Saturday, September 5, 2009

Commentary, "Crash Proof", Chapters 4 & 5

Chapter 4

Initially, this chapter is fairly good. Not real clear, a little misleading (maybe he will clear a few things up later), but overall, it is helpful. He does leave many of his earlier statements that include references to inflation as being just sloppy.

p. 72: Then, he is back to his conspiracy theory. What he says about the benefits of inflation to government is true, but to make it intentional, to suggest that many, if any, members of the government or bureaucracy planned it this way or even know anything about this, is really reaching. Especially since it goes across parties, ideologies, professions, and just people who do not like each other. Maybe he is like someone who is confused about the world and is comforted by the feeling that some supreme being is really in charge. Schiff isn’t willing to accept that these people have just fallen into this mess because of lack of education, clarity, foresight, a common, poor education, and their own desire for power. Really, in the present circumstance, Obama has no idea what inflation is.

p. 73: Well, what a surprise. “Much depends on how the new money enters the system and where it is spent first.” This is the key. Schiff offers it causally, without any fanfare. I think that it is central. But at least he offered it. It does raise the level of the book immensely. You just have to wade through a lot of gunk to get to it. Let’s see where he goes with it. [Nowhere]

p. 76: Oil Prices. I do not like this section. Oil, like any other product in an economy is subject to the effects of inflation. It is also one of the biggest political footballs, a major source of wealth, a target of the environmentalists, and one of the most controlled products in the world. Schiff acts as if the environmentalism does not exist. Nowhere, so far, has he mentioned governmental regulation in any regard. The guy has a singular focus.

The international price of oil is controlled more by politics and governments than by inflation. Politics and environmentalism have forced a restriction on the drilling and refining of oil. (Schiff’s comments about low prices leading to underinvestment applies to a couple decades ago, not since gas prices rose above $2 a gallon.) If the demand raises only slightly, the price will skyrocket. That demand could be from inflation, but there are actually other very apparent sources of demand, i.e., real people slowly moving to a more productive economic level, and they need more energy. Inflation would cause oil prices to raise as slowly as the other commodity prices, not sky rocket like it did just a couple years ago, not as it will again shortly.

I particularly do not like his statement that “purchasing power shifts form the United States to Asia”. This sounds as if “purchasing power” is a zero sum game and that in order for someone else to increase theirs the U.S. has to lose it. If he is talking about inflation adjusted value of the dollar to other currencies, he might be accurate, but the statement is not at all clear. My first reading made me think or real economic production, not currency.

p. 78: “Bogus Deflation Threat” Not bad. Incidentally, the Civil War was not the only time that saw an expansion of the money supply significant enough to cause widespread price raises. The gold rushes, especially the California gold rush (the 49’ers) had the same effect.

One factor that Schiff has argued constantly so far is that price inflation is much higher than the indexes the government publishes. In a way, as far as our futures are concerned, who cares. Even 2% price inflation has significant impact. As far as economic impact, high inflation is very bad, but more important is the rate of increase, since fast raising prices make it much more difficult to adjust and make plans. Actually, I think that the best indicator of the impact of inflation is corporate profits. Business can adjust and make at least some headway against lower levels of price inflation that is not growing very rapidly. However, the seventies showed that faster movement, or higher levels on price inflation wreck havoc with business success, and especially depreciation.

I also think that people are attuned to the effects upon their purchasing decisions of price changes, especially, continued increases. As prices raise, I think that people will tend to make their dismay known, regardless of the official indexes.

I think that Schiff feels he needs a number of “enemies” or “villains” in his book for effect. It may also be that he has long harbored negative feelings about government figures (not a completely irrational feeling). Whatever. I just do not think that ranting about the indexes is helping. We saw in the seventies that the indexes looked bad enough when price inflation took off.

p. 83: “How Government-Created Inflation Became Policy”

I think much of his discussion here is close to the truth, except for three points. First, (well, besides the point that there cannot be any non-government-created inflation) control of the money supply, and thus inflation, was the purpose of the Fed from the beginning. And it did its work, thus the inflation in the 20’s, leading up to the choke hold the Fed took around 1929, and that aftermath. The Fed might have been less active at times, but the “gold standard” never really had much impact, because the country had more than enough gold to allow more money to be created. A real gold standard means that all of the monetary gold (as opposed to gold used for jewelry or industry) is the currency. It would mean that every oz. of gold we had would be represented by a gold backed note. It would be a one for one relationship. The Fed never adopted this policy. From the very beginning, the Fed had all of the leeway it wanted to manipulate the money supply.

The reason the U.S. went off the gold standard, was because the money supply had increased to the point that the Fed’s activities had to be curtailed.

Second, there was no conspiracy. It was just government as is thought to be okay in the US, a result of our poor educations and the current philosophy.

Third, there are other factors operating in our world, not just inflation. Inflation is very important, certainly, but other wrong actions by our government also can be important. Other governments, too, can do bad things, and the oil mess was one example.

p. 85: “How the Federal Reserve Defied the Constitution” Actually, it was the Congress. I suspect that he is correct in his discussion. Certainly, the Founding Fathers knew about debasing of the currency and would have not wanted a government to have that power. It would be nice if Schiff had some reference to support his contention.

p. 94: “As the U.S. economy contracts, the federal budget deficit will grow and the perceived appeal of U.S. financial assets will be lost.” Didn’t quite happen that way. Everybody contracted. In considering the U.S. to be a hollow shell, he forgets about the interconnectedness of the world economy.

Chapter 5

This chapter is about the wisdom of owning American companies. First and foremost, Schiff’s arguments depend upon his claim that there is no productive capacity in the American economy. That the American private enterprise is worthless, or at least, worth very little. I have already made arguments that he cannot justify that claim.

Further, I have several arguments with many of his comments about investing, especially, over the long-term. For example, “Some stocks will gain, of course, but only at the expense of other companies, whose earnings shrink. If the market is trading at a given multiple, there have to be stocks whose earnings go up and stocks whose earnings go down. They all can’t be winners.” Some people call this a zero-sum game. It isn’t. Let’s leave aside the point that some companies are going to be poorly run, make bad decisions, have the wrong product at the wrong time, and so on. We aren’t talking about failure. Nothing Schiff said indicates that he is talking about failure. No. Schiff’s view is that, in normal circumstances, if one stock goes up, another has to go down. Mr. Schiff, what is wealth creation? If there is such a thing as wealth creation, it occurs over time, and then, as a whole, the value of the ownership of American companies would grow and be worth more. The value of a company on a free market will be determined by its profits, and anticipated future profits, this in spite of Schiff’s requirement of dividends.

Maybe what is happening here is that Schiff has the myopia that you see in Wall Street of so often these days, that can only deal with the next 90 days, or 30 days, or until the closing bell. Sorry. Humans live a lifetime. That is our time-frame. 90 days is besides the point. [Schiff seems to provide evidence that he does not have this myopia elsewhere, which makes the discussion here less clear.]

p. 106: “The only acceptable reward for taking the risk of ownership is dividend yield. A cash dividend policy is the only insurance an investor has that a business will be operated for the benefit of shareholders. Non-dividend-paying growth stocks can be attractive but should be viewed as speculation rather than investing.”

This statement is very curious, I don’t mean the point about shareholder interest, but the last part. What is the significance between investing and speculation? Certainly, most speculation is done in the short-term. If you buy a stock that pays no dividend and hold it for 10 years, then yes, you are doing so because for some reason, hopefully a good one, you expect the price of the stock to rise in real terms. You expect it to create wealth through its profitability. Would you buy a dividend paying stock and not expect its price to raise over time? One of the differences between a bond’s interest and a stock’s dividend, is that the interest remains flat during the bond’s lifetime. You do expect the stock’s dividend to increase in stride with the company’s growth over time as it remains profitable and creates wealth.

Actually, I have always considered speculation to be a category of investing, just as selling short, buying or selling options or futures. It is not gambling, but that seems to be Schiff’s implication.

It is also the case that you will only get dividend paying stocks from mature, established companies. New, smaller companies need to put their profits back into the company in order to grow. If you want to start your own company, you will be told that. You will be told that you cannot draw out money until the company has enough revenue, etc. Even then, most business owners are drawing salary or wages, not dividends. Their businesses are not sufficiently successful to generate a return on their capital in cash. Maybe they could in capital gains when they sell the company, if they can. [I am not clear how his dividend requirement relates to his latter instruction to buy smaller companies outside the U.S.]

I think that Schiff is drawing a false differentiation. He is also looking at speculation as something less than investing, as if it was slightly dirty.

As for the point about shareholder interest, I think that the motives and purposes of a company’s management become clear over time. It is part of doing your research to determine if a particular company fits in with your investment goals. And, you do have to continue to watch.

I think Schiff sees conspiracies and malfeasance everywhere. Certainly, there is some, more malfeasance than conspiracies. I don’t think that it is really healthy or helpful to approach things as if most people are unworthy of trust. It is actually more helpful, I think, to realize that the government and business leaders all went to the same schools, read the same texts, heard the same lectures, and they were exposed to a lot of ideas that have no connection to reality. Consequently, they are acting the way they were taught and bad stuff is happening. That approach is much clearer, understandable, and true.

p. 110: “Adjusting for inflation, if you bought the Dow Jones Industrial Average in 1966, you would have waited until 1995, nearly 30 years, to get your money back.”

Did you ever see a salesman who picked exactly the figures that made him look good, and ignored the one that wouldn’t? Schiff has cherry picked these dates. 1966 is the year that begins the problems with price inflation. Remember, I mentioned earlier that companies’ profits decline during higher periods of inflation. They did. From 1966 to 1982, profits and thus stock market performance stayed pretty flat. Interestingly, considering Schiff’s views, this performance is vastly understated because the Dow is made up of mature, fairly successful companies, almost all of whom pay dividends. When dividends are factored in, the Dow did somewhat better, but, that is besides the point. Then, however, if you factor in inflation, even that thought sours, since the Dow stayed fairly flat, in real terms, those companies lost well over half their real value. [Schiff makes this point later.]

However, since 1982, the market was robust, and a significant reason was that price inflation had subsided.

Between 1966 and 1982, stocks, bonds, and cash were bad places for money, until the last part of that period, when interest rates began to fall, and then you should have bought bonds, and then held them until interest rates stabilized or were low, relatively speaking. To show you why I’ll use a made up example. Let’s say you bought a bond paying 16% and five years later it was paying 4% and you sold. You would have sold for almost 4 times what you paid for it. In a price inflation environment, that is the only way to make money in bonds.
An annoying part of this statement on p. 110 is his comment about “adjusting for inflation”. Is he talking about his view of what prices have done during that period or the CPI? He doesn’t say. It makes a difference. If he is using his view, then we would need an idea of what that rate is. If he is using the CPI, why?

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