Yesterday I received a nice comment and was asked about setting up a permanent portfolio via a 401k plan.  As a side note, I don’t always respond to comments as I don’t want to get bogged down in debates and get sidetracked, but if someone asks an interesting question, I will post a response if I think I can contribute something insightful (I’ll have another response to another comment tomorrow).

For a 401k plan, it is hard to set up a permanent portfolio (as described by Harry Browne in his book Fail Safe Investing).  It is even harder to recommend something because every company is different in what they offer.  Some companies offer plans that limit you to just a few mutual funds, while other plans may offer hundreds of funds.

If your 401k plan is limited and only offers a few funds, then it will be impossible to set up anything close to the permanent portfolio.  My best advice in this situation is to split up your money between stocks, long-term bonds, and a money market fund.  Hopefully your plan at least includes these options.  The problem here is that you don’t have anything in gold or even related to gold.  This leaves your portfolio vulnerable to inflation and if you are going to be short on something right now, an inflation hedge is the last thing you want to leave out of your investments.

In this circumstance, take any non-emergency money that you have saved up and invest it in gold or gold related investments to make up for the shortfall in your retirement plan, if this is possible.

If your 401k plan offers a lot of choices, then you may be able to work with it.  I have seen plans that offer all of the Fidelity mutual funds and Fidelity offers a lot of select funds.  The stocks, bonds, and cash portions should be easy.  For your inflation hedge, you can at least invest in a precious metals mutual fund. Now understand that this is not the same as owning the metal.  Gold stocks are actually much more volatile than the price of the metal.  So if you can’t invest in gold directly, you should go lower with a mutual fund of gold stocks.  In this case, it might be good to put 10% in a gold mutual fund.  For more inflation protection, you could also add in 5% for an energy mutual fund.  If you were to put a full 25% in a gold mutual fund (made up of gold stocks), your portfolio would get hammered if something happened like the fall of 2008.

In some Fidelity plans (and I suspect others offer similar options), you can use “brokerage link”, which allows you to invest in most mutual funds and maybe more depending on your plan.  If this is an option, you can take most of your 401k money and put it into the permanent portfolio mutual fund (PRPFX).  If your plan allows you to buy exchange traded funds (ETFs), then you can buy TLT (bonds), GLD (gold), and an ETF of the broad market like the S&P 500.  The cash portion is always easy to find something.  In addition, you could always take your gold percentage down to 20% and put the other 5% in SLV (silver).  Silver is more volatile, but can be very profitable in a commodity bull market.

Explore your choices with your 401k plan and adapt as necessary.  Just make sure you find some protection against inflation.  The Fed is creating new money like crazy and having all of your money sitting in cash is actually a huge risk right now.

Yesterday, Paul Craig Roberts had an article on the latest jobs report that said there were 192,000 new jobs last month.  In the latter part of the article, he discusses how these figures are determined.  I can’t really confirm or deny his comments there.  If his claims are accurate, it almost makes you wonder why anyone would pay any attention to such a report.

The part of his article that I would like to discuss in more depth is at the beginning where he points out that most of the added jobs were service jobs.  Paul Craig Roberts is a good writer and has been a great advocate for civil liberties.  He has taken a principled anti-war position and has been very libertarian in these respects.  Although he can provide interesting information when it comes to economics, this is the area where I disagree with him on a lot of issues.  He does not understand the free market.

He says in his article, “How can Americans, who had no growth in their real incomes and who are foreclosed from their homes and maxed out on credit card debt, car payments, and student loans, spend more every month in bars and restaurants?  How can a few service areas of the economy grow when nothing else is?”

This is representative of things he has written before.  He has a lot in common with Pat Buchanan.  Now, I agree with Roberts up to a certain point that, generally speaking, things are a mess right now.  There are a lot of distortions in the economy and government interference is preventing the proper allocation of resources according to consumer demand.  But who is he to say that there should be less jobs in the service area and more in some other area.

Back in January, I wrote a post on a classic article by Harry Browne dealing with economic fallacies.  In Browne’s article, he addressed this exact point.  For decades, people have been complaining that the U.S. does not manufacture enough.

What Paul Craig Roberts and others fail to realize is that there is nothing wrong with service jobs if that is what is being demanded.  Last time I checked, there was no shortage of food and clothing in the United States.  Now I understand that we don’t have a free market in the U.S., but it is still free enough that there is some natural aligning of resources with their proper use.

In an advanced civilization, more services mean more luxury.  There is nothing wrong with this.  It takes less people and less resources to make food, clothing, shelter, and other basic needs.  This is due to a variety of factors within the free market.  The high division of labor allows people to specialize.  There is comparative advantage which means that an American might be better off allowing someone in South America or Asia to make food, clothing, and other goods.  The CEO of McDonald’s might be the best cashier there is, but it doesn’t mean it is a good value of his and the company’s time to have him working the register.

In addition, technology gets better and there is more capital investment over time.  This allows more and better goods to be produced at cheaper prices (if there wasn’t monetary inflation) and it frees up human capital to focus on other things.  If consumers have all of their basic needs met, then they will demand other things.  Those things might be restaurants, spas, hair dressers, massage parlors, etc.

Again, I’m not saying that the economy is great right now (it’s not) and I’m not saying that all resources are being properly allocated (they’re not).  But if there really are service jobs being added, there is nothing wrong with this, especially when it seems that other industries (cars, construction) are being the most subsidized by government.

Housing prices have gone down across the United States in the last 5 years.  In some areas, prices are down by 50% or more.  Of course, other areas have seen smaller declines and there might even be a few areas that haven’t seen declines.  But where will housing prices, in general, go from here?

This analysis is a generalization as housing prices can vary and do different things from region to region.  For example, I wouldn’t recommend buying a house in Detroit, regardless of what the overall housing market does in the U.S.

There are a lot of pros and cons for buying a house today.  There was a huge bubble in real estate and we have seen the bubble pop.  The question remains if the bubble has completely deflated yet.  It is hard to say because the government has worked hard in trying to prop up prices or at least decreasing the rate of decline.

There are a lot of people underwater in their homes now.  They owe more for their mortgage than what their house is worth.  There a lot of short sales and foreclosures.  A good portion of these need to be cleared before housing prices will go up again.  In addition, it is hard to say how many people would like to sell but aren’t even trying right now because of the depressed market.

There are certainly a lot reasons to be bearish on housing right now.  With that said, there may be one very good reason to be bullish.  That reason is the Federal Reserve’s monetary policy.  While it is the Fed’s policies that caused the original bubble in the first place, the Fed is creating new money like never before and it will continue at least through June, unless they cancel QE2.

If you are looking to buy a house as your primary residence, I don’t think you should be too concerned about the short-term outlook on housing prices.  Instead, you should be asking yourself other questions.  Can I afford the payments each month?  Do I have money for a down payment?  Can I afford all of the other expenses with home ownership?  Do I plan to stay in the house for several years?

If you are answering yes to all of these questions, then perhaps you should buy a house for your primary residence, as opposed to renting.  Interest rates are not quite as low as 6 months ago, but they are still very low by historical standards.  If you can lock in a 30-year fixed rate mortgage, then you will pay it back in depreciated dollars.

If you are looking to buy an investment property, then the most important thing to look at is your payments vs. the rent.  When you consider your payments, you have to factor in the mortgage, the property taxes, association fees, homeowners insurance, repairs, and possibly a management company.  If you add up all of these things and average them on a per month basis and you can collect rent that is higher than this amount, then it is probably a good investment property if it is in a decent area.

The biggest indicator of a bubble five years ago was rents vs. prices.  You could rent a place for far less than your monthly mortgage payments on a similar place.  It meant that prices either needed to come down or rents had to go up.  In a situation where rents are higher (as we are beginning to see in some areas), then either rents will go down or housing prices will go up.

I think we will see some more in the way of price decreases in the near future.  But interest rates are a wild card right now and there are more signs of price inflation.  Even if housing prices don’t go up in real terms, they may go up in nominal terms due to the falling dollar.  This will be good for people with a fixed rate mortgage.  You can pay off your lender in money that is worth less and less each passing day.

As far as investments, I have warned about the possibility of uprisings in Saudi Arabia.  As far as oil is concerned, Libya is small peanuts compared to Saudi Arabia.  If major protests begin in Saudi Arabia, you can look for the price of oil to double or more if oil supply disruptions are threatened there.

This is an example of where international events affect the entire planet, both short-term and long-term.  Overall, the events should be positive for liberty in the long-term.  People are tired of oppression by thug dictators and are beginning to rebel.  We can thank technology for a large part of this.

It is interesting to observe where these uprisings are occurring.  There is a theme of protests happening in Middle Eastern countries, which are mostly dictatorships.  In addition, most of these dictators get money from the U.S. government, which makes it easier for them to suppress opposition.

We shouldn’t ignore the demographics of the countries that are experiencing these protests.  These are mainly poor countries where a lot of the people are living on a few dollars a day, if that.  Some of them have computers and cell phones because of the inexpensive technology industry.  But many of them are struggling just to put food on the table each day.

Saudi Arabia is different.  The Saud family are dictators and they are oppressive.  There is very little social freedom in Saudi Arabia.  But it is an oil rich country and there is a little bit of free enterprise there.  Although it is nothing like the U.S., there is somewhat of a middle class there.  In addition, there are a lot of foreigners working in Saudi Arabia.  The Saud family recently said they would spend $36 billion to help the people there.  If they were smart, they would have just offered it all in checks directly to everyone, but instead it looks like it will be more like an Obama stimulus on government programs.

Although there is certainly a possibility of revolution in Saudi Arabia, it is a different country that Egypt, Tunisia, or Libya.  There is more for people to lose there.  Sometimes when you have more wealth, you don’t take as much risk because you don’t want to lose what you have.

I had seen earlier stories listing several countries that could face revolution.  I saw the United Arab Emirates on this list a few times.  I don’t think the people who wrote these stories thought things through.  They have obviously never been to a place like Dubai.

Dubai and other parts of the United Arab Emirates have freer markets than the U.S. and almost everywhere else.  Dubai is an example of a benevolent dictatorship.  There are still problems with social freedoms, but even here it is a far better place than Saudi Arabia.  Economically speaking, it is a booming place.  Sure it had some problems a couple of years ago, probably because of its ties to the U.S. dollar, but Dubai has a lot going for it.  Despite what many people think, it is not a wealthy country primarily due to oil.  It has a huge tourist industry and it is a great place for international businesses.  There is very little in the way of taxes and regulations.

In addition to all of this, the majority of people there are immigrants.  People go there for jobs.  These people are not going to hit the streets and protest.  They know they have a better life there than the third world country from which they came.  I see the prospects of revolution in Dubai and the rest of the U.A.E. to be low.  I don’t see a revolution happening in a place that has indoor skiing.

Saudi Arabia is the wild card right now.  It could go either way.  If big protests do begin there, I hope you own some oil stocks or futures.

There is more and more talk of U.S. government intervention in Libya and other countries with protests.  There are calls for humanitarian aid and some are even saying the U.S. military should set up a no-fly zone.

Let’s examine the libertarian position on this issue.  First, it is wrong for anyone to initiate violence.  It was amazing how much restraint protestors in Egypt showed.  Even in Libya, it seems that most of the violence is coming from the government or in response to it.  It gets more complicated when a third party enters the picture.  Oftentimes, it can make things worse when an outsider steps into the picture as it can just cause more conflict.

This situation gets even more complicated because it is not one individual against another individual.  It is millions of people protesting the government, while the government is trying to retain power.  It is likely that there are also millions of people who support the Libyan government, even if tacitly.

It is important to realize that the same government that runs trillion dollar deficits, wastes tons of money, lies, cheats, steals, kills, and messes up everything it touches, cannot do anything right.  I am talking about the U.S. government here, although the same could be said for most or all governments.  But the point is that the U.S. government can’t magically make things better in Libya or anywhere else.  Washington D.C. is one of the most crime-ridden cities there is.  Let’s see the politicians clean up that one city from poverty and crime before it tries to remake the world.

From a libertarian standpoint, any individual should be free to donate money to protestors or even go over there and help them.  But it is not for the U.S. government to decide for Americans what to do.  The most that Obama and his administration should do is encourage non-violence (which would be hypocrisy of course).  The U.S. government should not spend one dime doing anything in Libya or any other countries for that matter.

With a bad economy and price inflation becoming a bigger concern, it would not be surprising for the politicians in DC to look for a distraction.  This could mean a minor war.  Another war would be horrible, but it would certainly serve as a distraction.  It could also be used as a scapegoat for high oil prices and a down economy.  Don’t rule anything out at this point.

Also, let’s keep an eye on Saudi Arabia.  If things start to erupt there, look for oil prices to spike a lot more than they already have.

Yesterday, Ben Bernanke was in front of Congress and he spoke about the rising price of oil.  He said that a prolonged rise would pose a danger to the economy.  However, he said, “The most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation.”

It is ironic that the man most responsible for rising oil prices is discussing this issue.  Although the news out of Libya and the rest of the Middle East have triggered a run-up of oil prices in the last few weeks, we shouldn’t ignore the importance of monetary policy.  First, as I discussed the other day, higher oil prices do not cause price inflation.  Monetary inflation is what causes higher oil prices.  If oil prices go up without monetary inflation, then we should expect to see other prices (especially those not directly tied to oil) go down.

When there is new money injected into the economy, this new money does not get spread around equally, especially at the beginning.  It goes into hot spots.  In the late 90’s, it went into stocks, particularly technology stocks.  In the 2000’s, it went into real estate (among other things).  Now this new money (whether it is from QE1 or QE2) is looking for hot spots.  There are disturbances in the Middle East where there is a lot of oil, therefore new money is used to bid up the price of oil.

When there is a general rise in prices over time (ignoring short-term effects of velocity), there is only one thing to blame.  It is from an increase in the money supply.  The Federal Reserve and the government that gives the Fed its power are solely responsible for this.  The central bank has been granted a monopoly over the money supply in the U.S.  Only the Fed can legally create new money out of thin air.  So for Bernanke to be sitting there talking about higher oil prices with a straight face is something to be seen.

This is why it was important for the government and bankers to change the definition of inflation.  Inflation used to be an increase in the money supply.  Now they define inflation as an increase in prices.  This is so that they don’t have to take the blame for inflation.  When there are higher prices, people like Bernanke find others to blame.  They can pick the enemy du jour.  Right now, they can blame Libya.  Then they can claim that the higher price of oil is causing inflation.  Don’t buy this nonsense.  Don’t even buy it with your depreciating dollars.

Harry Browne’s wisdom has been missed for 5 years now.  Fortunately, his legacy and his influence live on.

Although this blog is mostly about economics and investments from a libertarian standpoint, it is also about general advice on money.  I have written before on Dave Ramsey and Suze Orman, but I think it is worth repeating.  Although the two of them may have some differences, they are also similar in a lot of ways and I am going to lump them together for the sake of this discussion.

For people with spending problems, I would highly recommend listening to these two.  Give each of them a chance and see which one motivates you more.  If you are in debt (other than maybe a reasonable mortgage and car payment), then you should seek advice.  You should work extra hard and save extra hard to pay off your debt, especially if it is on a high interest credit card.  As Dave Ramsey says, eat “rice and beans”.

I heard Suze Orman once say that she is not in favor of budgets.  I agree with her on this, although I think exceptions can be made.  She said that budgets are like diets.  If you want to be healthy physically, you shouldn’t diet.  This implies that it is temporary.  You should eat healthy as a way of life.  The same is with spending.  You shouldn’t buy something or not buy something because it is or isn’t in your budget.  You should be disciplined to spend only on things you need or, if it is a want, it should be something that you will use and something that truly is worth what you are paying for it.  In other words, your spending should be based on a reasonably frugal lifestyle, not on a budget.  It doesn’t mean that you never treat yourself; it just means that you prioritize.  Part of prioritizing is paying yourself first.

I have heard both of them offer good advice in other areas.  I have heard Suze Orman say several times that she is in favor of term life insurance and not whole life insurance.  I have heard both offer advice that goes way beyond money.  Sometimes it is more like listening to Dr. Phil.  Now I’m not saying they are always right, but certainly their advice is worth listening to and considering.

With all of that said, there is one area that I would recommend you not listen to both of them.  Neither one of them understands Austrian economics.  They do not understand the workings of the central bank.  They don’t understand the dangers of a fiat currency.  They don’t understand the boom-bust cycle and how it is caused by central banks creating money out of thin air and artificially lowering interest rates.

This is why they tell you to invest in mutual funds.  They tell you to buy and hold and that the market will provide good solid returns over the long run.  They do not understand the benefits of having gold and other metals and commodities in your portfolio.  They don’t understand that gold is a much better hedge against inflation than stocks.

If you are looking for advice on investing, read Fail Safe Investing by Harry Browne.  Follow the advice on the permanent portfolio.  For other advice on money, I think Dave Ramsey and Suze Orman are worth listening to.

Frank Shostak has written a piece for the Mises Institute on price inflation.  He is predicting that price inflation will pick up this year.  He makes the assertion that “it takes about 36 months before changes in the money supply generate a visible effect on the prices of goods in general.”  This would mean that the Fed’s more than doubling of the monetary base in late 2008 and 2009 would only begin to show up this year.

Whether you agree with this or not, there are certainly a lot of arguments in favor of higher price inflation in the somewhat near future.  The monetary base has gone up like never before and even though much of this new money is sitting at the banks as excess reserves, there is that looming threat that it will be released and massive price inflation will hit.

The most fascinating thing right now is that price inflation is making a lot of headline news, even in the mainstream media.  CNBC has had several segments talking about inflation in the little bit of time I have watched it.  I have also seen stories on popular financial websites talking about inflation.  I will also see the occasional opinion article saying that deflation is actually our biggest threat, but even this is insinuating that most people are viewing inflation as the bigger threat (despite what Bernanke says).

Normally I would be a contrarian and believe the opposite of what the mainstream media is saying, but in this case my contrarian view is that even though many are predicting an uptick in price inflation, I don’t think they understand just how bad it could get.

If the banks start to loan out those excess reserves, prices could move higher very quickly.  In addition, the velocity of money or the speed at which money changes hands will play a big role.  Velocity has been low as Americans are fearful of the future and have been trying to save more and spend less.  If people start to perceive that prices will continue to move much higher in the near future, then it gives an incentive to buy “things” right away before losing purchasing power.  This drives prices even higher and can be a bad cycle.

At that point, the Fed will have to slam on the monetary brakes or risk hyperinflation.  I am reasonably sure that the Fed will stop creating money and allow interest rates to rise (a lot).  Then we will experience a very harsh depression and DC will be forced to cut back severely (which won’t be depressing at all).

Get your investment ducks in a row now.  Make sure that you are ready for high price inflation.  Make sure that if price inflation hits 20%, that your investments will do well enough to keep pace.  This means that you must have some investments (such as energy and precious metals) that will do really well in a time of double digit price inflation.  And do not count on wages keeping pace with inflation, at least in the near term.

The short answer is no.  And it doesn’t matter how we define inflation.  In Austrian economics, inflation is an increase in the money supply.  Obviously higher oil prices can’t cause an increase in the money supply.

The definition of inflation used commonly today refers to an increase in the general price level.  While there can be a correlation between higher oil prices and price inflation, oil prices do not cause a general increase in the price level.

Higher oil prices can cause certain prices to go up.  One obvious example is gasoline.  Even though consumers ultimately determine prices, higher oil prices do increase the cost of gasoline, which is generally passed on to the consumer.  Higher oil prices could cause other certain things to rise.  If a certain item costs a lot to be shipped, perhaps the increase in transportation costs could affect the price of the item.

But we are talking about a general rise in prices.  If anything, higher oil prices would have the opposite effect.  Let’s say that you have a family budget of $2,000 per month.  Part of that budget is gasoline and you have $100 per month budgeted just for that.  Now let’s say that gas prices double.  Most of your driving is necessary (commuting, going to the store) and you can’t cut down on it.  Therefore, you now have to budget $200 per month.  This means you will have to cut $100 from somewhere else.  Perhaps it would be eating out at restaurants or some other form of entertainment.  No matter what, you will be spending $100 per month less on something else and this will actually drive other prices down.

The only way for you not to cut spending somewhere else is for your budget to increase.  For this to happen, you need an increase in the amount of money you have.

Now take this example and translate it to the entire economy.  If oil (and hence gasoline) prices go up, most Americans will cut somewhere else, thus driving other prices down.  The only way that all or most prices can go up with oil and gas is if you have more money in the system to bid up prices.  Therefore, we would need monetary inflation to drive up the overall general price level along with the price of oil.  This is ignoring the short-term effects in changes of velocity or the speed at which money changes hands.

Therefore, if oil prices go up without an increase in the money supply, it is likely that some other prices will fall.  This is a classic case of why the definition of inflation has changed over time.  If inflation was defined as an increase in the money supply, then everyone would know to blame the Fed for higher prices.  Instead, when inflation is defined as higher prices, we get to hear hacks blame everyone but the Fed and government.  They will blame China, greedy businessmen, or whoever else is convenient at the time.  Of course, they will also blame higher oil prices, which is obviously ridiculous based on what is written above.

Oil prices do not cause inflation.  Inflation (an increase in the money supply) causes higher oil prices.  Other things can cause higher oil prices like supply and demand or the perception of a coming change in the supply and demand.  If we see higher oil prices and a general rise in other prices, we can be sure to blame the money creators at the Federal Reserve.