The Inflationary Fed

Here is a picture of inflation: two tickets to a lower box seat to see the San Francisco Giants, the first (on the left) from 1985 and the other from 2005.

The price of the lower box seat ticket in 1985 is $8.00.

The price of the lower box seat ticket in 2005 is $31.00.

What changed? Granted, the Giants got a new ballpark, but the seats are not any bigger. What changed was the dollar itself got a lot smaller. It used to take eight dollar bills to cover one lower box seat, in 1985. By 2008, it took thirty-one bills to cover a seat of similar size.

The dollar shrank in size by a tremendous factor. In fact, if you calculate the annual rate of inflation of lower box seats between 1985 and 2008, the inflation rate for lower box seats to see the SF Giants works out to be over 7% annually.

Always remember that when someone talks about "the inflation rate" that rate is different for every specific good and service. The CPI or the PPI are looking at specific goods and services in order to try to measure inflation in a more general sense. Giants tickets have clearly been inflating at a higher rate than the CPI over time; college tuitions have been inflating at an even higher rate.

In general, the fiat money system instituted in this country with the initiation of central banking (and the Federal Reserve) in 1913 has resulted in an inflationary monetary regime. The level of inflation has increased and decreased over time: one of the primary factors in the positive growth of business and innovation from 1981 to 2000 was a more predictable level of inflation than had existed in previous decades.

Currently, inflation numbers have been rising at more alarming rates, in response to Fed measures to prevent a "impending recession" that (as we have written previously) we do not believe was actually impending (and the credit crisis that caused the angst in the first place was directly related to earlier inflationary behavior by the Fed).

So what is the best protection for the purchasing power of your assets given the nearly unbroken decades of history of an inflationary Fed?

While a traditional response has always been to run to gold or other commodities, there is a better (although perhaps less glamorous) answer: invest in businesses.

Well-run businesses that are providing value can deal with adverse situations that arise, whether the problem is a shrinking dollar or some other problem. In the case of higher costs from their suppliers, for example, a business can take one of many courses of action (including passing those costs along to their clients or customers), but if they are a well-run business in front of a fertile field of growth and they can continue to grow their earnings, you have an excellent ability to stay ahead of inflation by owning shares in that business.

In fact, ownership of common stocks has an unsurpassed track record of outpacing inflation -- there has been no other asset class when comparing any thirty-year period since 1872, or any twenty-year period since 1929 which comes close to the performance record of common stocks, and that includes gold and other commodities (see statistics discussed here; for a more recent comparison against real estate you can see statistics posted here).

For later blog posts dealing with the same subject, see also:

• "A troubling quotation" 03/04/2008.

• "What about commodities?" 03/31/2008.

• "The inflationary Fed, part II" 05/13/2008.

• "A Phillips-curve Fed?" 06/27/2008.

• "Liberty and Property" 07/03/2008.

• "What about commodities -- revisited" 09/08/2008.

• "Stand still, little lambs, to be shorn!" 06/03/2009.

• "The Fed's oversteering and the wreckage of the past decade" 07/23/2009.

• "What about commodities? (part 3)" 11/20/2009.

• "The 97-pound weakling" 12/16/2009.

• "Ben Bernanke's non-New-Year's Resolution" 01/05/2010.

• "Avatar and long-term inflation" 03/02/2010.

• "Bubble alert!" 06/07/2010.

• "Why do we want the Fed to steer the economy?" 09/01/2010.

• "Gold versus Apple" 10/25/2010.

• "Likelihood of Fed over-steering increases" 01/25/2011.

• "Inflation is a monetary phenomenon" 03/07/2011.

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Build your house of bricks

cartoon copyright 2004 by Patrick Hardin. used by permission.


We've written before about "deworsification" and included a scholarly graph in a previous post.

Here is an all-time classic cartoon which drives the point home perhaps more effectively than any graph you will find in a business-school text.

The wolf is advising the pigs against "putting it all into bricks." As we said in the earlier post on the subject:

"Diversification is an important concept in investment management. However, the marketing machine of Wall Street has taken an important investment concept and used it, in some cases, to convince people that they need to own more different products, and thereby more holdings, than they actually need."

In this cartoon, the wolf may well have an ulterior motive for recommending "sticks and straw as a hedge."

In real life, an advisor may not have an ulterior motive at all, but may be doing what he thinks is best, without even realizing that sticks and straw and all the other "hedges" created by the financial industry are not as good as simply sticking with the bricks.

Because advisors generally don't even pick stocks anymore, finding an ever-wider variety of instruments for clients is almost the typical advisor's automatic instinct (which we wrote about in several places, such as this post).

We reiterate the lesson that Rowe Price first observed in the early 1930s, and which he emphasized again four decades later in 1973: "most of the big fortunes of the country were made by men retaining ownership of successful business enterprises which continued to grow and prosper over a long period of years."

Financial market assets do not need to be as complicated as the financial industry makes them out to be. Reasonable diversification from solid stocks and solid bonds should form the majority of the foundation. When the big bad wolf is huffing and puffing, we'd still rather own good old-fashioned bricks.

For later posts dealing with this same topic, see also:

• "Invest like Mr. Howell" 05/18/2009.
  

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Must-read: Unleashing the Exaflood by Bret Swanson and George Gilder

Today's article, "Unleashing the 'Exaflood'" by Bret Swanson and George Gilder in the Wall Street Journal Opinion page is a must-read.

Here is another article this week in the New York Times by someone who does not see what is coming, entitled "Web Movies Show Why DVDs Sell."

George Gilder has seen it coming since at least 1990, when he wrote Life After Television.

If you are trying to invest in businesses in front of fertile fields of growth, you need to be able to analyze what the business landscape will look like over the next four to six years.

The Swanson and Gilder article embodies that ability. They cite several graphic examples of the exponential growth and changes to internet data traffic over the past few years.

The New York Times article embodies the opposite of that ability. It takes conditions today and projects them into the future in a static fashion. For example, the author says, "downloadable movies require high-speed Internet connections - and only about half of American households have them. That number won't change much for years."

If you believe that the way most Americans have built big fortunes over the past few decades, or the past hundred years, is to own shares in well-run businesses in front of fertile fields of growth for a long period of years (see this previous post, among others), then you should understand the differences in these two mindsets, and you should read Swanson and Gilder's article very carefully.

For later posts dealing with the same subject, see also:

• "Big changes coming, part II" 07/08/2008.
  

• "Video is clearly the killer app here . . ." 08/06/2008.
  

• "The Unstoppable Wave" 01/12/2009.

• "Clayton Christensen, disruptive technology, and your portfolio recovery plan" 02/04/2009.

• "Revisiting the 'New Economy'" 05/06/2009.

• "Ladies and Gentlemen, start your bandwidth engines!" 06/26/2009.

• "The Unstoppable Wave: Revisited" 12/22/2009.

• "Was the decade lost?" 01/14/2010.

• "Exaflood update" 06/01/2010.

• "Have you heard of this company? HITT" 07/06/2010.

• "Have you heard of this company? IIVI" 08/05/2010.

• "What battles of the tech titans tell us about investment theory" 09/08/2010.

• "Another wake-up call" 11/29/2010.

• "Have you heard of this company? EZCH" 12/09/2010.

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The Intermediary Trap

There is a new Taylor Frigon commentary available which ties together arguments we have made previously about the detrimental effects of the rise of a class of financial intermediaries between the investor and the money manager.

In the diagram above, the investor (A) can be an institutional investor or an individual investor. He typically focuses on the performance record of the money manager (C), which can take the form of a mutual fund, a separately managed account, a closed-end fund, or many other vehicles.

Very few people realize that the performance experienced by the investor (A) can be very different from the manager (C) due to the timing and behavior of the investor in putting funds into C and taking them back out of C. Measuring the performance of A is much more difficult than measuring C, but studies such as the Dalbar Quantitative Analysis of Investor Behavior (QAIB) have done so for years and shown that the performance of A has been terrible.

Lost in this analysis has been the fact that the intermediary (B) may well be contributing to the problems of the investor (A). These intermediaries are often called "financial advisors" or "financial planners" in the individual sector and "investment management consultants" in the institutional sector. They are not money managers (C), and their track records are generally not easy to examine, as are the records of the managers.

Click here to read "The Intermediary Trap."

To read our previous blog posts on the subject, click here(1) and here(2) and here(3) and here(4).


For later blog posts dealing with the same topic, see also:

• "The Intermediary Trap and the Current Bear Market" 11/03/2008.

• "The Bonfire of the Intermediaries" 01/29/2009.
  

• "Investor Behavior or Advisor Behavior -- 2009" 06/26/2009.

• "The ETF industry and their promise of easily adding alpha to all" 09/04/2009.
  

• "Some lessons from 2009" 12/28/2009.

• "What a farmers' market can teach us about money management" 01/18/2010.

• "March 9 anniversary" 03/09/2010.

• "The financial services timeline, 1977 to present, and what it means to you" 03/18/2010.

• "Investors fleeing equity funds for bond funds" 08/25/2010.

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Washington's Birthday (Feb 22, 1732)

Today the markets are closed for the federal holiday marking Washington's Birthday. Since the elimination of a holiday on his actual birthdate in 1971 following congressional action in 1968 to move certain mid-week federal holidays to Mondays, the holiday (now on the third Monday in February) never falls later than February 21st .

Although Congress has never officially changed the name of the holiday from Washington's Birthday to President's Day, many calendars, schools, advertisements and media outlets now refer to it as such, causing many to believe that an official name-change has taken place. Moreover, some states have changed the title of their state holiday to President's Day, including California (states can create whatever holidays they want, and are not required to follow the federal model).

Presidential scholar Gleaves Whitney laments in this piece in today's National Review Online that the disappearance of Washington's Birthday has left Americans less educated about the qualities of the first president, and the selflessness for which he was well known. Particularly noteworthy was Washington's willingness to hand over the reigns of power after accomplishing his mission. For this he was widely known as the American Cincinnatus (Cincinnatus was a Roman farmer appointed supreme commander during the early republic, and returned to his farm sixteen days later after defeating the enemy).

Had Washington not possessed his admirable restraint and a belief in a limited government, the new nation might have wound up like the many states around the globe today headed by military dictators, and there would have been no markets to have been closed today in honor of his birthday.

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