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“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money……….” -Milton Freidman renown economist.
Inflation most people know as increasing prices in the things we buy. The actual definition of inflation is a general increase in prices and a fall in the subsequent purchasing value of money. The fall in purchasing power leads to the increase in prices.
A simple example is to imagine a small town walled off from the rest of society. It has only so many groceries for sale and no more. Everyone has about $1,000 to spend so the bidding for groceries can only go so high as the amount of money in the economy. Prices rise as people need food and that rise in prices is called demand inflation. More demand equates to higher prices. Then imagine everyone finds another $1,000 buried in their basement. Now the bidding for groceries resumes fast and furious as everyone now has more money. Prices rise. That increase in prices was caused by the increase in the money supply allowing the bidding to go higher as everyone has more cash. That is what Freidman refers to as monetary inflation. More money in a `system` means higher prices.
That said, the crisis of 2008 was addressed by the government (the FED) by printing up about five trillion dollars and buying bad mortgages with that money (among other things).
Some analysts forecasted skyrocketing inflation as five trillion dollars was a lot of money back then (and still is). But inflation never skyrocketed. In fact, it was fairly benign in many items. Commodities for instance (the basic material things are made of) actually went down continually in the years that followed as measured by certain metrics (CNBC)
It begs the question: why, in the face of trillions of dollars going into the U.S. economy, did we not see the high inflation many predicted?
For monetary inflation to occur, the money has to actually go to those spending it. You could say it has to go into the “system”, which is to say into the hands of consumers.
Imagine instead printing up ten trillion and then burying it in a hole. Since the money is not ‘in the system”, it just sits in the hole and is not spent. It’s like the money in our small town before it was found. It was there but not yet in the `system` until the townsfolk found it. Prices only rose after they started spending it.
In 2008, although copious amounts of money was created by the FED, for the most part it went into the banking and mortgage systems to buy bad mortgages (among other debt) and not into the hands of consumers.
There are two things the banking financial systems can do with money handed to it by the FED.
They could have loaned it out, but remember the call to “get the banks’ lending again”. Had they embarked on lending all that money out, it would have gone into the `system` (consumers) and that would have likely caused the expected inflation.
But most of the money was instead shuttled back to the FED in a mechanism called “excess reserves’. Simply put, the banks elected to park much of that money back to where it came from (the FED) as the FED pays interest on any money parked there.
For those doing the easy math, the FED gave them money for the bad loans to stabilize the banking system. The banking `system` in turn parked it back at the FED and got interest for it instead of loaning much of it out (Rollingstone.com) and therefore not incurring any risk.
As a result, most of the money never made it into the hands of consumers and therefore never made it into the system. Hence not much inflation.
Fast forward to Corona. The FED once again is creating trillions. In fact, it is on pace and forecasted to exceed the 2008 bailout. The difference here is much of that money is going into the hands of consumers in the form of a variety of well-known stimulus, unemployment and loan programs. The money will now go into the system.
Many argue, including this analyst, that this time is different. Much of that money will now be spent. That dear reader, means there will be an increase in the money supply, and that leads us back to the possibility of inflation in our future.
Freidman’s monetary inflation, the most aggressive kind, and with trillions feeding it, it has the possibility of being very severe.
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Do you have a way to STOP losses in downturns?
Two months into the Corona event and we find the Dow off about 17% at the time of this writing, up from a recent low of down 39%. Some investors might be delighted if their balances just got back to even having not had any stops in their stock positions.
Stops are sell points where a person essentially sells some of their stocks as markets fall. Not practiced by many investors or advisors, predetermined sell points go against the belief that the market always goes up over the long term is the only strategy one needs.
Although buy and hold diehards may be convinced they will never sway from the strategy, during extreme market sell offs, all conviction can go out the window as life savings evaporate daily down the black hole of plunging markets.
Watching day after day a sea of red ink in your balances can be excruciating and probably won’t do much for your overall mental or physical health either.
Indeed, more than one heart attack, suicide, divorce or other unpleasant negative outcome has resulted from such severe market crashes such as the one we just witnessed. Although the Dow Jones Industrial Average dropped almost 40% in March, there have been worse corrections. 1929 saw an S&P correction of 86%.
Can you imagine?
To address the hand-wringing phone calls to advisors as lifesavings evaporate, the money management trade could be said to have a great answer for all ills.
Actually its two answers, both might be said put a win-win spin scenario on an otherwise grim reality. The spin may be related to the client in two parts, at two different times, depending on an up or down market environment.
Put simply, in up markets the advisor is thought to be a genius and takes the credit for soaring balances. In down markets, the buy and hold advisor blames it on the market saying “well your balances are down because of the stock market.”
Pretty slick.
Like I said, it’s a win-win for the paid money manager.
I am not a fan of buy and hold. Imagine for a moment if a predetermined sell point or multiple sell points had been exercised while the market fell. The resulting dry powder could be picking up stocks on sale at much lower levels.
It’s possible not only had losses been prevented, but the resulting shopping spree from having cash with markets down 40% could mean substantial profits if markets rebounded. Compare that to the reality of waiting for the markets to recover so one could get back to even.
How do predetermined sell points work?
One only has to envision money management while playing the slots at a favorite casino. A simple narrative can allow almost anyone to envision a stop loss strategy.
When someone decides to throw money at a slot machine, almost everyone (except those with a severe gambling addiction) arrives at a point where they stop gambling and walk away. Whether it be a predetermined set point of losing $20 or $100, or just getting tired of pulling bills out of one’s wallet, they eventually leave the table.
In other words, they say enough is enough and leave. What they don’t do is practice what they may be practicing when handling their life savings.
That narrative goes something like this:
Day one of a crash: “you’re not down far enough, don’t worry about it”
Day two: “you’re not down far enough, don’t worry about it”
Day three: “you’re not down far enough, don’t worry about it”
Day 10: “you’re down too far now, you don’t want to sell out now”
See the problem?
Imagine using that strategy at your local casino. You could end up broke with continued trips to the ATM until your entire life savings disappears down the proverbial slot.
In a nutshell, most people practice proper money management when gambling yet do something entirely different with their retirement plans.
Sure some of you out there might be saying the market always comes back.
I would say, never say never.
What if someday it doesn’t?
Or takes decades to do so?
Hold for the long term?
That depends on how much long you have left in your term now doesn’t it?
This article expresses the opinions of Marc Cuniberti and should not be construed as individual investment advice. No one can predict market movements. Investing involves risk. You can lose money. Stops do not guarantee against losses. Mr. Cuniberti is an investment advisor representative through Cambridge Investor Advisors Inc. a registered investment advisor. Marc can be contacted at SMC WEALTH MANAGEMENT, 164 Maple St, Suite 1, Auburn, CA 95603 (530) 559-1214. SMC and Cambridge are not affiliated. His website: moneymanagementradio.com
Mr. Cuniberti holds California insurance license #0L34249
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