Oil prices were up huge today.  The price of crude went up about $8.  This is a major jump when the price isn’t even at $100 yet.  The main reason for the big jump was because of continuing protests in the Middle East, particularly in Libya this time.

There are reports now that long-time dictator, Gaddafi (there are about a million ways to spell this guy’s name), has fled Libya.  This has spooked the oil markets due to fears of an interruption in supplies.

From a liberty standpoint, these protests are a good thing.  They won’t produce some libertarian paradise overnight for sure.  And we know that democracy can be just as bad as dictatorships at times.  But despite what you might hear from hacks like Sean Hannity, these protests are not mainly about religion or ethnicity.  They are mostly about oppressed people seeking some freedom.  And they are not like the protests out of Greece or Wisconsin with people demanding more government handouts.  There may be some of that in these Arab states, but it is mostly about people wanting the grip on them loosened.

Russia is a corrupt place in many ways and there are certainly more desirable places to do business.  But not many people would deny that Russia is a better place to live than 25 years ago when it was the Soviet Union.  Freedom does not usually come all at once.  Just like socialism progresses with baby steps, sometimes it is the same for freedom.  So overall, these protests are a good thing as people seek a taste of freedom that they’ve never had, but maybe heard about.

With all of that said, these protests could be a short-term disruption for business.  Along with oil prices, gold and silver prices went up significantly today too.  This is not to say that they couldn’t all fall back down tomorrow, but we can’t ignore these huge moves.  Libya produces some oil, but it is no Saudi Arabia.  If protests start to flare up against the Saudi dictators, then the oil market could really get spooked. We could see the price of oil go to $150 or even $200 in a very short period of time.  Gas prices will not be far behind.

It might not be a bad insurance policy right now to have a few oil plays in your investment portfolio.  Just the price of gas alone will get expensive if something major happens.  There are ETFs, individual stocks, and mutual funds that can be bought to get exposure to the price of oil.  If you buy individual stocks, I would recommend that you stick with the big companies.

The other interesting thing we will watch in the future is how this may affect velocity.  The velocity (the speed at which money changes hands) has been low in the U.S. since the fall of 2008.  If velocity picks up because of these events (or any other reason, like QE2), then high price inflation could be closer than people think.

The price of silver is at a 30-year high.  One ounce of silver is now trading over $32.  The only reason it is not at an all-time high is because of its brief rise to almost $50 back in 1980.  That brief explosion in silver prices occurred when the Hunt brothers tried to corner the silver market.  It also happened during a time of high inflation and right about the time that Paul Volcker slammed on the monetary brakes.

I am a fan of silver related investments only up to a point.  As we can see from 1980, the price of silver can go down just as quickly as it can go up.  Silver is far more volatile than gold.  For this reason, I suggest that you invest a far higher proportion of your money into gold related investments than silver.

Silver may have a place in your portfolio, but it should be a small place.  I wouldn’t recommend more than 5%, or maybe 10% if you are really aggressive.  It is a good speculation because there is such a high upside potential.  If gold goes to $2,000 per ounce in the next year or two, silver could easily go to $75 per ounce or more.  This is not a prediction, but just an observation that silver is a higher risk and reward play than gold.

If you are good at timing the market (almost nobody is), then silver is a stronger play.  If you invest in it as a speculation, try to be disciplined and take some profits if and when the price goes up.  You will never know exactly when it will reach its top, just like any other investment.  It is important not to get too greedy and to take profits on the way up.  It doesn’t mean you have to sell all of it at once.  Actually, it is a good idea if you don’t.

Again, I am talking about silver and silver related investments here as a speculation.  It should not be part of your permanent portfolio.  For Harry Browne’s permanent portfolio, the gold portion will be your protection against inflation and a crashing dollar.  Gold is far more stable than silver and I expect it to continue that way.

The adjusted monetary base is on fire.  A couple of months ago, I was starting to doubt whether QE2 was actually happening as it wasn’t showing up in the monetary base.  Well, the February 17, 2011 update of the monetary base shows a line straight up since the beginning of the year.  It is obvious now that the Fed is actually doing what it said it would do.  QE2, otherwise known as the Fed buying government bonds, otherwise known as money creation, is happening.

You can view the chart here:
http://research.stlouisfed.org/publications/usfd/page3.pdf

We will closely follow the excess reserves held by commercial banks over the next few months.  We want to see if this increase in the monetary base is at least somewhat sterilized by an increase in excess reserves.  Bernanke claimed that the Fed was not increasing the money supply in circulation.  Either he expects all of this new money to go into excess reserves or he is lying.

If even part of this new money gets into circulation through the banks, then price inflation should be close at hand.  I think prices could explode at any time.  It is hard to say what will lead the way.  Commodities and precious metals could be the leaders.  Stocks might keep doing well, but that is harder to say.  When consumer prices start going up at a good clip, you can count on food prices to rise significantly.

We may be coming up on one of those rare investment opportunities.  Although high inflation won’t really be good for anyone, we can at least try to profit from some of it, or at least protect what we have.  If the excess reserves don’t keep pace with QE2, I think all of our speculative investments belong in hard assets.  The dollar will get crushed and price inflation will take off.  Hard assets like gold, silver, platinum, oil, food, and maybe even real estate will do well.  You can’t make these things on a printing press.

For anyone that studies the money supply, it can be quite confusing.  There are different measures of the money supply and you can read or listen to three different people come to completely different conclusions, based on different measures of the money supply.

Robert Murphy has written a piece that gives a good summary of what makes up some of these different money supply measurements.  It certainly can be confusing on what measurements you use and what you should use them for.

First, a big reason for looking at the money supply in the first place is because we want to predict price inflation.  The only problem is, there are so many variables.  There are different measures of the money supply, but there are other factors too.  There are excess reserves held by banks, there are loans, and there is the velocity of money or the speed at which money is changing hands.  These all have an effect on prices.  In addition, an inflation in the money supply may show up in asset prices like stocks or commodities while not showing up in consumer prices.

With that said, we still want to have a useful measure of the money supply.  My personal favorite is the monetary base.  The reason I focus on this measure is because it is the measure that is most directly controlled by the Fed.  For example, with QE2, you will see the Fed’s buying of bonds show up in the monetary base.  The Fed can buy or sell assets and change the monetary base.

Now that banks are piling up excess reserves, we have to pay attention to this too.  But overall, the monetary base tells us what the Fed is doing.  It can’t tell us with any certainty what is going to happen with price inflation or the stock market or commodities, but neither can any of the other measurements.  At least the monetary base can accurately tell us what the Fed is doing and can at least provide us with that little piece of the puzzle.  Right now, it is telling us to watch out for rough waters ahead and to buy gold.

I am subscriber to Harry Browne’s permanent portfolio.  With all of the uncertainty in the world, it is good to have some of your investments safe and sound, or at least as safe as possible.  The permanent portfolio is set up to weather any type of financial storm and it has done its job well.

With that said, I think it is ok to speculate with a portion of your money, as long as you can afford to lose it.  Right now, I think the best speculations (in my opinion) are in non-dollar assets.  The federal government (along with state and local governments) is piled high in debt with no end in sight.  The only solution coming out of DC is more money creation.  This is bearish for the U.S. dollar.

For your permanent portfolio, your gold portion should be in assets that correlate directly to the price of gold.  You can actually buy the metal in coin form, you can buy certificates that are redeemable in gold, and you can buy an ETF (symbol: GLD).  However, for your speculative investments, gold stocks are a more interesting play.  There is more leverage and more risk.  But the rewards can also be far greater.

An interesting exchange traded fund (ETF) that you might want to look at is GDXJ.  It is made up of junior mining stocks.  It is a good way to get some exposure to this sector.  It is a risky sector as many junior mining companies never really get off the ground and make a profit.  But they can also be very profitable.  This ETF is a way to get exposure to junior mining stocks while also spreading your risk around.

This is an investment that could easily go down 50% or more in a stock market or gold market downturn.  On the other hand, if gold goes up 20%, you could easily see this ETF more than double.  The good thing about it as a speculation is that you can liquidate it quickly.  It trades just like a stock and you can buy it with almost any online brokerage account.  When you are ready to take profits, you can sell it in minutes or less.

Again, you should not mix this with your permanent portfolio.  This is a speculative investment as a play against the U.S. dollar and for gold.  You can review GDXJ here.

There are budget battles going on in Washington DC.  Republicans in the House have proposed up to $100 billion in cuts.  Obama has proposed cutting $1.1 trillion from the deficit.  This would be decent if it weren’t for the fact that the $1.1 trillion in cuts would be over 10 years.  This calculates out to just over $100 billion per year.

The Republican cuts are a real joke.  They are playing games with the numbers, counting things as cuts from future spending increases.  Even if these were real cuts, they are still a joke.  The deficit for this year alone is expected to top $1.5 trillion.  Therefore, a cut of $100 billion isn’t even 10% of this amount.  And don’t forget that this is just the deficit.

So even if Obama and the Republicans came up with $100 billion in cuts, it means we might have a deficit of $1.4 trillion next year.  This means another $1.4 trillion added to the national debt, which is already sky high.

The Republicans could propose cuts in all sorts of programs.  They could scrap the Education Department. They could get rid of all subsidies to farmers.  They could end all foreign aid.  These would be easy things.  In fact, they don’t just have to propose cuts, they can actually do it.  They hold control of the purse strings.  The president can only sign what is put on his desk.  If the Republicans never pass a budget with these things, then they will automatically be gone.  The same goes for Obamacare.

Aside from the easy things that won’t even happen, the only way to balance the budget is to look at military spending and so-called entitlement spending (Medicare, Medicaid and Social Security are the big ones).  There is no will to touch any of these things.

So what does this whole thing mean for the big picture?  It means the federal government is heading over a cliff at a high speed.  Maybe they can stop the car from accelerating.  Maybe they can even slow it down by one M.P.H.  But unless they slam on the brakes right now, this car is going off the cliff.  This means some kind of default.  It will mean painful defaults for people that will be counting on Medicare and Social Security.  It will mean high inflation.  It may mean an outright default on bonds.

All of your speculative investments should be counting on a weaker U.S. dollar for the long-term.  The politicians in DC are guaranteeing this outcome.  The Fed will go along until it faces hyperinflation.

Robert Murphy has written an article, published on the Mises Institute website, on the subject of price inflation.  Murphy is one who has predicted stagflation.  The recession part of it has been correct, especially with unemployment so high.  But Murphy admits that there has been little vindication yet when it comes to price inflation.

Some libertarians would argue that we have price inflation.  We can look at health insurance, grocery prices, college tuition, and the stock market.  For the stock market, this is an asset class that is not a good qualification for consumer goods.  While monetary inflation certainly causes asset bubbles, it is hard to put this into the category of price inflation, only because it is not seen as a bad thing by the general population.

It is hard to count college tuition and healthcare costs because the government is so heavily involved.  All of the regulations raise prices for us and it doesn’t matter whether there is inflation or not.

For grocery prices, this is certainly a consumer good and it affects everyone.  The only problem is, while prices have been going up a little, it is not significant enough to grab people’s attention.  People can live with a 5% rise in grocery prices for a year.  It may not even be that high.

So while we certainly have monetary inflation, we do not have high price inflation.  I know many libertarians don’t like the CPI, but it is still a good measurement of the trend and it is showing that price inflation is still low.

In his article, Murphy shows a long-term chart of the adjusted monetary base.  You can see where it more than doubled, starting in late 2008.  We have never seen anything like this.  We also haven’t seen excess reserves increase like they have.  We are in a unique situation in modern day America.

While Bernanke seems to like the current situation where all of the monetary inflation has gone into excess reserves, I don’t think it can last forever.  Even if it did last forever, there will be a shakeout eventually.  There was a lot of malinvestment from the Fed’s loose monetary policy of the 1990’s and 2000’s.  A lot of resources were diverted into unsustainable things like real estate.  These resources need to adjust back to their proper place according to consumers.  This can take time and it will take a lot more time when the government is interfering with the correction process.

Whether the banks start to lend or not, Bernanke and the Fed will be faced with a choice sooner or later. They will have to choose between massive price inflation and depression.  I still think they will choose price inflation to begin with, if it is just to kick the can down the road.  Ultimately, the Fed will have to tighten up its monetary stance to avoid hyperinflation.  This will cause a massive depression that most people have never seen.

I have seen more stories on nickels lately, for some reason.  Here is one piece (via LRC).  It is a good time to review the subject of collecting nickels.  Nickels are a unique investment right now.  It is the only investment I can think of that is a hedge against inflation and deflation at the same time.

It is obvious why a nickel would be a good hedge against deflation.  It is money.  It is cash.  In a deflation, your money will gain purchasing power.  If you have a whole bunch of nickels, you can use them as cash. You can trade your rolls with the bank for bills.  Holding cash is good in a deflationary environment.

Now to the inflation side of things.  A nickel is made up of 75% copper and 25% nickel.  If you take the monetary value of the metal in a nickel, it is actually worth more than 5 cents.  Right now, it is worth a little more than 7 cents.  So a nickel is actually worth 40% more than 5 cents if you take the value of the metal.

It is inevitable that the U.S. Mint will stop producing these.  It does not make sense to produce coins at a loss when it is a fiat currency.  Of course, the government does a lot of things that don’t make sense, but this will come to an end eventually.  Now, it is illegal to melt pennies and nickels.  It may or may not continue to be illegal when the government changes the content in a nickel and penny.  But this does not really matter.  If you go to a coin dealer, they will actually pay you more money for older pennies.  You will get the silver value of pre 1965 quarters.  The same goes for silver dimes.  People don’t melt them down anyway.  They use the recognizability of the coin and store it or trade it for the metal content.

Of course the hard part of this whole thing is that a nickel is only worth 5 cents (or 7 cents if you judge it by the metal content).  You have to collect a lot of nickels to make it worth it.  A penny actually has metal value too, but it is just too small a value and too burdensome to consider collecting pennies.

Even though you have to collect a lot of nickels, why not start now?  At the very least, don’t spend your nickels.  Put them in a separate jar.  Don’t trade them in to the bank.  The worst case scenario is that I’m totally wrong on this and you will one day roll your nickels and trade them in for cash.  But the more likely scenario is that Gresham’s law will take hold and the money will be driven out of circulation.  As the Fed continues to inflate and money becomes worth less and less, the metal content of a nickel will be worth a lot more than 5 cents or 7 cents.

You can certainly try hard to collect them.  You can ask for a roll of nickels at a store.  You can ask for some rolls at a bank.  I would not tell them your true purpose.  At the very least, stop spending your nickels.  Save them in a jar somewhere.  Keep them for a rainy day.  If you end up saving up a few hundred dollars worth of nickels, it may turn out to be a good investment.

The question of the day is:
Can you have hyperinflation without a significant increase in the money supply?

First, to answer this question, we must define hyperinflation.  Austrian economists usually define inflation as an increase in the money supply.  By this definition, the only way you can have inflation (or hyperinflation) is if the money supply is increasing.

But let’s debate the question using the now commonly used definition of inflation.  For the sake of this discussion, let’s say that inflation is the equivalent of price inflation.  For the definition of hyperinflation, let’s say that this means very significant price inflation.  This means that prices are rising very rapidly, probably over 100% per year.  This means that prices may be going up every day, but at the very least, once a month or more.

So can we have massive increases in prices without a significant increase in the money supply?  While the probability is low, it is not impossible.  When we look at the overall price level, there are two sides to the equation.  There is the money supply on one side and there is the demand for money on the other.  They may or may not correlate.

Right now, there is actually a fairly high demand for money.  This means that velocity is low.  It means that money is not changing hands as frequently.  This is actually the equivalent of a decrease in the money supply.  People are frightened of the economy.  There is a lot of uncertainty.  People are paying down debts and saving money (if they can) for a rainy day, at least more than they were doing before.

Velocity occurs based on how people are thinking.  If people are scared and feel the need to hold some cash, velocity will be low.  If times are good, people may be willing to spend more and velocity will be higher.  But there is also a scenario where times are not necessarily good and yet velocity is high.  If people fear that their money will not buy as much tomorrow as it does today, they may go ahead and spend it and get rid of it before it loses more value.  People will buy “stuff”, because at least the “stuff” will hold its value better.

This last scenario is most typical in an environment of big increases in the money supply.  This is what happens in countries that experience hyperinflation.  It is a bad cycle.  This is what happened in 1920’s Germany.  It came to a point where prices were going up much faster than the money supply.  This was due to extremely high velocity.  People did not want to hold cash.  They wanted to spend it immediately.  People would get their paycheck and immediately run to the store to buy food with it before the food prices went up again.

Usually in a high velocity environment, people are expecting the money supply to continue to increase.  But it is technically possible to have high velocity without an increasing money supply.  People may just expect it to increase or they may lose faith in the currency for some other reason.  It is technically possible that the majority of Americans will wake up tomorrow and start reading the Mises Institute website and become Austrian economists.  Based on public opinion, especially if legal tender laws were repealed, people could all of a sudden reject the fiat currency and turn to gold or some other money.  It would even be possible for the market to turn away from gold because it found something better.

So to answer the above question, because of the velocity of money (how quickly money changes hands), it is possible to have runaway price inflation without a dramatic increase in the money supply.

Because we live in a world of fiat money, it is hard to imagine a society that functions with free money and free markets.  Many people, libertarians included, forget that so much of what we are accustomed to only takes place because of fiat money.

Let’s imagine a society with a truly free market.  If this society had any government, the only thing the government would do would be to protect people and their property and enforce contracts.  This means there would be no or minimal taxes and no or minimal government regulations (the market would have regulations).  It also means there would be no legal tender laws and no central bank creating money out of thin air.

Now let’s say that the free market in this society chooses to use gold or silver (or perhaps both) as money.  People would be free to use whatever they want, but most likely one or two things would win out and become money for society.  People would obtain gold or silver so that they could save, invest, and buy other things.

For the sake of discussion, let’s say that banks did not participate in fractional reserve banking.  I would argue that even in a free banking system, banks would keep close to 100% reserves anyway, but either way, let’s say for this discussion that all banks kept 100% reserves.  Now, this is not realistic, but for discussion sake, let’s also say that the amount of money (gold or silver) does not change.  There is no new mining and the money stays within this society.

Now, that is a lot of assumptions, but what would this society look like?  Besides the fact that it would flourish, there would be a lot of differences with what we have in current day America.  For example, we are accustomed to wages going up (at least before a couple of years ago).  This would not really happen any longer as a whole, at least not in nominal terms.

Over time, we usually see stock prices go up.  We usually see housing prices go up.  We usually see the prices of consumer products go up.  But this would all go away.  Housing might actually get cheaper over time.  While stocks would still go up and down, the overall stock market would not likely go up.  This is hard to fathom.  So why would anyone buy stocks?  Well, any one particular stock can go up, but you could still buy index funds because they would pay dividends (especially with no tax on dividends).

This is really tough for people to grasp.  Wages would not go up.  You would have the same money supply, so how could they go up?  Where would the money come from?  But this is all ok.

Many people think that as the number of goods and services in society increases, that the money supply must increase to accommodate this.  But it just isn’t true.  What happens is that your money becomes worth more.  With the same amount of gold or silver, you can buy more today than you could yesterday.  We would live in a world like the electronics industry.  Things would get better and cheaper as time goes on.  You wouldn’t see a rise in nominal wages, but your standard of living would shoot up as your wages could buy so much more.

This is what actually happened in much of 19th century America.  Prices actually fell gradually.  But it wasn’t some scary deflation.  It was an increase in purchasing power due to increased investment, technology, and productivity.  This is the way it should be.  We should expect more for our dollar tomorrow, but instead we get less.  We have been brainwashed by fiat money.