Q: What defines a safe asset?
A: We talked about this already.
Q: You promised that you would discuss assets other than stocks.
A: Oh, yeah. So what do you want to know?
Q: Isn’t gold a safe asset?
A: If you want gold, it certainly is. After all, gold does nothing.
Q Doesn’t it protect against inflation?
A: Sure, it protects against inflation, but what if you get deflation? Gold will depreciate relative to fiat currencies then.
Q: But that can’t happen, governments always tend to inflate.
A: Are you wearing platform shoes, and listening to Tony Orlando and Dawn?
Q: I don’t get what you are saying.
A: The 1970s were a unique period of peacetime inflation. Many people were scarred by that experience, but in general, the elites that run the US want to preserve the well-being of the wealthy rentier class that wants the value of their income streams to be preserved. How else did we get the Great Depression? It wasn’t an accident, except that it got out of control…
Q: Really, you think depression is a risk?
A: Yes. Particularly when debt levels are high, as they are today, things get dicey, and it only takes a little volatility to make things fail.
Q: You’re kidding.
A: Then why has the Fed been so aggressive with monetary policy over the past two crises? They were trying to avoid depression. Bernanke couldn’t even utter the word “taper” without sending markets into a tizzy. As it stands now, it seems as if the Fed is targeting the stock market, which is an utter perversion of monetary policy, a sop to the rich, and a signal to everyone to take imprudent risks. They think the Fed has their backs. As one internet crank wrote:
One thing is certain — when the Fed starts tightening, some levered parties will blow up. Even the mention of the taper caused shock waves in the emerging bond markets. And when something big blows up, the Fed will stop tightening. It always happens, and they always do.
So please give up the idea that the Fed can do what it wants. It looks like it can in the short-run, but in the long run markets do what they want, and the Fed has to respond, rather than lead.
The Bond Market Tells The Fed What To Do, Not Vice-Versa
Q: Slumming on the internet, huh? But you seem to be arguing for inflation, not deflation, and certainly not a depression.
A: Sort of. I think we are headed for trouble. I just can’t predict what kind of trouble because I can’t predict the response of the US Government and the Fed, particularly if the US Dollar sinks a lot. In that scenario, the Fed might blink as inflation rises, and tighten policy. But so many of the major economic powers of the world are debasing their currencies that this is remote. Almost every major economy has too much gross indebtedness. And as the aforementioned internet crank said:
When there is too much debt, we tend to get deflation, because we slowly realize that all debt claims will not be honored. That leads to uncertainty and slow growth, as people try to preserve the value of what they have, rather than take risks to grow their assets.
Efficient Markets versus Ben Bernanke
Q: It really doesn’t seem that way now, given the run in the NASDAQ 100. Why do you listen to that loser anyway?
A: Reinhart and Rogoff said much the same thing. As have Gary Shilling, Lacy Hunt, and a few others. Anyway, we were talking about safe assets, and in this case the safe asset could be high quality bonds, perhaps even long Treasuries.
Q: Why should I lock my money into an asset that can’t appreciate much? After all, rates can’t fall that much more. The Fed doesn’t want negative rates, which don’t seem to work in stimulating the economy.
A: That would be true of low rates as well. Punishing savers does not aid economies. But in a situation like this, with equity markets so high, owning something that won’t fall much if the stock market falls is a good diversifier. Long Treasuries still fit that bill, as does other high quality fixed income. A 60/40 split between stocks and high quality bonds could still work well. It’s not that you are trying to lock in a low income rate, you are trying to keep dry powder for a bear market.
Q: But you said that the Fed was targeting the stock market. Maybe stocks are the ultimate safe asset then? Don’t fight the Fed!
A: (sigh) I said that it seems as if the Fed is targeting the stock market. I wasn’t that definite. That said, I don’t want to rely on the intelligence of the US Government or the Fed. They have made severe mistakes in the past; they will do so again. Besides, though political prompting from the rich normally drives policy, every now and then, average people get organized and they drive policy. The latter is usually inflationary, and the former deflationary. You can’t tell which way policy will go.
Q: If you are that uncertain, then can you even tell me what a safe asset is?
A: No, but I can tell you what safe assets are.
Q: Huh?
A: We can think in a portfolio context, like the Permanent Portfolio. None of the four assets are perfectly safe, but they hedge ach other well. My version of safety is like this: 60-75% in stocks, 40-25% in bonds. The stocks should be cheap and not have a lot of debt. The bonds should either be a barbell (long/cash) or a ladder (bond maturing evenly over a fixed period). These portfolios try to evenly hedge the risks of inflation and deflation. It’s not that each of your assets will be perfectly safe, but as a group you won’t lose much over any 10-year period, adjusted for inflation.
Q: Do you do that?
A: Yes I do, and it has worked well for me over my life, though some periods have been better than others.
Q: So there are no safe assets, only safe portfolios?
A: There are individual assets that are safer in each asset class, but yes, the main idea is that safety comes from a well-designed portfolio, not a single asset or asset class. Let’s leave it there for now, and if you get some more questions, we will take them up.
Q: Thanks.