I received a question recently regarding investments beyond a 401k.  I think this advice might be helpful to others, so I will respond with a post.  The question was as follows:

The price of crude oil passed $113 per barrel today.  It has been climbing steadily for the last few months.  If you are looking for a good mutual fund with energy stocks, there is an energy fund by Fidelity with the symbol FSESX.  I have no opinion in trying to time it.  You really should have bought this fund a couple of years ago, but if you think oil is going higher still, then this may be a good mutual fund to own.  If you want to own it, just buy it and don’t try to time the market.  If you fear a pull back in the short-term, then dollar cost average your way into it, but don’t wait.

The price of oil had already been climbing, but it really started to take off when the protests in the Middle East and Africa began.  When Libya started to erupt, then the price really took off and has continued.  It is easy to blame the situation in Libya for our current oil price, but it really misses the big picture.

The Fed’s program of QE2 (money creation) is the elephant in the living room that many don’t want to talk about.  The Federal Reserve has almost tripled the monetary base since 2008.  Although most of this new money has gone into excess reserves with the banks, the new money is still having an effect on prices.  We are starting to see that now.

When new money is created, it is not evenly distributed throughout the economy all at once.  It can go to certain hot spots.  It causes bubble (and later busts).  Right now, it seems to be going into oil, precious metals, and other commodities.  It is also going into stocks to a certain degree.

When something happens in Libya or there are reports of things happening in other oil producing countries, the hot money starts bidding up the price of oil.  It is almost as if the market is looking for a reason to bid up certain prices.

So although the supply and demand (and the perceived supply and demand in the future) of oil affect its price, the supply and demand for money also affect its price.  The supply of money is going up.  Expect prices to go up.  Oil and precious metals are going higher right now.  Food prices will probably not be too far behind.  Be prepared for higher prices.

The adjusted monetary base is on fire.  You can view it here:
http://research.stlouisfed.org/publications/usfd/page3.pdf

Sometimes it is important to take a step back and get some context.  The longer term chart is here:
http://research.stlouisfed.org/fred2/series/BASE

The money supply has approximately tripled in the last 2 and a half years.  Nothing like this has ever happened in modern day America.  It really is unprecedented.  Oftentimes, I think libertarians get carried away with their predictions of doom and gloom.  People that believe strongly in the free market do not give enough credit to the free market’s ability to overcome government obstacles.  But this explosion in the money supply really is something to worry about.

Quantitative easing is the new term that refers to money creation.  QE1 happened after the fall of 2008.  We are now in QE2 mode which is supposed to continue until June.  You will hear some say that the economy is bad because banks aren’t lending.  What these people don’t realize is that the lack of bank lending is what is keeping this economy from completely falling apart.  If the banks were lending out all of this new money being created, we would be facing the possibility of hyperinflation.

I am not sure if the Federal Reserve has any idea as to what it is doing.  This crazy money creation is causing great damage that we will see in the future.  It is misallocating resources on a grand scale.  It is preventing previous malinvestment from correcting.  It is setting the stage for what could be the Greatest Depression, even worse than what we saw in the 1930’s.  I hope I am wrong and that the Fed slowly starts to pull this new money out of the system.  I hope we go through a recession like we did in the early 1980’s.  Bernanke and the Fed are playing with fire right now.

Expect for price inflation to slowly pick up throughout the year.  I don’t expect QE3 any time soon, but you never can tell with the morons that are running the Fed.  If you haven’t already done so, prepare yourself for price inflation like we saw in the 1970’s or worse.  Buy essentials that you need.  Buy extra and don’t wait.  You obviously can’t buy extra gasoline and most food now, but there is a lot you can stock up on.

For your investments, you should have at least 25% of your portfolio in investments that do well during times of high inflation.  This is the minimum.  You should invest in things like gold and gold related investments, silver and silver related investments, oil stocks, oil mutual funds, oil ETFs, other commodities, etc.  You should prepare for interest rates to go much higher, but I wouldn’t necessarily speculate on it right now.

I have a lot of faith in the free market, but the Fed and the government are doing too much damage right now for us not to feel some major pain in the near future.  Prepare yourself and don’t wait.

Since the national debt is in the national news, now is a good time to review it.  The national debt is over $14 trillion and growing.  It is slightly less than the GDP.  The debt-to-GDP ratio will be over 100% soon enough.  So what are the consequences of this?

We hear so often that we are putting a burden on our children and grandchildren because they will have to pay this back.  There is an element of truth to this, but let’s examine it closer.  Our children and grandchildren technically don’t have to pay back anything.  They can stiff all of the bondholders.  If there are enough people who understand the issue and take a stand, then it will be the bondholders that will suffer.  That will include foreign governments like China and Japan, foreign investors, American investors, and I suppose the Federal Reserve.

The national debt has real consequences and they are happening right now.  When the government spends money, it is misallocating resources.  It is draining resources from the free market economy.  There is less capital investment on the so-called private side.  It is wasting resources.  This diminishes our standard of living.  By not completely reforming our system – that is, by not withdrawing our consent to be governed – Americans are hurting themselves by allowing this debt to continue to grow.  It really comes down to Bastiat’s philosophy of what makes a good economist.  We can clearly see the so-called benefits that the government hands out.  What we don’t see is all of the products and services that would have been invented, improved, and more affordable.

The reason that the national debt is hurting our children, grandchildren, and future generations isn’t because they will have to pay it back.  The reason is because of the lack of capital investment that is taking place because of the national debt and out-of-control government spending.  The government is misallocating resources on a massive scale.  It means that there will be less to consume in the future.  It means that there won’t be as much growth in technology and production.  With less capital investment, the standard of living will not be as high as it should be for future generations.

The national debt will probably never be paid off.  It certainly won’t be paid off in dollars that are worth as much as today.  The national debt has very real consequences though in making our standard of living far lower than what it should be.

There probably won’t be a government shutdown (unfortunately).  If there is, it probably won’t last long.  If there is, it doesn’t mean that all troops will be coming home and that Social Security checks will stop.  It means that some government employees won’t be reporting for work for a short while.

This whole debate is for show.  The Republicans have to show a little bit of allegiance to the tea party people and the Republican politicians need to pretend that they care about cutting spending and reducing government.

The Republicans originally proposed about $100 billion in cuts.  Much of this turned out to be decreases in proposed spending.  The real cuts amounted to about $62 billion.  This didn’t pass the Senate.  Now they are talking about cutting $33 billion below current spending.

This whole thing is a joke.  This is a debate about nothing.  The national debt is over $14 trillion.  The annual deficit is over $1.5 trillion.  The DC politicians are arguing over amounts that total less than 1% of the total federal budget.

This whole thing is symbolic.  What it is really symbolic of is the coming fiscal collapse because the spending in DC is out of control.  The Fed will continue to print money to fund the bad habit.  We will have to wait for high price inflation and higher interest rates before the Fed will consider putting on the monetary brakes.

We will see fiscal discipline forced on the DC politicians, much like we are seeing in many states.  The DC politicians can keep their game going longer because of the central bank.  When the dollar is on the verge of collapse and the Fed has to stop creating new money, then we will finally get to see the show.  Then we might see a true government shutdown where the troops really do come home.  If it is really bad, we might even see Social Security checks stop.

I am a strong advocate of the permanent portfolio, as recommended by Harry Browne in his little book Fail Safe Investing.  For those not familiar, I recommend reading it and implementing it.  To give a very brief summary of the permanent portfolio, it is a portfolio in which you divide up your investments as follows:

25% stocks
25% long-term government bonds
25% gold
25% cash (or cash equivalents)

The idea of this portfolio is asset protection with some growth.  It is highly diversified so that it will be protected (and possibly grow) in any economic environment.  There are variations of the portfolio such as the permanent portfolio mutual fund (symbol: PRPFX), but the idea is still the same.  The portfolio has done remarkably well over time with very few down years and significant growth.

One thing about the permanent portfolio (including the mutual fund) is that it has an inflationary bias.  In other words, the portfolio performs much stronger in a highly inflationary environment.  This is because of the 25% weighting in gold.  The mutual fund is similar, with a small portion in silver.  This is much higher than the typical investment advisor would recommend.  It is surprising when you get an investment advisor recommending as much as 10% in gold  or gold related investments.

This inflationary bias with the permanent portfolio is just as it should be.  If you are in a period of deflation and falling prices, you don’t need your portfolio to do really well.  You just need it to stay the same and your purchasing power would be increasing due to falling prices.  But in an inflationary environment with rising prices, you want your portfolio to be going up more than the price inflation rate.

If prices are going up at 10% per year, then you want your portfolio returning 15 or 20%.  If prices are flat, then a return of 5% on your investments is reasonable.  When looking at it this way, the permanent portfolio is even stronger than just looking at the charts (which is impressive anyway).  The returns, when factoring in price inflation, are even more steady for the permanent portfolio.

I recommend having your core holdings in something that is set up similar to the permanent portfolio.  I am not against speculating, but I think that should be done with “play money”.  There is nothing that is guaranteed in this world, but the permanent portfolio is the closest thing to safety as you will find and you may even get some decent returns with it.

After a lawsuit was filed by Bloomberg, a case that went all the way to the Supreme Court, the Federal Reserve has released over 29,000 pages of documents which gives us some detail of the bailouts that took place 2 and a half years ago.  Although much of it will be called lending from the discount window, it is still a bailout nonetheless.    If a bank, or any firm, has to get a loan from the Fed’s discount window, it is being subsidized.  No private party would make a loan under the same conditions.

The documents show that some of the biggest “borrowers” were not even American firms.  The most ironic of them all shows that a company which is partly owned by the Libyan central bank (part of the Libyan government) borrowed billions of dollars.  This pretty much fits in line with U.S. foreign policy: “we were for them before we were against them”.

If you are not outraged by this, then you are either a long-time libertarian who has become numb to what is happening or else you are just not with it at all.  The American people were overwhelmingly against the bailouts that took place in the fall of 2008.  Despite the outrage, Congress, along with Bush, passed the bailouts, telling us that the whole system would have collapsed otherwise.

This was hard enough to fathom at the time, but now we know the Fed was also bailing out foreign banks and, apparently, foreign governments.  Where does this end?  I suppose the answer to that is with a collapsing dollar.

This whole episode is another black eye for the Fed and the federal government in general.  The American people are starting to figure out that these clowns in DC are not on their side.  They do everything for themselves.

Since Ron Paul’s campaign in 2007, the Fed is being questioned more and more.  The internet has played a huge role in spreading all of the information and disinformation.  Although the numbers are still small, more people are becoming educated about monetary policy and the central bank.  More people understand that the Fed simply creates money out of thin air, which then makes the dollars we have worth less.

While this release of documents should outrage the average American, I think it is a good thing overall because it alerts people as to who the enemy is.  When high price inflation becomes more apparent, I want people to know who the culprit is.  I want people to blame the Fed, just as they should.  The Fed has gotten away with things for almost 100 years and finally, the tide is starting to turn.

For some reason, foreign governments and foreign central banks continue to buy U.S. government debt.  The Chinese and Japanese governments are by far the largest holders.  The “leaders” of these countries are mostly Keynesians or some sort of off-shoot.  You could also call them mercantilists.  They are stupid to continue to fund Congress’ spending spree.  The Chinese and Japanese governments would be better off buying gold.  Actually, they would be better off accumulating nothing and just allowing their economies to be free.  Although the Chinese government has been more openly talking about buying gold, it is not anywhere near to the extent of U.S. government debt.

These foreign governments are basically subsidizing U.S. consumers.  This is good for most U.S. residents, at least in the short-term.  The bad part is that the foreign governments are helping to support a bad habit (spending by Congress).  It is like a parent that keeps giving money to the irresponsible kid.

When foreign governments buy U.S. treasuries, it means that the Congress can keep running up the debt without having to worry about who will buy its bonds.  If, for example, the Chinese government said “no more”, or even worse, if it started selling U.S. debt, then other buyers would have to step in.  It could be other foreign governments.  It could be foreign citizens.  It could be U.S. citizens.  And of course, it could be the Federal Reserve.

In order to entice buyers, interest rates would go up.  This means the federal government would have higher interest costs.  This means that there will be even more deficit spending, unless Congress makes cuts to the budget (yeah right).

It is just hard to grasp how these foreign governments could be so stupid.  They should easily see the writing on the wall.  With QE2 in full force, the dollar has nowhere to go but down in the future.  The Chinese and Japanese will get paid back in dollars that are worth less, while getting paid tiny amounts of interest.  They are central planners and they don’t understand economics.

The free ride in the U.S. is almost over.  The politicians in DC will continue to spend like crazy until they are forced to cut back.  The Chinese and Japanese politicians will continue to be stupid for a while longer and hold onto U.S. government debt.  But the market will straighten things out eventually.  There will be a day when rates will go up and the Fed will be forced to create new money to support the spending habits in Congress.

The ultimate day of reckoning will be when the Fed faces a complete destruction of the dollar.  The Fed will have to stop the money flowing or else face hyperinflation.  When the Fed stops the money flow in an attempt to save the dollar, then the politicians in DC will really be squirming.  They will face angry voters.  They will be forced to cut spending on a massive scale.  They will face a similar circumstance as what many states are facing.  It will just be on a much larger scale.

The Federal Reserve has a monopoly on the money supply in the United States.  No individual or business can legally do what the Fed does.  Although the Fed supposedly has a dual mandate of keeping stable prices and maintaining low unemployment, it does neither.  In fact, the Fed causes higher unemployment and less stable prices.  The real purpose of the Fed is to protect the big banks and allow Congress to deficit-spend.

Although more Americans are understanding that the Fed creates money out of thin air, most do not understand how it is done.  Basically, the Fed buys assets and it does so by creating digits.  These new digits represent money.  So when the Fed buys assets, it is creating money out of thin air, essentially with an accounting entry on the computer.

Now, many of us like to say that the Fed prints money.  This is technically not correct, but it does get to the point.  The Fed creates digits.  If more people try to redeem these digits from the banks, then actual money will be printed.

Before 2008, the Fed only bought U.S. government treasuries/ bonds.  In late 2008 and early 2009, the Fed bought huge amounts of so-called toxic assets.  These were mortgage-backed securities that were owned by the big banks.  These mortgages (pooled together) were in trouble because of the crash in the housing market and the recession.  More and more people were defaulting on their mortgages and these assets were declining in value.  The Fed bought many of them from the failing banks in order to save the banks.  The Fed bought them at their original value, instead of their lower market value.

Usually, if the Fed wants to lower its balance sheet (take money out of the system), it can simply sell some of its assets.  These assets are typically U.S. treasuries.  But in the case of these mortgage-backed securities, they may only sell on the open market for half of what the Fed paid for them.  Therefore, the Fed will have trouble pulling back the money supply with these.  And the Fed will not dare sell them back to the banks at the original values or else it would sink the big banks.

The Fed can create money out of thin air by buying anything.  The Fed could start buying cars and televisions.  But since the Fed typically buys government debt, it allows the federal government to run up its debt to very high levels as we currently see.  This has an effect on interest rates because of what the Fed is buying.  If the Fed bought cars and televisions, it would distort those markets, but it would not impact interest rates anything like buying government debt does.

With QE2 in full force, the Fed continues to create new money at a staggering pace.  Usually this new money would be lent out by the banks and the fractional reserve banking process would take over.  But this new money has gone into excess reserves, which has kept price inflation in check (for now).

It will just be a matter of time before the Fed has to make a major decision.  It will either have to continue to create new money and fund the Congress or it will have to stop and maybe even reverse.  If the Fed continues, it will eventually risk hyperinflation and a complete destruction of the currency.  If the Fed stops (which I think it ultimately will once we have high price inflation), then we will experience a major depression and the federal government will be forced to cut spending dramatically.

We have many reasons to be optimistic in the long-term.  We also have many reasons to be pessimistic in the short-term.  Hold onto your hat for a wild ride ahead.

Libertarians understand that government interference in our lives generally makes things worse.  This holds true in any area, but particularly in economics.  We know that when the government taxes or regulates, it harms free individuals trying to freely associate.  Taxes and regulations harm employers, employees, customers, etc. and they also distort production.

One thing that is overlooked outside of Austrian economic circles is the importance of the monetary system.  You can have a limited government as far as taxes and regulations, but if the monetary system is bad, then the economy will suffer greatly.

The United States saw the greatest growth in productivity and living standards in the 19th century as ever before.  People who have some grasp of free market economics attribute this to the low taxes and regulations during that time.  And while this aspect was certainly important, I believe the monetary system was even more so.

During the 1800’s, the U.S. had a fairly stable monetary system.  It was not exactly an Austrian economist’s dream, but it was definitely a lot better than what we have today.  There was not a complete free market in money and there wasn’t even a pure gold standard.  But it was still a monetary system based on gold and silver.  Although it had its flaws (due to government interference), the monetary system of the 19th century kept a very strict limit on government inflation and debt.

The 19th century provided the people of the U.S. with price deflation (oh the horror).  But this was not deflation like during the Great Depression.  This was an increase in purchasing power for the average guy. He was able to buy more with his money as technology and productivity increased.  Capital was accumulated and invested like never before.  People saw their standard of living increase, even though the early 20th century really exploded off of the capital investment and technology from before.

The fact that the monetary system was reliable and predictable really set the stage for booming business.  Although there were “panics” and mild swings in the 19th century (again, usually caused by government), it was actually a much more stable time.  Since the Federal Reserve was formed in 1913, we have seen booms and busts like crazy.  These wild swings are attributable to the Fed’s monetary policies.

If the U.S. (and any other country) really want great prosperity going forward, the first thing that needs to happen is to get rid of the central bank and allow a free monetary system.  To start this process, we should all advocate the repeal of legal tender laws.  We should all be allowed to do business with whatever currency or other form of money we wish to use.  The Fed should not have a monopoly on money.  This should be a major goal for those who love liberty.