INFLATION & SUCCESSFUL INVESTING

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 The majority of people with serious money use inflation-adjusted performance measures to assess their investment returns. Inflation is a hot topic right now, and the dilemma that we all face is how to accurately measure inflation rates, and then, how to assess the positive and negative impact of inflation on future wealth.

Official inflation rates, such as consumer price indexes (CPIs), are not a good place to start. These measures have become political tools. They are used for setting public sector spending budgets and debt ceilings, making interest rate decisions, and calculating inflation-linked state payments. When the real inflation rates give the “wrong results” governments simply change the underlying methodologies.

Governments do the same thing when measuring unemployment rates, but that is a different story for another time.

The latest gimmick of the USA government is to use a completely artificial figure to keep reported inflation rates very low. What’s that? Fuel, food & power costs are deleted from the consumer price index because they are “too volatile.” Input now includes “imputed rents” on homes owned. Because interest rates are lower than usual, and home prices are lower than usual, “imputed rents” are way down. “Imputed rent” is essentially an imaginary figure. The government –to justify using this artificial construct—claims it represents the ” current cost of home ownership.”

Obviously the cost of home ownership is lower after a real estate crash, but only to new buyers. And in the current market these are few and far between. Although not a single person in the world pays an imputed rent, this artificial figure brings reported inflation way down.

For investors, the main problem with consumer price measures is that they don’t give a true and fair view of changes in asset values in specific asset classes, commodities and currencies. They don’t account for escalating prices in some areas, while prices in other areas are falling. They certainly don’t provide a good measure of our changing purchasing power, in the areas where we are really likely to spend our money.

Another serious concern about inflation is the amount of new money that central banks are currently injecting into the financial system. Will this turn out like the famous Monty Python restaurant sketch, where the waiter serves his fat customer more and more food, until that final, fatal one little mint? Is this what is happening to our economies? Will we grow fatter and fatter on “quantitative easing” until we explode into hyper-inflation? It’s certainly one scenario that economists talk about, even if the actual result is more likely to be a mix of deflationary and inflationary pressures, something that will be exceptionally hard to hedge correctly.

Good or bad, inflation is definitely in our future. It will have a big impact on our wealth and the prosperity of our children and future generations. If you are invested in the right assets, commodities and if you have borrowed currencies, then inflation could be a very good thing. Families who invested in high quality real estate, in the right locations, ten or fifteen years ago would probably have done a lot better than those who invested their money in conventional, index-tracking stock market investments. The same is true for investments in some high risk, high return business sectors. Few people call the tremendous growth in income and profits in successful sectors like Google or Facebook “hyper-inflationary”. Trouble is, it is hard to pick winners like this before they become winners.

If you are invested in the wrong assets or if your businesses are margin sensitive and you rely on selling goods and services that are becoming more and more expensive, then you can get into trouble. Many multimillionaires have gone bust because they could not repay their loans due to short term factors. Insolvency is a danger whenever you have loans outstanding. Equally, if you set aside a specific amount of money for the future and find that the your savings no longer gives you or your dependents the standard of living you expected, then inflation is bad news.

History suggests that it pays to take a long hard look at your inflation-adjusted expectations for the future. Do you want to have the same purchasing power as you have now? If so, what specific assets, commodities and currencies do you expect to purchase? For example, if your young grand-children and other relations all want to live in nice houses in fifteen years time, how much should you set aside to help them do this? *Looking back fifteen years ago, you’d probably have grossly underestimated the money required to buy a decent house in an up-market location today.*

*Grandpa’s Comment-

30 yrs ago $100,000 bought a substantial upper middle class apartment or suburban home anywhere in the world. Now $100,000 won’t even get you half a garage in New York City, Monaco or London.

These are precisely the kind of calculations that you need to be making now. Using a government supplied measures of domestic supermarket shopping basket prices (for instance) is not going to help you in the real world. Your investment performance report that shows investment returns adjusted for such a simple measure of real inflation probably put you in a negative position. One thing is sure. This is NOT the time to be holding cash at historically low interest rates. Your purchasing power will be eroded by inflation. That is definite. My favorite orange juice was €1 a liter just a few years ago. Today it is €2. Yet the official government food price inflation index shows a 4% increase, not 100%. Gasoline, Diesel and other things I buy every day are up a minimum of 50% from a few years ago. Accordingly, the Consumer Price Index of the USA or any government must be treated with a major grain of salt.

Reader question: You say “no cash.” So what instead?

Real estate and gold? My ex-real estate associates in California were telling me (as of 2011) that there are seemingly good deals around in distress property, at 50% below old market values. But with most of the USA states broke, the real estate taxes are probably going to confiscatory levels. Thus, holding costs on even “bargain property” may make any deal unattractive. Much property could end up abandoned and publicly owned–as happened in the Bronx (NYC). Then too, in many communities there is rent control, so that on residential income property anyway, there will be no positive cash flow–ever.

Thus, (from a rent control standpoint) that leaves the investor to consider only commercial property like warehouses, stores, factories. Factories are largely non-competitive with Asia, India, etc. & so the future rent on them is doubtful. Warehouses seem to be a good bet.

I personally look at real estate in tax havens where there is no tax & no rent control. Unfortunately, the returns there (Monaco-Bermuda-Andorra- Campione for example) are maybe 2-3% per year because the prices are already so high. Where can you get a decent 10% annual return from rental real estate. I was in Panama for the winter, and saw that although prices of condos have fallen, the rental market is still very strong. There is a 20 year tax exemption on new buildings.

Stocks? Most of mine are down –mostly way below what they were 20 years ago! This includes Berkshire Hathaway (after adjusting for inflation).

I SUPPOSE THAT LEAVES US WITH (MY) 1ST CHOICE

YOU SHOULD OWN YOUR OWN BUSINESS OR HAVE A PROFESSION WHERE YOU PUT IN EXPERTISE + TIME (MAYBE BORROWED MONEY) .

YOU TAKE OUT SOME MONEY TO LIVE ON 50% AT MOST, AND TRY TO SAVE & INVEST 50% OR MORE. HOPEFULLY WITHOUT TOO MUCH TAX.

2) Own your own home or low overhead apartment in a place where you will suffer little or no tax. With high inflation quite likely, and very low interest, owning several homes or condos, highly leveraged, seems a good bet. If you can avoid personal liability on your loans, so much the better. Friends and others can use your apartments in exchange for covering overhead-repairs & maintenance. In other words- if you are a boy scout with this arrangement you don ‘t generate any taxable rental income.

Consider this: Maybe the place you live in should be free and clear of loans so if all else goes sour, you will always have a rent free home. In Italy and much of Europe a modest primary residence has little or no real estate tax. So one can be secure and self sufficient with just a one hectare garden, water supply, and electricity generation on the property.

3) Consider owning low profile agricultural property where you can produce fruits, vegetables & food — any plants –even flowers for yourself and a surplus for resale. Be sure you have water & windmill or watermill power.

Have a few pigs, chickens, cows, and an off the beaten path retreat for yourself if things get really tough.

*Note: Grandpa doesn’t think the end of the world is at hand. But it can’t hurt to be prepared for all eventualities. *

4) Alternatively consider a fishing boat or fish ponds.

5) Passive Investments? When you are retired like me and there is no choice but stocks, bonds or paper representing commodities (options, etc.) – realize that it is high risk and the best you can hope for is to beat inflation with diversification.

6) Precious Metals? As a practical matter, when you buy gold coins you pay a 3-5% premium and when you sell you do so at a 3-5% discount. It is not so easy to “make money” when you need the product to go up 6-10% just to break even. Is this the top of the market? I don’t know, but when prices are at all time highs, it is not generally the best time to buy.

7) Collectibles –OK–But Only when you are a dealer and know exactly what you are doing. Merely buying art or other object at up to a 30% commission in and another 30% out means the dealer gets rich, but you only hold an empty bag.

AS TO GOLD, around 1972, the gold bugs like Franz Pick & Harry Schultz were talking of $3000 per oz and up. In those days gold went from $200/oz to $800+. I loaded up –mostly at just below $800. Then Gold went back down to around $200 … I had to wait 30 years before it came back. Inflation adjusted, at anything under $4,000 per oz., my gold investment is still way down below what I bought it at. Similar story on my silver. Bottom line being that these metals are just commodities and they go up and down unpredictably– & we (as investors) have no control over them. Grandpa is happy to do intelligent risk-averse investment planning with his paid up consulting clients at no extra charge.

The retainer for two years of unlimited (but reasonable) personal :Grandpa” contact is €15,000. This covers advice on all business deals, domestic relations, immigration, investing, residence, introductions for social/business purposes and citizenship –anything remotely related to being a P.T. We only take on a maximum of 5 consulting clients and there is only one opening for this year. The fee includes all of my writings, past-present & future.

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