Here are some things I think I am thinking about this weekend.
1) Portfolio Insurance. I did a segment on Fox Business with Charles Payne this week in which we discussed a tweet of mine from earlier this week.
T-Bonds are deflation insurance. Gold and commodities are inflation insurance. Bitcoin is fiat currency insurance.
I was very excited about this because this was the first time my daughters have ever been on national TV. But when I showed them the segment my youngest daughter turned to me, unimpressed, and said “I got poopy”. Sigh.
Anyhow, I will write something more detailed on this in the near future, but I have always liked the idea that certain “alternative” assets are insurance. The basic thinking is that stocks and bonds are the core assets in our financial system. By market cap real estate is the only thing that even comes close in size. So it makes sense that we try to use lots of things to insure these assets. But it’s crucial to get the balance right here. What most people want from their portfolio is growth, stability and liquidity. A simple portfolio of T-Bills and stocks would get that job done. But depending on your balance you might want to insure that stock piece because it will dominate the volatility in the portfolio. At the same time, the T-Bills won’t beat inflation in the long run. So you might need some other stuff in there to insure the portfolio from stock volatility AND inflation. That’s the basic thinking behind a Harry Brown All Weather portfolio. But the Harry Browne portfolio is arguably too overloaded with insurance (it’s 25% gold, 25% stocks, 25% cash and 25% long bonds).
After years like 2022 it’s becoming increasingly popular for people to shift into alternatives and high fee products that will protect a simple stock/bond allocation. But remember that insurance is a satellite asset, not the core asset. You’d never buy a $1MM house and then insure it with a $10MM policy because that would make the insurance irrationally large relative to the asset you’re protecting. And that’s unfortunately what many investors do when they invest in high fee alternative assets. Don’t get me wrong. Insurance is a sensible part of any financial plan, but never build your portfolio around the insurance. You add the insurance around your portfolio’s core assets.
2) Do Higher Interest Rates Cause Higher Inflation?
My friend David Andolfatto had a very good post on Friday about the theory that higher interest rates cause higher inflation. The basic thinking is that interest expenses are functionally “money printing” that forces the government to pay out more money. So, if the Fed raises rates they’re making the Treasury spend more. It makes sense at a basic level.
Of course, it’s more complex than that and a recent paper used Turkey’s recent experience to debunk the idea that high rates are inflationary. In the case of the USA I think the evidence is becoming increasingly clear. First, higher rates cause lower asset prices. Second, higher rates cause credit contraction as credit becomes more expensive. In the specific case of the USA the rate hikes added about $400B of interest expenses to the government’s annual spending. Meanwhile, the bond market fell by $10 TRILLION. And perhaps more importantly, credit growth has slowed to 2.1% compared to the historical average of 7%. That’s hundreds of billions of dollars of “money printing” that isn’t being done by banks under a normal interest rate environment. So, it’s no surprise that all of this has added up to falling inflation because interest rates are not inflationary in an economy like the USA which has large developed bond and credit markets that are rate sensitive.
Then again, it would be very different in an economy that is less rate sensitive. Many emerging market economies have less developed bond markets and credit markets and so monetary policy wouldn’t have the same impact. But I think the answer is now pretty clear in the case of an economy like the USA – higher interest rates kill credit demand, hurt asset prices and make consumer demand lower than it otherwise would be.
3) Socialism Sure Isn’t Boring.
Here’s a provocative article titled “Will Socialism Be Boring?” The basic gist of the article is that a socialist economic regime wouldn’t lead to a stagnant and monolithic style of equality across the economy. It’s a nice sort of idealistic narrative. We’ll all have our basic necessities as well as the luxuries that make life enjoyable. The problem is that it’s never worked like that and the only economies that come close to being sustainably “socialist” are economies like the ones in Scandinavia, which are actually capitalist with a side serving of Socialism. More problematic is that the handful of economies that have closely reflected true Socialist regimes, like the USSR or many cases in South America, have ended up with disastrous currency collapses. They surely weren’t boring because it was like experiencing a slow motion car crash.
This isn’t to say that Capitalism is without flaws or that some social safety net isn’t a very good thing. I wrote in my book many years back that some level of redistribution and Socialism actually makes a Capitalist economy work better because Capitalist economies veer towards inequality and inequality threatens Capitalism by making the populace believe that the system doesn’t work. But the reason Capitalism works is really quite simple – it’s an incentive structure that says “give people what they want and they will reward you”. And as I’ve written in the past, there are two ways to view this. You can be a self serving Capitalist or you can be a subservient Capitalist. The prior operates solely for the benefit of themselves while the latter operates for the benefit of others knowing that they will benefit along the way. And the prior is boring because what fun is making gobs of money if you don’t get to enjoy the ride along with hundreds or millions of other people?
The point is, Socialism surely isn’t boring. But it’s exciting for all the wrong reasons.
Have a great weekend.