The House of Risk
Below is my little analogy/risk house that I thought up a few days ago.
But first a commercial
: I agree that inflation is the real risk out there long-term. We keep printing and digitizing money like there is no tomorrow. Have been for thirty years at least. I believe that if we keep it up at the accelerating pace many commentators see we will end up going down like a ton of bricks—but probably much later in the future than we all imagine and also much worse. Inflation is the fear of older people, people who have saved money their entire working lives so that they can draw it down in the golden years. No one here has experienced how severe inflation really impacts people, although we did have a hint of it 1976-1982. Near the end of that time we really revved up the motor with loose money AND credit cards and many other forms of new debt. Wow, years of fun for everybody. Now we’ve reached the point where the debt bubble is ready to burst, in my opinion.
There are two sides to creating money: one side is simply creating it, printing it up or digitizing it; the other is how it is delivered to the users such as businesses and individuals. The gov’t ultimately controls both halves. Some of this money is delivered to us thru wages, profits, price increases, asset appreciation, etc.—all the typical, easily understood means. An increasingly large portion of this money has been delivered thru debt. We borrow from credit card companies, we release value from our properties, we borrow short to use long, we buy a new business with borrowed money, etc. This has steadily accelerated, especially over the course of our most recent mini-recession.
This excessive quantity of money, as most inflation experts know, sooner or later finds its way into price increases. Or, as A. Greenspan knows full well but lies about, into bonds when a better use cannot be found for excess money. This creates his bond conundrum.
The Fed and gov’t have in there wisdom determined that 2-3% inflation is wonderful. It greases the wheels of everything and everybody. People buy homes thinking 2-3% wage inflation will make making the payments a snap. An enticement for keeping this stuff going. Debt is good because I can pay it off with higher wages, the extra money I’ll be making. It’s a wonderful thing as long as it stays under control and returns on financial instruments return even more than the inflation rate. Wonderful stuff for everybody.
Until the wages stop going up, until people can’t make their debt payments. We are reaching that point soon—maybe. I’m hoping so. I’m hoping for a stock market and housing pop to bring people to a debt crisis. Then we really learn and experience something about the true nature and pain of debt—and, hopefully, use that knowledge going forward from that point. A rebalancing is needed soon before the serious stuff--hyperinflation--takes over the country.
We, of course, have another serious problem, 3-4 billion people that are willing to work for far less money than us. This right now is keeping middle class wages from rising no matter how much digital money/debt gets pumped into the system. As I see it, it’s a race between debt and wages. Debt keeps gaining to my mind. When/if we have another mild recession, I suspect whatever politician in office at that time is going to borrow the money to get us out of that future mess. More of the same, more money from nowhere, more excesses.
If the gov’t succeeds somehow in getting the money to us, then we just keep rolling toward hyperinflation—until that ends at some nasty point—probably in our lifetimes. I don’t want to be eighty years old with fifty million worthless dollars and smugly thinking I’ve got more of those thingys than anyone else—but no food, or meds, or working children to take care of me.
The excesses of money and society need to be sopped up at some point. It has amused me that our current administration takes a bifurcated view on this subject: Someone said “Deficits don’t matter.” out of one side of his mouth and out of the other came our new bankruptcy bill that basically says you can run, but you can’t hide (from your debt—it stays with you).
We can try to keep the game going by somehow getting more (and then more) money to the spenders/consumers thru false tricks. (Or thru real tricks like Katrina) History shows that this manipulation of money and hiding of real debt/costs in the future generation’s cradle always ends badly. We just keep sopping the excess money up with higher prices. Plus, sooner or later we inflate our way out of any type of stored value. Living standards fall dramatically as gas, healthcare, and food take an ever larger percentage of our income. A real stability of life is lost throughout the system—money. The alternative is to sop up the current excesses with a recession that sucks the liquidity, the excess money, out of the system now—in a controlled fashion—a managed or semi-managed recession.
My hope is a general awakening just after the bottom of a near-term recession, so we don’t have to go through the hyperinflation stuff. I’m hoping people see the craziness that they— and I—have been participating in. But I’m hedging a bit just in case I’m wrong—again. I don’t know how it will play out, what steps or stages it will take, or how society will react to it. I do know it is coming.
End of the commercial.
So my investments are in a house, a five story house, a five story house with structural problems that I think I can judge fairly well as an amateur financial engineer. My guess is that the top two floors (2/5, 40%, DOW 6000) of the house may collapse in the near future, possibly wiping out some of my best friends. Of course, maybe the whole thing will collapse. But if that happens, there’s nothing for me to worry about—as they say.
So, where do I put my in-laws in this house? Just kidding DW. They can actually go find their own house. On the bottom floor I put my safest stuff: The precious metal shares, TIPs, I-bonds, some other commodity shares, and a little cash. These things are basically protection for the long term dangers of hyperinflation. They will wiggle and jiggle quite a bit if the upper floors collapse, a couple might even pop and go bye-bye before I need them--or don’t need them. I want them there if the worst happens. I also want them to grow larger and stronger if inflation is evident—to counteract the falling top floors. Normally, REITs and rental property would go here, but things are now so out-of-whack in that realm, to my mind.
On the second floor, I begin to store the safest income producers. For me this is short-term US and some municipal bonds—all AAA. And CDs. This is stuff that I can easily liquidate and then use to repair the top two floors if that is needed at some point or to buy more first floor stuff if things look like they are going in that direction.
Third floor: A little more risk and a little more dividend—but still mostly bonds and dividend paying stocks that will keep paying during dark times. The stocks have low or no debt ratios; I have cleared them for use as best I can, believing that payments will be made until the lights go out. They provide the basic necessities to people, things such as electricity, water, fuel, etc. The prices of these stocks will wiggle and wobble when crushed from above, but I hope they survive. I’ll buy more if the timing and prices are right.
Fourth Floor: The dividend payers that may have some growth opportunities built in, where I see a possible gain in our current market that is greater than the risk. But most of this stuff will be redeployed to the lower floors if I see the fall in sight. I have some investment real estate here—that stuff is not easy to move quickly. The risk-reward is baked into that cake. Not much I can do but watch—and have faith. But I won’t panic at an inopportune time because I know how this floor will behave under a collapse from above. I think I know what will pop and what will bend but hold.
Fifth Floor: My wild and crazy stuff. Who knows: Longer term bonds, growth stocks, whatever strikes my fancy and what may go very well or very badly in a variety of situations. Lots of activity, both up and down. This stuff keeps me interested and focused on timing and what the heck is going on in the world. It’s my play pen in the sky. I climb up there everyday to view the world and all the danger surrounding me.
Lots of working parts here. I look at each level and each component at each level and imagine how they will function if/when serious inflation or recession hits. I look at each part as it relates to the whole and what happens when the serious movement starts. Lately, I’m worried about stagflation too. This is my personal slice and dice.
Some people may have a two story house, a balanced fund comprised of stocks and bonds. It’s tough to watch this house to my mind because of the broad (protective?) nature of the beast. The bond portion contains a diverse mix of corporates, gov’t, foreign, short and long-term stuff. Tough to see the wiggles and wobbles as they happen. All one can do, oftentimes, is watch the price of the fund go up and down—thinking extreme diversity protects you, not a limited, more focused knowledge of a smaller number of components. Ditto with the stock portion. Good luck living blind in that house. Pay special attention to your CD ladder while the house whirls, flattens, billows, pops, and spins. Lots of different slice and dice methods. Many far, far better than mine.
--Greg
![:-\](https://www.early-retirement.org/sk/forums/images/smilies/undecided.gif "Undecided :-\")
