benefit debtors at the expense of savers.

So while our standard of living would be much higher if there were no government monopoly over money (and granted to the central bank), I want to look on the positive side and offer at least a little good news about monetary inflation.

First, inflation itself is limited, even if it doesn’t seem so.  If the Fed allows things to get out of control and we actually see hyperinflation, then the Fed would destroy its own power.  Hyperinflation means that the money would no longer serve its proper function as money.  The market would be forced to switch to something else.  For this reason, I actually don’t think we will see hyperinflation.

Second, inflation can actually counteract and correct some other bad government policies.  One example is the minimum wage and unemployment.  The minimum wage laws do not allow the labor market to clear.  There are unemployed people who do not have the skills and productivity to make it worth it for employers to hire them, even at the minimum wage.  However, if we see enough inflation and the minimum wage does not rise in unison, this could actually help the unemployment situation.  Real wages could actually go down, even if the nominal numbers do not.

This actually happened in America during World War 2.  The government was trying to keep wages up.  But the inflation that came with World War 2 actually helped in this particular area.  It allowed a decrease in the real (inflation adjusted) wages, which actually helped unemployment.  Of course, sending millions of young men off to war also caused unemployment to drop, even if it wasn’t “productive” labor.

Another example of inflation counteracting bad government policies (that phrase may be somewhat repetitive) is in dealing with the budget.  It is commonly discussed that devaluing the currency allows the government to pay back its debts with money that is worth less.  But this also can work against the government with its annual budgets.  I recently discussed the Obama and Bush budgets, and the annual spending over the last 3 years has actually gone up very little (although it started at a very high point).  If the budget goes up at say 2% and inflation is at 3%, then the inflation-adjusted government spending is actually decreasing.  While this may not seem like much, and it isn’t, I am at least trying to look on the bright side with something.

I will throw in one final last “benefit” of inflation.  While it devalues the money being collected by savers and those on a fixed income, this also includes all of the government employees with pensions.  This means that Ben Bernanke’s pension becomes worth a little less each time he inflates.  This is another reason that I believe the Fed will not go to hyperinflation.

Even in a free market economy, there is sort of a business cycle, at least in the sense that it is constantly changing.  Human wants and needs are constantly changing and this factor, along with changes in supplies, means that prices fluctuate and resources are constantly being redirected based on those prices.

However, in a free market economy, we would tend not to see the business cycle as we know it today.  We wouldn’t see the huge swings, particularly with virtually everything at once.  In a free market economy, there would be less tendencies for big bubbles and busts, particularly without a central bank (or some other institution with a monopoly over money).

The Austrian Business Cycle Theory is very helpful in explaining past bubbles and busts.  It is also helpful in telling us that artificially low interest rates and increases in the money supply are likely to lead to new bubbles.

The tricky part is that we can’t know where the next bubbles will occur.  We can certainly take educated guesses.  And even if we could take a good educated guess, it is impossible to determine the timing of when the bust will occur.  There are simply too many variables.  And one of those variables is human action, which is almost impossible to predict.  Again, we can take a good guess, but it really is impossible to say.

If it were easy to determine where the bubbles are and when they will go bust, then the Austrian school economists would be rich.  Perhaps we could say that there are some Austrian school people who have above average wealth and above average investment returns because of their knowledge.  But there are also plenty of Austrians who have gotten things wrong.

Some recognized that there was a housing bubble at the time.  Most did not understand just how big it was, but there are some people who saw it.  But some people saw it in 2004.  It would have been hard to listen to them, as housing prices increased most dramatically in the next couple of years.

The same could be said for tech stocks in the 1990’s.  Some people thought a crash was imminent in 1997.  They were somewhat right in their analysis, but a couple of years too early in their call.

The point is that these bubbles can drag on far longer than it almost seems possible.  Timing is more of a guessing game than anything.

I think that interest rates will eventually rise and government bonds will get crushed.  But I do not own one single short position on bonds because I have no idea when it will happen.

I think there is something of a student loan bubble and a college bubble in general.  I don’t think the increasing prices are sustainable, particularly when so many college graduates are unemployed.  But again, I have no idea when we will see a change big enough to actually cause college prices to drop.

I have no particular investment advice with this post, other than to say that you should always be cautious with your investing in regards to timing.  It may seem obvious to you that bonds are a losing proposition, but you have to realize that not everyone else sees it that way.  And even if others are starting to see it that way, it doesn’t mean they will act on their knowledge.  Of course, you also have to realize that it is a manipulated market because the Fed is a buyer of bonds.

The same goes for price inflation.  Many Austrians have been predicting serious price inflation for the last several years.  It seems like a good guess because of the huge increases in the money supply.  But again, the human race had other things in mind.  Banks have been tight on lending and many people have been tighter than usual on spending.  This has helped offset the huge increases in the money supply.  Again, there are always variables to consider.

In conclusion, I think the Austrian Business Cycle Theory can be very helpful in understanding economics and even in making sound investment choices.  But don’t think that it can give you the knowledge of where and when bubbles and busts are going to happen, or at least not with any precision.  It is impossible to predict human action with any certainty.

There are polls showing that Congress is widely unpopular.  There was one survey that showed Congress is less popular than cockroaches and traffic jams.  For this alone, I applaud the American people for realizing that the politicians in Washington DC are generally not looking out for their best interests.

But there is a problem.  While most Americans are against the Congress, they keep re-electing the same people into Congress.  The reelection rate for 2012 was about 91% for the House of Representatives and 91% for the Senate.  So while the average American doesn’t like Congress, they find their own Congress critter acceptable.

Can they all be right?  No.

If incumbents are being elected at a rate of over 91%, while only 9% approve of Congress, then there is a major disconnect.  People aren’t looking into the mirror.  Most people think it is someone else’s fault.

While I think there are far more liberty-minded individuals today than there were 10 years ago, there is still a lot of work to do.

While a large majority of Americans are upset with what is going on in DC, they are not nearly irate enough.  They have little idea of how much they are being taken advantage of.  They don’t realize that the power of a small number of individuals rests solely on the consent of the general population.  How can 535 people in Congress rule over 300 million people?  The only way is for a large majority of the 300 million people to consent to it.

So while a large majority of Americans are unhappy with Congress, they still look to Congress to help them. They want their favorite federal programs left in place.  They think they need the politicians to keep them safe and secure.  Until this mentality changes, we will continue to live in chains and Congress will continue to rule over us, even if they are unpopular.