Episode 049 - How to lose half of your wealth in 10 years

In this episode we talk about inflation and how those that are not keeping an eye on the looming threat could become a victim to it. Inflation is a cancer that erodes wealth in its path and the government numbers that are used to calculate base interest rates are just plain wrong. We will look at alternative inflation calculations that are more consistent with your normal experiences of shopping for groceries, fuel, health insurance, etc. and why you need to factor in these numbers in your projection calculations.

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Show Notes

Let’s talk about inflation

Here’s the TLDR on this episode:

The “official” numbers used by the US Federal Reserve showed inflation at 0.03% which are total bullshit
Alternative calculations made by various economists, show it more to be tracking about 6-7%
Your money will be worth 50% of its value in 10 years time - what’s your plan for this?

Firstly why is getting the inflation rate number so important?

The levers of an economy that is based on debt are manipulated by interest rates.  If an economy has meaningful inflation, the means of tempering that is to raise interest rates.  If it has deflation or stagflation (basically negative or flat inflation), lowering interest rates tends to spur consumption.

Who defines what the rate of inflation is?  

There are many parties that do this, but the only one that really matters is the central banks since they determine the cost of money to the other banks.  They use their own CPI type numbers and they are weird.   

Many people are saying that these numbers are manipulated, fictional or erroneous (to be generous).  Although I’m not one to embrace conspiracy theories, with this one I tend to think they could be right.

There are many parties that get screwed over with lies and miscalculations here:

Savers

If you saved up $1 million and inflation was at 6.7%, over 10 years you have just lost 50% of your money.   So anyone who is saving up a ton of money to retire on, now has half of their capital to try and get a return on it, 10 years into their “golden years”

Borrowers

If you borrowed money, the interest rate of that money is calculated based on what one bank can “buy” the money for, and the arbitrage they make selling it to you.  The most visible of this is mortgages.  If you have a 3% mortgage, and you lock that in for 30 years, great.  But if the person who wants to buy your home 10 years later, can’t get a 3% mortgage because the inflation rate goes up, and is looking at a 10% mortgage, you won’t sell your home for the price you expected because there are fewer borrowers that can afford the payments for it.

The general public

Governments have embraced the art of debt over the past 40 or so years, to the point where they are so insolvent that they can’t afford even a small increase in the interest due on the debt they have.  So if interest rates go up, that’s fewer government services for all of us, less money sent down the wire to your state and local government, and more costs that end up on your lap.  It may not be increased taxes (god forbid) but it may be increased costs of public services, more that you pay and less that they provide (ie. medicare & social security), less defense spending, etc.

Why this is a death sentence for anyone trying to do “the right thing”

When I was a kid, I was encouraged to save money.  Remember “piggy banks”?

Back then, we were told that you save 10% of your income.  This was so that if you needed money, you had provided yourself your own supply.  It was the “be your own bank” idea.  

This concept has not changed that all that much, in fact the FIRE community took it and amped it up to the point where people try and live frugally, make mega-income and save it at 50-75% savings rates.  Good for them.

But bad for their money.  The problem is that our world changed to a debt based economy - not a savings based economy.  Where it used to be that banks would pay you a reasonable rate of return for your savings by way of interest, which was relatively low risk for you, they don’t now.  Many banks charge you to hold your capital, and in many countries they have negative interest rates, meaning that they take value out of your account if you elect to give them your money.

They also effectively own your money if you give it to them, but give you back an agreement that they will pay it back to you (for the most part) if you ask for it.  They try and provide more incentive to lock the money away (ie. term deposits), but the problem is that their interest payment to you has to be competitive with the cost of the money that they can get from a central bank, and with central banks writing down the cost of money to 0%, why would they pay you anything for it?

So “traditional” low risk investments through banks have little or no return.

This forces those with capital to move it into higher risk markets, ie. equities.  Stock markets crash over night periodically, which puts everyone on edge.  Imagine if you were a 65 year old retiree, who saved up $1 million, and is forced to put it into the stock market, only to see a drop in market value of 50% over night?  Your capital is now worth half.  That’s fine if you think that over the next 24 months or so, it will recover back to where it was.  But you are not generating any return for 2 years, and with an average life expectancy of 80 years old for a US male, that is about 15% of your future life that you have no return coming in.  So what do you do?  You draw down against the capital for 2 years, reducing your $1 million to $900K and then when you reinvest that, you don’t get the returns either.  I guess if you only expect to live another 15 years, what do you care, right?

But what if you were a FIRE advocate and you did this at the age of 35 or 40?  How’s that going to work out if you have another 40 years of life expectancy?

All these numbers wonks that are out there telling you that historical returns are X and that you should just dollar cost average your investments, etc. have no plan for if/when that doesn’t work.  You can’t get a return in a bank, you can’t get a return with bonds and you better hope that equities do the job.  As you all probably know by now, I hate the stock market.  I see it as a casino, and not a safe harbor investment.

Before you pull the trigger on some plan for your future, know that you can’t predict the future and if you are trying to do this based on government statistics, you will be seriously disappointed.

The more realistic inflation rate is about 6.7% averaged over the past 2-3 years.  http://www.shadowstats.com/alternate_data/inflation-charts

Why is it then that the Federal Reserve and other govt agencies are saying that it has been 2.2% and right now it is 0.3%?

I’ll give you two types of answers to this:

Would you trust the Mafia to accurately tell you the crime statistics?
To quote Jack Nicholson, “You can’t handle the truth”

Case in point, our current US White House doesn’t like the COVID19 statistics.  It’s an election year as I record this, and Trump does not want the statistics to threaten his chances of re-election.  After all, people don’t like the idea of dying and if he is linked to the perception that mishandling of the virus is his fault, then no more Presidency for you.   

The numbers are large and collected from hospitals all over the country.  They are fed to the CDC, totaled and then reported back to the public.  This week the White House told the CDC, that reports under Dept of Health & Human services to the Executive Branch, that they will no longer publicly disclose the numbers - they are to give those numbers to the White House and the White House will disclose them.

Hmmmm....  You think you will get real numbers?  Nope.  This is about how to do what Steve Jobs used to refer to as “the reality distortion field” and it helps keep the general public oblivious to a looming threat until it is too late.

The same is true of the inflation rate.  First, only those that understand the basics of economics even know what the inflation rate is.  Most people only come up close & personal with it when they go to the grocery store and wonder why it cost them 20% more to buy their weekly groceries, or see their power bill go up, or see their health care premiums skyrocket, etc.

But here’s the way that works - first 80% of the world’s nations settle their transactions in $USD.  Their local currencies are probably not $USD, but they agreed (back in the Bretton Woods post WW2 agreement) to settle their transactions between nations through New York.  So the value of a $USD matters to 80% of the world.  If the $USD is devalued, then 80% of the world is devalued.

Maybe they should have tied their currencies to something more stable, that doesn’t fluctuate like that.  Gold, for example.

Well that all changed in 1971 when Nixon took the US off the gold standard.  Every other country that were settling their transactions in $USD followed suit.  In fact, to this day, the only one country in the world has their currency backed by Gold.    Lebanon.

Yep, one country out of 200 or so in the world.

Unfortunately Lebanon is deeply in debt so whereas its currency values are not moving around that much, its chosen to ignore its own currency and pursue the currency of debt.  Ipso facto, they slide when everyone else slides as well.

So if the $USD value is defined (in part) but the US Federal Reserve, who are the US Federal Reserve?  Well this is a cartel of private bankers, representing the world’s richest of the rich.  They operate in cloaked secrecy, but with the mandate from congress that they must support the best interests of the USA.  The problem is that the very same congress is not full of economists and are elected, so they have to just make their citizenry happy.  

The US Federal Reserve loans to the US government to cover the deficits (the loss) of each fiscal year.  That is money brought in through taxes and money paid out to run the country.  We currently have been trading at $1 Trillion loss per year, which is the highest it has ever been, despite all the claims that the US is being treated unfairly on the world stage.  Nothing has been done about this - in fact, it is WAY worse that it was.  So we keep adding this to our national debt.  As I record this, the US national debt is at $26.5 Trillion.

We have to pay interest on this money.  In 2019, the net interest paid was $593 Billion, but in 2020 this will be much more.  To put this in perspective the total cost of funding the US military in one fiscal year is $598 billion, which accounts for 54% of all discretionary spending.

God forbid we have to go to war.   Oh wait....

Remember the USSR?  They couldn’t fund their own country due to the costs of participation in the Afghanistan war.  Hmmmm.....

Look, this is all complex stuff.  I’m not going to win over an audience looking for entertainment in a podcast by trying to explain macro economics or monetary policy stuff.  Man, that’s boring.

And when your future, you ability to sustain yourself and your family, etc. is at risk, this is important stuff.   This isn’t something you can afford some “faith based mantra” on.  You need to start to read books, listen to podcasts, understand money, understand government, and understand risk.  Don’t be the ostrich and stick your head in the sand because of risk.  Risk is not scary, but it requires you to be active in combating it.

Look, I live in the desert.  In the summer it is common to have 110 degree days.  For months, BTW.  Things get destroyed under that barrage of heat.  From roofs to A/C units to paint, to gardens, etc.  You have to be pro-active to combat it.  That requires investment in maintenance and time to get out there and check things, to fix irrigation, etc. because water is life.  

If I stuck my head in the sand like so many in the FI community do, I’d be destroyed by the season.  No, the rain won’t magically come and wash away the problems.  Its the summer - it is always like this this time of year.  I have to man up, and deal.  That’s why we live in the desert.  It is the cost of doing business here.

You are living in the financial desert.  You have to man (or woman) up and put on your big boy pants and find a strategy for the changing financial seasons.  Sitting on the same “dollar cost averaging” world as your only strategy to handling this is naive if not downright stupid.  Sure, if a portion of your portfolio (let’s say 30%) is in equities, maybe you can afford that.  But if ALL of your portfolio is in equities you have no safe haven.  Wall Street cannot be trusted.  You need to remind yourself of this.  Go to Netflix and find the old 1980s Oliver Stone movie “Wall Street” with Michael Douglas and watch it.  Remind yourself what Gordon Gecko looks like.  He’s now working for Vanguard, Fidelity or Charles Schwabb.  Just remember that.

Don’t dismiss outright the older financial advisors who have made their wealth on slower, older paradigms, like precious metal investing.  Yes, I know - buying gold is the least sexy way to make money.  No fancy computers, etc. but it works if you are trying to maintain the value of wealth.  It will go counter to the devaluation of your $USD.  What about other forms of investments?  Think low tier Maslow’s hierachy.

Remember that right now, this is the time of the “essential service”.  While we go through a pandemic crisis, getting back to basics works.  It always has.  That’s why those not in essential services are either out of work, furloughed our about to be fired.  My local micro-brewery closed their doors this week, which was a huge sadness to me.  I grew up with pubs and I love to craft beer.  But even they could not exist in a world where people can’t congregate.  With that, the best IPAs in Phoenix gone.  

The thing is that if the could have pivoted to selling through more traditional distribution outlets, they probably could have survived but they wanted to be boutique.  Well boutique doesn’t work in a pandemic.  

And you need to take the same approach to your investments.  Diversification is key.  Don’t put all your eggs in one basket. 

When 2008 happened, I had a lot of leveraged real estate here in the Arizona in the rental market.  Since my strategy was about making smart income on the rents, there were roadbumps but people still needed a place to live.  The problem was that mortgages that were designed to be refinanced couldn’t because property equity values halved.

So how did I get through this?  I sold two properties in Australia that had tripled in value, paid down balances, refinanced and then used the rest of the money to buy other people’s disasters.

Having money in different countries makes you able to leverage off the changing economic climates of different countries.  When one is up, and another is down, you play the buy low, sell high game.  This requires that you control your capital.  That you don’t just give it blindly to a counter party like a 401K or IRA because the very same government that is feeding you bullshit numbers, bullshit inflation rates, etc. is telling you that they don’t want to be responsible for their part of the social security contract, so they will let you defer taxation until you are 59 1/2.

Really?  You trust them?  Will your money be there?  Probably, but what are the opportunity costs of you not having access to it, if we see a foreclosure spike coming in 2021?  What if there are other opportunities?  Do you just want to stick your head in the sand and do the ostrich thing while those pass on by?

How can you leverage from an international portfolio that might support your ability to travel, diversify, etc. if you have committed your money to a fund that you can’t quit if and when the opportunity presented?  And what if the fund doesn’t perform?

You have the right to choose any strategy you want for your investments.  I’m not presenting you with any one answer to this.  I’m just saying that blindly following a religious ideology of investing in one place, living frugally and saving money, in a world that exists solely on debt, is naive and goes so against the grain of regular economic theory of your own very government, that you might find yourself as the odd one out.

That’s fine - I’m a contrarian.  But there is a cost of being a contrarian and that is you must be nimble.  Most of the savers out there prefer to not be nimble but to commit to a strategy that only goes in one direction, doesn’t fluctuate and leaves it up to counter parties (ie. Gordon Gecko) to make them rich.  They don’t give a crap about you - stop fooling yourself that they do.  It is time to get off your faith based zealotry and diversify a bit so that you have options.  That’s what got me through 2008 (international diversification) and it may just get you through 2020 as well.  

Remember, we are going through an economic depression time right now.  Sure, the media isn’t telling you that every night, but we are.  This is no different to 2008.  We’ll look back in time, 10 years from now, and remember the 2020 pandemic, but possibly we’ll still be dealing with the economic fallout from it.

I wish I could give you a ton of positive news here.  I’m giving you tools to build an unconstrained future.  What you do with the tools is up to you.  Open your eyes and pull your head out of the sand and start to get critical of what you are being told.  Even me.  Be critical of what color I’m painting here.  Because ultimately it is your money, your life, your future.  Take control of it.  Please.