The Federal Open Market Committee (FOMC) released its statement today regarding the economy.  It stated that information received since June “suggests that economic activity decelerated somewhat over the first half of this year.”  With that said, there was no announcement of a new quantitative easing (QE) or any other kind of major stimulus.  The stock market was only down slightly on the news.

The statement said, “The Committee anticipates that inflation over the medium term will run at or below the rate it judges most consistent with its dual mandate.”  I find it hard to believe that they believe this.  If inflation is expected to be at or below its dual mandate and the economy is still showing weakness, then why wouldn’t the Fed inflate more?

As I have discussed recently, the Fed is holding back right now on purpose.  The monetary base has been flat for over a year now.  They are walking on a tightrope right now and they would prefer a controlled liquidation over any of the other options.  The Fed is saving any additional QEs for something more major than a minor stock market downturn or 8% unemployment (at least based on the government’s statistics).  In addition, as I recently discussed, the Fed does not care about re-electing Obama.

The Fed will buy more government debt to keep rates low and to keep the big banks afloat.  Right now, rates are at or near all-time lows and the banks are still technically solvent.  Therefore, the Fed will wait for something more major before creating more new money out of thin air.

The FOMC statement said, “To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate more consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy.  In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

This means that the federal funds rate will be near zero for at least 6 years.  That is unprecedented.  However, it is misleading for the FOMC to say that it is being highly accommodative by keeping rates so low.  While the original Fed monetary inflation contributed to the situation, it is not really the Fed that is holding rates low now.  The federal funds rate is near zero because the banks have built up massive excess reserves.

The FOMC decision was almost unanimous, with one person dissenting because he “preferred to omit the description of the time period over which economic conditions are likely to warrant an exceptionally low level of the federal funds rate.”

Yes, these are the people controlling our economic future right now.  It is not consoling.  The good news is that I don’t think the Fed/ FOMC will go to hyperinflation.  I see that with their actions now.  If I see anything new that changes my mind, I will be sure to write something about it.  But for now, the Fed is sitting tight and we should too.

I am a big proponent of the permanent portfolio as described by Harry Browne in his book Fail-Safe Investing.  I believe you should have a majority of your investments in a setup like the permanent portfolio.  For more conservative investors, it should be closer to 100% of your investments (not counting any investment real estate).

The one thing that scares many people, particularly libertarians, is the bond portion.  You are supposed to invest 25% in long-term government bonds.  Many libertarians (and others) are convinced that rates will be going up.  This would drive down the value of the bonds.  Ironically, I have heard this for many years now, even about 7 or 8 years ago when Harry Browne was alive.  Yet, bonds have done quite well over this period of time.

I understand the fear that people have of government bonds.  You shouldn’t be afraid of an outright default, as we see coming in Europe.  I’m not saying it isn’t possible, but I think we still have quite a bit of time before the U.S. government considers an outright default.  The main threat is rising interest rates.  If we hit a period of higher price inflation and the Fed is forced to stop buying government debt, then higher interest rates will probably occur.

The problem here is that the future is unpredictable.  Japan has really high debt and yet interest rates have stayed very low there for decades.  The bond portion of the permanent portfolio is designed to keep the portfolio performing well in the face of a deflation/ depression.  It actually kept the portfolio from falling too dramatically in the fall of 2008 when stocks and gold tumbled down.

So I have come up with a compromise for those interested in the permanent portfolio, yet too scared to put such a big portion in bonds.

Earlier this year, I wrote a special report titled, “Should You Pay Down Your Mortgage?“.  It is available on kindle for just 99 cents and can be read in less than an hour.  I have mixed opinions on this subject and I laid out the pros and cons of paying down or paying off your home mortgage.

One thing I mention is that paying down your mortgage is somewhat of a hedge against deflation.  While actually selling your house might be a better hedge, that isn’t a realistic option for many people.  Some people don’t want to rent.  Plus, it wouldn’t make much sense to sell your house in anticipation of deflation when you can’t be certain of the future.  If the deflation doesn’t come, then it was a bad decision to sell.

So here is my proposal, assuming you have a mortgage and assuming you have money to invest.

Instead of investing 25% in bonds, take half of that portion and make a payment towards the principal balance on your home mortgage.  In other words, let’s say that you have $20,000 to invest.  You will take $5,000 and buy gold or gold investments.  You will take $5,000 and buy a broad stock market index.  You will take $5,000 and put it in some kind of a money market fund.  For the remaining $5,000, you will take $2,500 of it and put it in long-term government bonds and you will take the other $2,500 and pay down the principal on your mortgage.

Assuming you have an interest rate of 4% on your home loan, you will get the equivalent of a 4% return on this money.  You will essentially be locking in that return with compounding interest, so it will benefit you if interest rates go lower. In other words, it is somewhat of a hedge against deflation.  If you have trouble thinking of it this way, just think that having a big mortgage is a hedge against inflation.  You can pay off your mortgage in depreciating money as time goes on.

With that said, I wouldn’t recommend taking the full 25% and paying down your mortgage.  You have more leverage with the bonds.  In addition, paying down your mortgage makes that money illiquid.  If there is a deflationary depression, you need to be able to rebalance your portfolio.  That’s why you should still leave a portion in bonds in your permanent portfolio, even if it is a smaller amount.

This is not an exact science, but neither is the permanent portfolio.  It is just a suggestion for those of you who are really scared of buying bonds with rates so low.  If you have a mortgage, then you can hedge against deflation by paying that down.

There seems to be an assumption that is held by a large number of people that the Federal Reserve tampers with its monetary policy prior to an election in order to juice the economy.  I have heard people say that they don’t expect a crash until after the election because the Fed won’t let it happen.

While I can’t say for certain that this hasn’t happened in the past, I don’t believe it is necessarily true.  Making this assumption could really guide someone the wrong way.

The Federal Reserve is a political organization.  Its website ends in “.gov”.  While the Fed is certainly there to benefit the big banks, it is also there to benefit big government and deficit spending.  It has a monopoly on the production of dollars, which we must use in many cases because of the legal tender laws.  In addition to all of this, the Fed chairman is nominated by the President and confirmed by the Senate.

While the Fed is a political organization, I’m not sure why people would think that it has to favor the incumbent.  The Fed is in bed with the establishment, not any one particular party or incumbent.  Why would Bernanke and the Fed care about saving Obama for re-election when the alternative is Romney? Does is really make any difference?  If anything, the establishment might actually prefer Romney at this point.  Obama seems to be overplaying his hand lately with comments about businessmen not really building their own business.  Obama is so philosophically wedded to big government, he is giving it a bad reputation.  The establishment might prefer someone like Romney who talks about capitalism and entrepreneurship, because they know his policies will still favor the establishment.

Now, if Ron Paul were the Republican nominee, then certainly Bernanke and company would be doing everything in their power to get Obama re-elected.  If they had to triple the money supply again just to get things looking good before the election, they would do it.  But since that is not the scenario, the Fed and the banking establishment don’t really care about Obama.

The current Fed policy proves that they don’t care about Obama winning again.  The adjusted monetary base has been flat for over a year now, since QE2 ended in June 2011.  If the Fed really wanted to cause an artificial boom prior to the election, they aren’t doing a very good job of it now.

I think another interesting point in all of this is to look at the past.  Paul Volcker came in as Fed chairman in 1979 and threw the hammer down.  He stopped the printing presses and let interest rates rise well into the double digits.  This sealed the deal for Jimmy Carter.  Volcker’s policy brought about a deep recession.  He was not concerned about Carter winning his re-election.  He was concerned about saving the dollar.  This was in spite of the fact that Carter nominated Volcker to his position.  It just shows that not even the president is really running the show.

I would not time your investments based on the election.  If you think there will be a stock market crash, I wouldn’t wait until after the November election to sell.  There is a lot of concern building that higher taxes will really hurt the economy in 2013.  These are expiring tax cuts and new ones from Obamacare.  When you couple this with the flat monetary base, there is certainly reason to be concerned about trouble in the short term.  Regardless, I wouldn’t count on the Fed going to QE3 just because Obama needs a boost.  They might do it for other reasons, but it won’t be for Obama.

I received this comment/ question recently:

The Wall Street Journal ran an article earlier this week about who invented the internet.  The author says it is an urban legend that the government launched it.  The article describes a brief history of some of the individuals and companies (like Xerox) that helped bring about what we have today.

I have always thought it was a ridiculous claim by statists to point out the internet as an example of something in which the government created or helped innovate.  The internet itself would be nothing if not for all of the contributing individuals and companies in the free marketplace.  How could anyone seriously ever compare the government to Google, Apple, Amazon, Ebay, or Yahoo when it comes to innovation?

The other thing that has always annoyed me about this claim that the government invented the internet is that it completely ignores what Bastiat taught.  A good economist should not just look at the things we can see, but consider all of the unseen things that never came about.  Government at all levels in the U.S. takes almost half of our income.  With that much money, it is actually surprising that the government can’t innovate more and invent more, especially with help from private companies.

If I had a trillion dollars per year at my disposal, I would think that I could hire enough people that I could at least cure a few diseases each year and invent some great new gadgets.  You could do a lot with even just 1% of that.  With 10 billion dollars per year, you could probably come up with some great things.

If the government hadn’t been taking all of this wealth out of society and misallocating it for the last several decades, it is hard to imagine what luxuries we would enjoy now.  Twenty, or even ten, years ago, nobody could have imagined an iPad because there was no such thing at that time.

The other interesting thing to note about this article is a fact that is missed on most people.  It was hard for the author of the article to pinpoint who exactly invented the internet.  It is hard to get it down to one company and even harder to get it down to one name.  That is because most things are not really invented by one person.

Most of the great things we have in our lives today were not invented by one person or even one company.  People are constantly building off of the works of others.  Chip speed and storage are getting better exponentially.  Yet, how many people could explain why?  How many techies do you know who could actually give you a coherent explanation as to why this is occurring?  A few might be able to tell you something, but they will probably just be blowing smoke.

There is nobody who knows how to make a car from scratch.  There is nobody who knows how to make a computer from scratch.  As Leonard Read told us in I Pencil, nobody even knows how to make a pencil.

This is the way civilization works.  We are constantly building off of the ideas and works of others.  This is how society can progress at such a rapid rate.  Most people specialize in one small thing.  They cannot tell you how all of the other parts work in the process.  They don’t need to.  It somehow all comes together.

In truth, nobody invented the internet.  It was millions of people who contributed.  Some people were more important than others, but it still would have happened if any one person had not existed.  It is rare that you have someone like Steve Jobs who makes such big contributions.  But even if Jobs had never existed, we would still have many great gadgets today.  It is hard to say if we would have iPads, but I’m guessing we would have other things similar.

Just imagine if the government ever got out of the way and all of the bright minds in this world were allowed to flourish.  Technology could grow even faster than it is today.  We can only imagine what might exist in another ten years.

There are two human beings in the history of America to have signed legislation mandating that individuals buy health insurance.  It just so happens that those two individuals are the two major candidates in the presidential election this year.

Mitt Romney and many of his conservative defenders like to point out that Romneycare was just done in Massachusetts.  They point out that it is a state issue and that while Romney passed such a plan for the state while governor, he would not support such a thing for the entire country.  In other words, there are many Republicans who are actually claiming that Romney is a states’ rights kind of guy.

Of course Romney only signed legislation affecting Massachusetts.  He was a governor.  There was no way he could pass something for the whole country.  And of course Romney is against Obamacare.  The hatred of Obamacare is the one thing that most unites Republicans and Mitt Romney is running on the Republican ticket.  Do you think he would have gotten the nomination if he said he supported Obamacare?

So the one major difference between Obamacare and Romneycare is that Romneycare only applies to one state and not the whole country.  But does this make Romney in favor of states’ rights?  Is he a big supporter of the 10th Amendment.

The 10th Amendment reads, “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

If Romney really supported the 10th Amendment, then he would not support 90% or more of what the federal government actually does.  In fact, he would be calling for the elimination of entire departments like Education, Housing, and Agriculture.  Unfortunately, Romney is not calling for the elimination of any departments or really any specific cuts at all.  He didn’t even do this while campaigning in the Republican primary, so you know he is certainly not going to cut anything if he is actually elected.

Romney can’t even get it right with another medical related issue.  He implies he is against Obamacare because he is in favor of states’ rights, but he doesn’t even respect the right of states to determine their own laws regarding medical marijuana.  He says he would fight against medical marijuana tooth and nail.  Watch the video below (thanks to Lew Rockwell):

Romney has no interest in smaller government.  He talks about it a little bit to pander to his base.  Anyone who is going to vote for Romney thinking they might get smaller government is simply naive.

The only way anything will be cut under a Romney presidency is if the Federal Reserve makes the decision to stop buying any more government debt and let interest rates rise.  That may force the government to cut back, or at least slow down.  Government spending will not be cut because of any philosophical principles that Mitt Romney holds.

Yesterday, I made a case against school vouchers using a moral argument.  Today, I will continue to make a case against school vouchers, but this time will use pragmatic arguments.  There could be a lot of unintended consequences (as with so many government programs) and these possibilities need to be explored.

Let’s say that in a particular school district or in a particular county, the average spending per student is $12,000.  Conservatives (and unfortunately, some libertarians) see the failing schools and unaccountable teachers and propose to institute school vouchers.  This means that every parent of a school-aged child would receive a voucher worth $12,000, to be used for the school of their choice.  Let’s explore some of the problems that could arise.

First, let’s say that you already send your child to a private (slang for non-government) school.  As a parent, you realize this is a rip-off because you already pay property taxes and other taxes that fund government education, which you choose not to use but are still forced to pay for.  Now that every parent/ child has a voucher, you will save money.  However, you weren’t part of that $12,000 per student before.  So if every child is given a voucher, the education costs will go up quite significantly, depending on the percentage of kids who go to private school.  There will now be more children to spend $12,000 per year on because the number will now include those not attending government schools.

It would be completely unjust to not offer a voucher to those already in private schools.  These parents would be really mad if that happened.  But either way, there would come a point where every child would receive a voucher.  In other words, government spending just went up and taxes will have to go up too.

Second, there are several reasons why parents might choose to send their children to a private school, even though they are double-paying (once through taxes and once to the private school).  They probably think the education is superior.  However, if vouchers are instituted, then that means any child could attend their school.  Now, I’m not against poor kids going to a good private school if the parent/ child really cares about getting a good education.  However, it is not hard to imagine that your school would all of a sudden be interrupted by troublemakers.  The parents who didn’t care before, probably still don’t care.  The same goes for the child.  Perhaps the school could kick out big troublemakers, but we can’t even be sure of that (see reason three next).

Third, if virtually all schools are receiving their revenue from vouchers, then politicians will start to exercise control over these schools.  It is not hard to imagine a politician saying that since these schools are receiving government funding, then they should have to meet certain criteria.  Perhaps they can only teach a certain curriculum.  Perhaps they can no longer teach anything about religion.  Perhaps they cannot kick kids out of their school for misbehavior (see reason above).  Perhaps they will have to give certain tests to make sure the children are learning the “right things”.  When the government has control, there are endless possibilities.  The really bad thing is that virtually all schools will be under government control in a voucher system, whereas at least now private schools do not have as many government rules and regulations to follow as government schools in most places.

Fourth, if every parent now has $12,000 per year to spend on each child for education, why wouldn’t education prices go way up?  It would be hard to imagine a school charging anything less than this amount.  Isn’t this the reverse of what libertarians want?  It isn’t complicated that when government subsidizes something, prices usually go up.  We can see this with medical costs and higher education.

These are just a few of the major reasons that libertarians should be against school vouchers.  Not only are they not ideal for libertarians, they are not even a step in the right direction.  They may actually be a step in the wrong direction, leading to government control over all schools and completely out-of-control government spending on education.

In conclusion, libertarians (and even conservatives) who advocate school vouchers should be careful what they wish for.  It could be a dream come true for the advocates of big government.

The issue of school vouchers is a highly divisive one.  It is even controversial within the libertarian community.  The libertarian argument in favor of school vouchers is similar to that of conservatives.  They see the government-funded school system as wasteful and in the hands of the teachers unions.  They see the lack of accountability and want some kind of a change.  They figure they can just hand a big check to parents each year to determine the school of their choice and that it couldn’t be any worse than what we have now.

There is a strong case to be made against school vouchers from a libertarian standpoint.  This is the position that I take.  It is completely different from those on the left who oppose school vouchers because they want the status quo.  I do not like the status quo at all.  I don’t believe in government education.  As I have written before, government education is a form of welfare.

As with most issues, there are two arguments to be made against school vouchers from a libertarian standpoint.  There is the moral argument and there is the pragmatic argument.  Today, I will focus on the moral argument against vouchers.

Libertarians generally believe that force or the threat of force should not be used for political or social change.  While I kind of stole that from the Libertarian Party pledge, it applies to all libertarians, whether or not they are a member of the actual party.

School vouchers does not change the fact that people are being threatened with force to obtain their money.  In fact, school vouchers don’t even reduce the amount being confiscated in most cases.  Most advocates of vouchers are not proposing a dramatic decrease in education funding.  They are just changing the direction of the funding.  Instead of the money going directly into the school systems, the money will first go to the parents, who will then decide on where the child and money go.

School vouchers are still welfare.  It is still a redistribution of wealth.  There is no way around it.  There are many people who never have kids, yet they are forced to pay for other people’s kids.  For those who have kids, the numbers vary.  Some have just one child, while others may have 4 or more.  Yet, when people pay their property taxes, it is based on the rate of the tax and the value of the property.  It has nothing to do with how many kids you have.  If anything, the money coming from Washington DC for education comes disproportionately from those with fewer kids or no kids, because they do not get the extra tax credits and deductions.

School vouchers would not reduce government in any significant way.  They would not eliminate or even reduce the amount being confiscated, so it is hard to make a libertarian argument in favor of them.

As we will see in Part II, there are also pragmatic reasons to be against vouchers for libertarians.  They may not necessarily improve education and they could make things worse.  Stay tuned.

I received a comment recently from an anonymous person.

This person sounds like a fairly typical example of a somewhat average American.  Perhaps you could say this person is somewhat of a typical example of an average American who reads my blog, since the person has some gold investments.

It is hard to comment precisely, not knowing details about family, location, income, total savings amount, and risk tolerance.  But I can make some comments that might be helpful.  Since others may find them helpful, I decided to write a separate post, instead of just a response in the comments.

First, I think this person is on the right track.  He (I will assume this is a “he”) has a good portion invested in gold and silver (hopefully more gold than silver).  He has some of his savings in cash or cash equivalents, which is actually a good position to be in right now.

It is good that he is only contributing to his 401k plan up to the company match.  You should never go beyond this.  I have written about the risks involved with 401k type plans before.  If your contributions are hurting your other savings to a large degree, then you might even consider not contributing to the 401k.  Yes, I know every financial advisor out there is screaming.  But 401k money is the most illiquid savings you can have, especially when your employer won’t let you withdraw your own money.  It is more important to have an emergency fund that you can actually access, than a 401k.

He did not say what his investments are in his 401k plan.  Hopefully it is well diversified.  Some plans allow you to opt in to a special brokerage link account where you can buy any mutual fund that you want.  You would probably have to fill out a special application for this.  If your company allows this, then you should do it and you can then put the majority of your 401k money into PRPFX.

I would not start a regular IRA.  If you are going to start an IRA, then go with a Roth.  At least you can withdraw your principal money (not any gains) before hitting retirement age without getting hit with a penalty.

For the brokerage account, this person can set up something similar to the permanent portfolio using ETFs.  I have written about this strategy before.  He is already doing one portion with a gold ETF, probably GLD.

I’m not sure the total net worth of this individual.  He says that he has some of his savings in cash though.  If he is in a decent location, he might want to consider investment real estate.  If he could just buy one three-bedroom house and put 20% down, it might be a good payoff in the long run.  Mortgage rates are historically low and housing prices are low, depending on where you live.  This should generate positive cash flow for the average month.  If it doesn’t, then it shouldn’t be done.

Of course, there is also the option of paying down your mortgage if you own a home and have a mortgage.  This is a guaranteed rate of return equivalent to the interest rate on your mortgage.  It is a good compliment to gold holdings that hedge against inflation.  Paying down your mortgage is more of a hedge against deflation.

Overall, I encourage everyone to set up the majority of their investments (outside of real estate) into something similar to the permanent portfolio.  You will probably sleep better at night.

While the price of gold in terms of U.S. dollars has been fairly steady over the last several months, that hasn’t been the case for gold stocks.  Most gold mining companies have been hammered, particularly in the last year.

Fidelity’s gold mutual fund (FSAGX) is down over 30% over the last year.
GDX, a gold mining ETF, is down about 30% over the last year.
GDXJ, a junior gold mining ETF, is down a whopping 49%.

This is why gold stocks should not be part of your permanent portfolio.  They should be left for your speculative investments.  It is obvious why by looking at the recent performance.

So where do gold stocks go from here?  It is a tough question to answer and I think it will all depend on the direction the economy takes.  If we fall back into a recession (not that it seems like we ever got out of one), then gold stocks are likely to continue their poor performance.  If a recession is averted, at least for a little while, then we could see gold stocks resume an uptrend like we saw years ago.

Much of this will depend on the Federal Reserve.  The adjusted monetary base has been flat since QE2 ended just over a year ago.  The Fed is on hold, waiting to see what happens.  It is possible that it is waiting for another crisis like we saw in 2008 where it bailed out the big banks and financial institutions.  It is possible that the Fed will give in to pressure to boost the economy if the stock market turns down significantly or even if unemployment stays high.

If the Fed starts creating new money out of thin air again on a regular basis, then I would expect gold to start another run up.  I would also expect that gold stocks would then reverse the downtrend and go up. If that happens, then now might be the deal of the decade with how much of a beating the gold stocks have taken.

If the Fed stays tight and the economy falls into recession, then gold stocks will likely continue their fall, especially with a fall in the broader stock market.

Owning investments that reflect the price of gold are still much safer than owning gold mining companies.  If you try to speculate on some gold stocks, or funds that invest in gold stocks, just be sure that it is money you can afford to lose.