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Don’t Let Your Political Views Cloud Your Investment Decisions

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Every newspaper, magazine, news show and internet blog in the country has been discussing the government shutdown this week and we feel no need to add to the discussion. We’ll only say that we are not making any portfolio changes at present but we continue to monitor the situation closely. If this turns into an extended problem and things like Social Security checks stop getting delivered then we will certainly need to consider making adjustments.

We are also watching the separate but related issue of US debt funding. The Treasury Dept. has said they will no longer be able to move money around to cover our debt payments after October 17th so in addition to dealing with the resolution to continue government funding, Congress needs to pass legislation to extend the nation’s debt limit.

Neither of these issues is insurmountable but the current Congress has shown that it can only get things done once they are elevated to extreme levels. Hopefully the grownups will get the children to behave and we’ll be able to kick the can a little further down the road. Our biggest fear is that this mess ends up at the Supreme Court.

It’s difficult not to get frustrated with our politicians these days but we feel it’s quintessentially important to keep political opinions out of investment decisions. Often, our political views reflect the way we want the world to be but markets don’t really care about our personal worldview. We need to make investment decisions based on how things actually are or we risk making major investment mistakes.

These days we see a lot of tooth grinding resulting from the Federal Reserve’s unprecedented purchases of government securities.

Unless you’ve been living under a rock you’ve no doubt heard about the Fed’s quantitative easing (QE) programs.

The chart to the right shows just how far the Fed has gone over the past few years.

According to the Fed:

“The Adjusted Monetary Base is the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks.”

In other words, it’s the money on the balance sheets of the nation’s banks.

We’ve seen no shortage of investor fear about this increase but it’s also an example of how political views can get in the way of investment decisions. Please note that neither of us (Jeff or Ken) is happy about this development. To a large degree, we feel that the people who made poor lending or borrowing decisions should face the consequences of their actions.

This isn’t going to happen.

Votes, political influence and huge sums of money are on the line here and as a nation we are not ready to face the consequences of our actions. We continue to kick the can down the road.

The QE programs are the government’s way of bailing us all out, probably to the detriment of those who are not even born yet. We don’t like it but we can’t make recommendations based on political convictions. We need to look at the world and try to figure out how we can best position client portfolios based on what we feel is most likely to happen.

Many pundits have written about the imminent inflation or even hyperinflation that must come from this action. How is it possible to pump that much money into the system and not see prices go through the roof? They feel that gold is perhaps the only possible viable investment in such an environment and that the US Dollar will collapse and become almost worthless.

We contend that while this is certainly a possible outcome, it is not anywhere close to becoming reality at least right now. The reason for this can be found in the chart to the left showing money velocity.

Money velocity is the number of times one dollar is spent to buy goods or services within a given period of time.

If velocity is increasing then more transactions are taking place in the economy and if it is decreasing, then fewer transactions are taking place. The chart shows that velocity is at its lowest level since the Fed began tracking it.

Put simply, people are not spending money. If people don’t spend money, it’s difficult to have inflation. Banks are not lending money and people are not borrowing so velocity remains at historic lows.

If you were running a major bank, would you make a lot of loans today at 4%? Probably not. The reason is that eventually, rates will increase from near-zero current levels in the next few years. What if lending rates go to 9% in 3 years and banks have to pay 6% on CDs to attract customers? If they have a large number of outstanding loans with a 4% rate and they have to pay 6% CD rates in the future, they’re probably not going to stay in business.

Interest rates and inflation will probably start to head back up but we don’t see how this can happen without the Fed’s blessing. They have stated their intent to control both short and long-term rates and until the Fed changes their mind (perhaps several years from now) we don’t see a reason to fight them.

We may not agree with Washington’s methods but there is nothing we can do about it. As such, it is our duty to manage portfolios within the realm of reality rather than our personal politics.

Side Note:

An event many people point to as an example of rampant inflation is Germany’s Weimar Republic in the 1920s. Indeed, the Germans did see insane inflation as the price of a loaf of bread went from around 1 mark in 1919 to around 100,000,000,000 marks by 1923 (not a typo) as the result of a multi-month nationwide strike.

People had gold coins back then as well but they were not a very good medium of exchange. This was because people didn’t need gold to survive on a daily basis. They needed food, shoes, shelter, clothing, tools etc.

Instead, people returned to a barter economy. They worked for food and other goods and services. For example, 2 eggs might get you a haircut.

If you really want to hedge against a collapse, it’s probably better to buy tents at your local military surplus store, start a chicken farm or buy up a bunch of work boots on the discount rack at Marshalls.

We still feel that physical bullion is a good investment for a certain part of your portfolio but we scratch our heads when people who have apparently never read a history book start blathering on about how gold coins will protect you in a hyperinflationary scenario.

Takeaways:

Jeff and Ken

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