For those of you who don’t know me in my personal life, I have some pretty geeky interests. One of them is collectible card games (CCGs); specifically I enjoy the White Wolf card game Vampire: the Eternal Struggle. Unlike other CCGs, VTES is a multiplayer game which requires the manipulation of the other players rather than simply “playing your deck.”
My book was a big hit at the last North American Championship in Montreal. Among the players that bought a copy was Ben Peal, who went on to become the only person to win the VTES NAC for a third time with his win this year. He sent me this email, and gave me permission to share it with all of you.
Yeah, I just finished it last night, and I was trying to track you
down to talk about it. Definitely a fun and useful read. While
I’m not a Libertarian and not a laissez-faire capitalist, I do share
many of the same concerns you have about where our economy is
I’m petrified of deficit spending and our national debt, which is
flat-out running riot. I’m likewise petrified of the impending
Social Security problem. I need to prepare for that two-fold
disaster, and the topic of your book definitely caught my attention.
The book is a very helpful primer on the way our economy actually
operates, Even if you factor out the national debt and Social
Security, I think you still illustrate that the cycle of our
economy is such that a Depression-level economic disaster is
still looming. Some questions I have:
Obviously gold (and specie in general) is what you recommend.
A lot of what you explain in the book is how economics is about
the transfer of real goods and services, which is why you focus
on gold (and also because it’s transportable). Are there other
commodities that are worthwhile investments? It seems as though
commodities in general would be a good investment in preparation
for a deflationary period, as they are real goods.
You describe the conditions under which we can expect to see
a deflationary period start. What resources are available for
one to monitor these conditions?
Speaking of which, you do a great job of describing how we’ll
get to the deflationary breaking point, but what happens when
it’s going on? How will the banks and government respond? How
have they traditionally responded? What should we be doing
during this time?
Who do I sell gold bullion to? Having managed a game store,
I know that the whole idea is for a company to buy at less than
market value and sell at market value or higher. If I’m selling
my gold, how can I get market value or higher for it?
When do I buy gold? Under what conditions can I expect the price
of gold to drop? Are there price cycles for gold? What is a
good price for gold?
What conditions lead to an economy getting out of a deflationary
Argh…gotta get back to work…I’ll be more than happy to chat
with you at some point about what I dislike about laissez-faire
Here is my reply:
Happy to hear you read the book. I try to blog everyday to give people stuff to read. If it’s Ok with you I’d love to post your questions to the blog and my answer to them.
You wanted to know what other commodities are worthwhile investments. You already know my feelings on gold, but strong arguments can be made for oil and silver. The personal investment I’m fascinated with right now (and I’m not legally allowed to recommend investments mind you) is Barrick Gold. They are a Canadian company, and the largest gold miners in the world. They have invested in expanding capacity, and have a solid balance sheet that will allow them to wait out any downturns. Not that there’s been any downturns in the physical gold market- demand has been going up as the economic crisis has worsened. Today it’s trading at PE ratio of 10 and close to their fifteen year low. So I like gold stocks.
Other people (bears) disagree with me. They feel that you either have to hold the physical gold bullion or be an active trader who is willing to get in and out in anticipation of where the market is going. If the market is going down, they want to be short the market to make profits off of the decline- which has been a great place to be. The feel that the pain involved in riding out a downturn in the stock market is just as intense if you’re in gold mining stocks than if you’re in google. The more I look at it, there’s no right answer. There’s all kinds of money to be made in investing with all kinds of different philosophies. So people are long term investors and don’t care where the price goes short-term. Others know exactly when they’re going to get out before they ever get in. Different philosophies. Who can say who’s better. I talk about this in one of my blog posts: http://www.prestonpoulter.com/wordpress/?p=296
That is to say, I see lots of opportunities to make money off of the decline, but what you have to do is decide what kind of investor you want to be and what your strategy is. I can recommend some books and services that I’ve found helpful in that regard, or point you to some other money managers who have similar philosophies.
In terms of monitoring the progress of a deflationary crisis, it classically goes in three stages: in the first stage, the borrowers go broke; in the second stage, the lenders go broke; in the third stage, the nation goes broke. In terms of monitoring how the stages have progressed, you’d monitor stage one by level of consumer indebtedness compared to income. The easiest statistic to monitor for that is the percent of income saved. If you’re an Econgeek, you can check out the tables yourself at the Bureau of Economic Analysis. Here’s there latest report (http://www.bea.gov/national/nipaweb/Nipa-Frb.asp). If you see that saving’s rates are going down, then people are taking on more debt, which should be inflationary. If saving’s rates plateau or start to rise, then that means that consumer credit is no longer expanding. While not necessarily an direct indicator of economic calamity, it could signal the onset of deflation. The next thing to watch would be rates of credit card and mortgage defaults. I’m not sure a good source of data on this, but you can use google to see if the rates are rising. Other things to monitor are the prices of major asset classes such as real estate and the stock market. Rising savings and falling asset values or a rise in defaults signal that stage one of deflation has begun.
As for state two, where the lender go broke, you need to follow LIBOR. The London Interbank Overnight Rate. As loans start to go bad, banks start to become insolvent and need to take on cash in order to stay solvent and in business. That would cause a rise rate of interest they loan money out to each other. It also indicates that banks are starting to worry about the solvency of other banks- they don’t want to lend money out if they might not get it back when the bank goes under. Also, the credit spread between US Treasuries and other debt is an indicator of faith investors have in the economy. If the spread is low, then people trust that businesses will do well with their money and only demand a few basis points over US Treasury rates to make it worth their while to take on the extra risk. As people become more fearful, the spread between the yield on US Treasuries and corporate debt will rise. As stage two progresses, you will start to see more and more institutions require bailouts or simply go broke.
In the final stage of deflation, the government has taken on so much debt, in part due to the inflationary mechanisms that I talked about in my book and in part because of taking on more and more debt in an effort to bail out the various institutions that international investors fear for the solvency of the country itself. The thing to monitor here is the exchange rate of the country’s currency and the interest rate yield on its bonds. As the yields rise on government bonds, investors are trying to make up for the fact that the bonds are riskier and the currency in question is losing purchasing power.
In terms of how to position yourself for each stage of deflation, cash is a good place to be in stage 1 and 2. Gold or foreign currency assets are best for stage three. Of course, it’s hard to know when to change positions. Things can come up on your pretty quick. This year is going to go down as the worst year in stock market history since 1937, and most of it materialized in the month of October. If you’re a long term investor or just a concerned citizen, then holding gold bullion is an excellent way to protect yourself.
If you’re trying to make profits trading at each stage of the deflationary event, then it’s much harder to adopt a winning strategy because you’re trying to outguess a lot of other people who are trying to do the same thing. And hedge funds greatly complicate things because they take sensible investing advice (such as, “buy gold” for instance) and leverage themselves up in an effort to squeeze the return out of it. Then when the hedge funds go south, they have to unload all of their positions as they get liquidated because of the debt they’ve taken on to stake their positions and you have weird things like Barrick Gold falling almost 50% of it’s market cap at a time when the demand for physical gold is unprecedented. Not to discourage you, I just want you to know the risks of the game. In terms of buying and selling gold, theirs not a ton of margin on gold bullion products such as coins. Ebay is one of the best places to sell your coins to get the best value and, as most bullion dealers are having a hard time keeping up with demand, one of the best places to get the product itself. Right now there’s a fairly dramatic price difference between paper claims to gold (i.e. Commodity market or COMEX trades) and the prices paid for physical gold. I discuss this in a few of my blogs, here is the latest (http://www.prestonpoulter.com/wordpress/?p=366).
If one had deep enough pockets, then you could buy a paper claim to gold and take physical delivery in which case you’d get it at a significant discount. Although, as I’ve also discussed in my blogs, the reason for the price discrepancy is most likely due to an effort to depress the price of gold as so they may deny delivery to all but the best customers in an effort to keep that paper gold market going. Like with gaming, the best margins on products are made in purchasing from the consumer who wishes to trade in his product. That’s where dealers of everything from bullion to comic books have tended to make their profits is off of buying from those who aren’t professionals. I’ve also been hearing of businesses advertised over the radio who will take your gold jewelry and give you cash for it. I’m sure they’re making good margin. As for me, I still feel gold mining companies are one of the best values, but, as I’ve also mentioned, other bears disagree with me. In terms of your last question, I feel the best thing to get out of deflation is to simply let it happen. As Treasury Mellon reportedly told Hoover, “Liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate. Purge the rottenness out of the system. High costs of living and high living will come down… enterprising people will pick up the wrecks from less competent people.” It was advice hat Hoover ignored. As you now know from the book, we’ve had many an economic crisis over our history, but they have all been fairly brief with the exception of when we’ve had large central banks trying to manage their way out of them. Japan seems to have made it’s deflationary downturn go on for almost two decades now. We need to stop socializing loses and just allow companies to fail. Traditionally this process has taken a good 6-18 months, but I’d prefer that to what Japan has gone through.
I look forward to hearing from you.