Monday, December 29, 2008

Economic reflections, Gold, and Peter Schiff

While taking a little vacation time I’ve been chewing on my investing strategy for 2009, changes I want to make to my portfolio, etc. I grabbed a couple books at Powell’s the other day that, after sitting down, I discovered were actually written by the same author, Peter Schiff. The two books were Crash Proof: How to profit from the coming economic collapse and The Little Book of Bull Moves in Bear Markets. I had seen Peter on a few Youtube CNBC videos discussing his views on the economy and decided I want to get more of his perspective. I’m not sure about some of his conjectures: in one sentence: buy commodities (think mostly gold), and foreign stocks. Duh. Fundamental to his premise is that we incorrectly give faith in statistics compiled by a government whose vested interests to maintain stability is to keep these numbers in check. Perhaps even worse, we put faith in Wall Street itself to provide us things like bond ratings (whoops!) or give merit to investment houses who make more money the more often we buy and sell stocks. A question that’s been looming in my head about the past 8 years is this: did we create any real wealth in the past 8 years? If we really calculated what I might call a ‘true GDP’ would it have gone up? It seems to me the answer would be NO. Essentially, consumers used inflated home prices to justify loans to get money to spend on krap to fill their gigantic spaces of suburban sprawl. Money changed hands, but the fundamentals of a strong economy would be if that money was used to buy things like manufacturing tools and technology to get better productivity: more chemicals for cheaper prices, more efficient fuel consuming devices, longer lasting paints, stronger structural materials, more efficient fabrication facilities (intel calls them ‘fabs’). How much of this occurred relative to people acquiring buying higher end coffee that has turned into the swill that any sufficiently advanced capital market provides? (TODO: short essay on the decline of quality and value during the maturation of a capitalistic enterprise as investors seek to maximize return). There is a difference in the dotcom boom. This was fueled by real value. Metcalf and Moore’s laws observed real productivity boosts for business. The consumer was given a greater degree of choice and price transparency.

Schiff has an important thesis about the stock market and its ‘true value’ has declined over the past 8 years. To draw this conclusion, he uses gold instead of US dollars. The US dollar, and all other major currencies, are fiat currencies—backed not by anything real but instead by the faith and credit of the institution that issued them. If you assume the real rate of inflation is 8% (and I agree with something closer to this number than the CPI the government gives) then the Dow has lost 42% of its value. If you use gold, the Dow was worth 43 oz of gold in 1929 and is worth less than 12 oz today. (granted, gold rallied over the past few years) [page 26 of author’s note]. My question is simple: why is gold any better than the faith and credit of the us government? One might say ‘because its real’. What does that mean? Its real? You mean its physical? Oh, okay. folks, IT’S A SHINY ROCK. It has no more intrinsic value than an economy. Its pretty? Its limited? To a similarly artificial degree, so is land. so what would we obtain if we divided the Dow by the avg. price of a square foot of land in 1929 vs. 2008? I don’t understand humanities fixation on gold as a ‘gold standard’. By the way, I can pound lead with some additional goodies (protons, neutrons and such) and make gold. At some point, this becomes economically feasible, so the ‘gold is fundamentally limited’ premise is simply not true. What about oil? Well, oil is only good so long as it’s the most cost effective energy source. As soon as it breaks that barrier, oil is just some dirty junk better left underground. I simply don’t have a good way to measure any real value..I can observe relative fluctuations. Is economy science, religion, or math? We use math as a tool in our economic arguments but this does not make it math any more than using math in science makes science any more than a religion backed by math.

Philosophical arguments aside, Peter’s book has been a good read so far, and I do think it is influencing my investment thinking. The last influential author was Benjamin Graham who advocated a 50/50 strategy between stocks and bonds. This adjustment in thinking has had benefits in the recent past. With that said, I should point out I was pummeled in 09 regardless of the diversification, just less so than I might have been had I not taken his advice. Now, I’m challenging the current ‘US as stable place for my money’ and entertaining thoughts of more direct international exposure and commodity markets. The bubbles in India and Shanghai have burst, and this may have provided good entry points to these markets.

1 comment:

kim said...

You are the third of my friends to recommend Schiff's books lately. Might have to give him a try.

This months National Geographic has a good article on the history of gold and of the gold supply chain. I agree with your point, it's just market value, so not the greatest barometer. I guess all yardsticks are just valued based on perception, so I'm not sure there is a good one. Maybe an average of a number of them for comparison. I dunno.

The thing about putting your money into emerging markets, is that they've put alot of their newfound wealth into the US, viewing that as a stable place to put it. THus their being taken down with us. It's very meta and very funny at the same time!