Categories
Wealth Work

Equity performance and inflation

Right now there are over 10 million job openings in the United States. Meanwhile, 4.3 million Americans quit their jobs in August. It has been a long time since labor has had so much power.

Many of these job openings and quits are hitting small businesses especially hard. Competition for skilled, unskilled and semi-skilled labor is fierce.

When the quantity demanded is high but the quantity supplied is low, prices rises. And that’s what we’re seeing in the market. Small businesses are raising worker compensation to compete for labor.

Wage inflation is now the most commonly-reported type of inflation affecting US businesses, closely followed by higher raw materials and transportation costs.

If these inflationary trends persist, it is reasonable to expect interest rates to rise. The 10yr US Treasury bond yield has risen to 1.544%, and many expect the rise to continue.

The Fed continues to buy $120b of bonds each month, so there is quite a bit of runway before they must raise short term rates, but what would happen if they did? The following chart looks at equity market returns during previous tightening cycles. Although, this time could be different as inflation today has much different characteristics than during previous cycles.

What if someone invests today and the market subsequently crashes?

The following table looks at how someone would have performed if they invested right at the market peak before major market crashes. On a long-enough time horizon, the markets have historically been quite forgiving.

Categories
Life Work

Do you Live to Work?

Are you really free? If you’re like most middle-aged people, you’re probably living a life to serve the system.

Everyone starts with 24 hours:

  • 8 hours for sleep
  • 1 hour for showering, breakfast, etc. in the morning
  • 1 hour commute
  • 8-9 hours at work
  • 1 hour commute
  • 1 hour meal prep, eating, cleaning
  • 1 hour of exercise
  • 1 hour kids homework

What does that leave you? 1-2 hours of ‘freedom’. Yeah, your best hours to invest in yourself can begin after you’ve fully drained all your mental and physical energy.

Do you have hopes and dreams? Save them for between the hours of 10:00pm and 11:00pm.

You’ll notice I’m leaving out laundry, groceries, repairing the back stairs, mowing the lawn, dry-cleaning, picking up pencil crayons for your kid’s art project, and so on. That’s where your weekends go. And if you’re like many people, those obligatory social gatherings – after work drinks, in-law’s birthday party – might as well be minor forms of work too.

The time each of us have to actually do what we want is minimal. If you’re like me, you have to find enjoyment in the daily chores.

The funny thing is, most jobs don’t require 8-9 hours. How much of your day is wasted? This has become especially apparent when we started working from home. This new setup is amazing! I can get my work and daily errands done much faster than before.

But the system doesn’t like it. The system wants us indebted with minimal free time. This keeps us dependent on our employers for money. Moreover, with little spare time we blindly purchase short-lived dopamine hits – retail therapy, objects of desire – benefiting our employers. The house always wins.

Yeah, that’s it…your pusher wants you to happily return every penny he provides you so you’re totally dependent. It keeps you coming back for more, despite hating every minute of it.

Ever have a boss suggest you buy a bigger house or upgrade to a new car? Perhaps after they just gave you a raise? They certainly don’t want you using that extra money to pay down your debts to achieve financial freedom. If they’re to shape your behaviour they need you financially subservient. Highly mortgaged people with families to care for make the best indentured servants employees.

God forbid you smoke a little ganga when not on the clock and your employer tests. That stuff stays in your system for a while – doesn’t matter how good you are at your job. Even your free time is co-opted by the system.

In the end, you’re just an anonymous cog in a machine. Those people at work that call each other family will fall off the face of the earth as soon as they retire/quit/fired/die. Although turnover is a pain in the ass, in the long run everyone is replaceable. We’re all just worker drones.

So don’t give your life to work. Because work will happily take it. Break free by striving to become debt free while owning income-producing assets. Only then can you live life on your terms.

Categories
Investing Life Wealth

How Can Inflation Coexist with Deflation?

How does one explain a world in which macro trends are deflationary (DumbWealth: The Case for Deflation) yet the basic necessities of life are increasing in price?

While it sounds contradictory, the two paradigms can coexist. Look at housing prices and healthcare costs over the past 10 or 20 years. Look at commodity prices during the 2000s.

From the late 1990s to early 2010s commodity prices across the board were going through a super-cycle, driven by rising Chinese demand. Commodity prices were booming, yet – despite some cyclical bounces along the way – the secular disinflationary trend that began around 1980 continued until present day.

Medium Term Crude Oil Prices

Makes no fucking sense, right?

There are those who argue the CPI stats don’t reflect reality. The thing is, price ‘reality’ for one person isn’t ‘reality’ for another. We all have different baskets of goods and all spend different proportions of income on those goods, so our true experiences will differ.

ShadowStats has re-calculated CPI based on its own interpretation and has consistently printed double the reported inflation rate:

So, despite the long-term deflationary pressures of debt, demographics, productivity and imports, one must still respect how quickly commodity prices have risen lately. We’ve seen this battle before.

Over the near term, we’re going to see rising prices. Perhaps the scariest part of all this is how quickly global food prices are rising. Over the past year, the FAO Food Price Index has risen almost 40%!

This doesn’t necessarily mean that you’ll witness a 40% price increase in the grocery stores or a huge impact to your food budget. However, for the poorest portions of global society this could mean the difference between paying rent and feeding their kids.

In the end, the cure for high prices is high prices. This means two things.

  1. Much of the current increase in commodity prices is caused by supply chain issues created (exposed?) by the pandemic plus growing shortages of raw commodities. Higher prices are incentivizing production (and delivery) to quickly come back on line, which will eventually mitigate further price increases – potentially even lowering prices.
  2. Higher prices could break demand. At some point people simply can’t afford to pay higher prices. There’s an argument that the final straw that broke the housing market’s back prior to the 2008 Global Financial Crisis was higher gas prices. People could no longer justify longer drives, eroding demand for new suburban sprawl developments. Simply put, higher prices eventually erode demand somewhere, somehow and this can have a domino effect on the economy, ultimately replacing rising prices with a deflationary shock. This is what we saw in 2008.

Final thoughts

Although the ‘peak oil’ movement seems to have disbanded with the influx of lower quality, relatively expensive American shale oil, it is quite possible the world is riding a deflationary low-tide coupled with broad resource shortages that result in inflationary waves.

My prevailing shower theory (i.e. something I came up with in the shower) is that the secular deflationary forces will remain omnipresent, but most of the world will fixate on the boom/bust cycles driven by resource demand and shortages, exacerbated by fragility in the global just-in-time supply chain.

There will be rotation from good times to bad and back, but ultimately there is no end to this inflation-deflation battle. We can’t make more easily accessible, high quality oil, copper, etc. Yet, ‘economic progress’ requires us to use more and more. However, demographics and debt will continue to act as a counterbalancing force for our destiny.

Categories
Wealth

Chart: Urban-Rural Divide

Folks living in rural communities have become increasingly vocal about the deterioration of their way of life. Understandably so.

Flyover states are often overlooked by policies crafted to support economically dominant coastal regions. Meanwhile, they’ve watched globalization pass them by as jobs were replaced by machines or overseas workers. They blame city elites, immigrants and foreigners for their misfortunes, and gravitate to those who promise a return to the ‘good old days’.

Politicians have long used this to their advantage by misdirecting fear and anger to scapegoats, as opposed to the true source. Cheap labor didn’t steal American jobs – corporate executives drove the decision to dismantle labour power, automate and offshore. All in pursuit of higher profits, funneled to executives and shareholders. Old fashioned corporate greed, one might say.

Really though, this isn’t new. The urban-rural divide has long existed in many forms. Put aside blame and ethics, and you’re left with a rural population passed over for generations.

The following chart illustrates this.

In the early 1900s, the standard of living in America was rapidly improving as new technology was introduced. However, the experience wasn’t evenly distributed. Infrastructure – water pipes, electrical wires, gas lines – is easiest and cheapest to build in dense areas. Consequently, dense urban cities were the first to benefit from essential modern conveniences like flushing toilets.

Of course, rural populations understandably took this inequality as representative of America’s priorities. The characterization of urban favouritism has since passed down for generations and continues to this day.

Data Source: “The Rise and Fall of American Growth”, Robert J. Gordon.

Categories
Wealth

How Canadians’ Incomes and Wealth Changed During the Pandemic

Statistics Canada recently released some data measuring changes to household incomes, expenditures, savings rates, assets and liabilities during the pandemic.

I decided to create a few graphs to illustrate their findings.

Before we get to the graphs, here are some of Stats Canada’s key findings:

  • Disposable income declined for most households in the fourth quarter of 2020, with the largest losses for the lowest-income earners (-10.2%).
  • Despite declines in disposable income in the fourth quarter, all households recorded higher income in 2020 compared with 2019.
  • In 2020, the lowest-income earners saw their net worth grow more than that of other households. These gains were driven by larger increases in real estate assets that outpaced increases in mortgage debt.
  • Lower-income households reduced their non-mortgage debt by more than other households, also contributing to their higher gains in net worth in 2020.

Household incomes rose for all income brackets during the pandemic:

As you might expect, spending declined:

This allowed many Canadians to save more. Note, however, those in lower income quintiles still have negative savings rates:

Higher incomes, less spending and greater savings helped propel net worth. Of course, Canadians’ net worth also got a big boost from rising real estate and financial asset values:

Finally, Canadians are exiting this pandemic in a better financial position than when they entered:

Categories
Wealth

The Origins of Money and Inflation

Since the early days of humanity we have strived to obtain the goods and services we desire by trading our surpluses to fulfill our deficits. Throughout history a society that could produce an excess of sable furs (for example) would trade with neighbouring societies that were especially efficient at producing wagons. 

Early trade simply entailed an exchange of goods, known as the barter system. This method of trade is very cumbersome because it requires both participants have coincident needs, appropriate divisibility of tradable assets and agreed-upon measures of value. These three conditions often prove elusive leaving many potential barter trades incomplete and many others unfair. As an alternative to the barter system, universally-accepted measures of value developed in different cultures around the world in many different ways.

The first universally-accepted measures of value were items with widespread appeal, easy division and widely-accepted values. In many societies, commodities were often used as a medium of exchange because they tended to have widely-known and stable value for most people in society. In many societies, commodities were the first form of money and gold was often the commodity of choice. 

In Britain goldsmiths helped to develop the modern banknote. During the English Civil War of the 17th century, citizens deposited valuables (gold, jewellery) into the safes at various goldsmiths for safekeeping. In return, the citizen would get a receipt that provided proof of ownership when the person wished to later withdraw. 

Gold withdrawals were made to make a payment for goods and services. Some merchants, however, were willing to accept gold receipts as payment since they knew the receipts were ‘as good as gold’. Goods providers accepted gold receipts as payment since they knew the receipt could be converted into actual gold at any time. The exchange of gold receipts for goods eventually became common-place and, in effect, these receipts became early gold-backed currency.

Once they discovered gold was rarely withdrawn from their safes but gold receipts were being readily traded, some enterprising early goldsmith ‘bankers’ decided to start issuing and lending more receipts than the available gold to back up the receipts. They did this knowing that most customers never actually ever withdrew their gold, so the chance of having to back up all the receipts at the same time was miniscule. This was an early incarnation of fractional reserve banking with a portion of the monetary base tied to a physical commodity, such as gold.

The ability to convert to gold is the basis on which paper money was derived. Paper money wasn’t created out of thin air…it was a contractual ownership stake of a certain amount of gold that was held in a goldsmith’s safe. As long as the public was confident that an appropriate amount of gold was readily available for convertibility, they maintained confidence in the paper receipts that represented those claims.

Of course, some goldsmiths got greedy and lent out far too many receipts. These goldsmiths created the risk that gold would not be available if many receipt-holders redeemed at the same time. Some merchants would question the ability to easily convert the receipts into gold. If it appeared that not enough gold was kept at the goldsmith to back up the receipts, merchants would no-longer accept the receipts at face value. Instead, merchants demanded more receipts for the same amount of goods. In effect, the value of the receipts went down (therefore the prices of goods went up). This illustrates the basic monetary force that creates inflation.

Like the gold receipts of 17th century Britain, the US dollar was at times convertible into gold. The history of US dollar convertibility into gold is mixed – the US dollar has been taken on and off the gold standard a few times. The last time the US dollar (and most other world currencies) was tied to gold was after World War 2 under the Bretton Woods system. 

During World War 2, many central banks around the world shipped their gold to the United States for safe-keeping and payment for armaments. By the time the war ended, the US had by-far the largest gold reserves on the planet. In an effort to stabilize the global economy and create confidence in war-torn European economies as they rebuilt, the Bretton Woods exchange rate system was created. Essentially, the Bretton Woods system tied global currencies at a fixed rate to the US dollar. The US dollar, in turn, was tied to gold at a specified convertibility. Therefore, (whether or not they actually had gold in domestic vaults) all currencies were indirectly convertible into gold in US vaults.  

During the late 1960s/early 1970s, the US was running a fiscal deficit to pay for the Vietnam war, and for the first time in the 20th century was running a trade deficit with the rest of the world. Interest rates started to rise and it is widely believed that the US Federal Reserve began printing money to buy US Treasuries, thereby increasing money in circulation as a percent of available gold reserves. As the market grew more suspicious of the lack of gold reserves backing US dollars in circulation, confidence in the US dollar began to wane, and Germany and Switzerland left the Bretton Woods system in 1971. 

Foreign holders of US dollars started demanding gold in exchange for their US dollars. Growing conversions put pressure on gold reserves and, as the proportion of gold available for conversion declined, it was only a matter of time that all US gold was used up in the conversion process, leaving the remaining US dollars worthless. To prevent this, US President Richard Nixon abandoned convertibility in August 1971. 

The act of banning convertibility effectively freed US monetary supply from the anchor of the gold standard, allowing the US Federal Reserve to print money within less restrictive limits. Monetary policy’s only anchor became the ‘full faith and credit’ of the US Treasury and the US Federal Reserve. Of course, central bank and treasury credibility becomes far more subjective with the elimination of a gold standard. 

During the 1970s, growing money supply, combined with a decline in productivity, a slowdown in post-war disinflationary forces (due to the tightening of post-war economic capacity in Europe and Asia) and the oil supply shocks were the ingredients that led to high inflation and stagnant economic growth – stagflation.

After a decade of haphazard economic initiatives (e.g. price controls) and ambivalent US monetary policy, Paul Volker – who became chairman of the US Federal Reserve in 1979 – significantly raised short-term US interest rates, starting one of the greatest post-war recessions. It was this dramatic change in interest rates that crushed inflation helping the US Federal Reserve regain credibility. 

Why did the US Federal Reserve wait so long to combat inflation? With the memory of the Great Depression still fresh in the minds of many policy-makers, US economic policy was targeted at maximizing employment, and inflation was not seen as a primary economic threat. It was widely felt that aggressively combating inflation would tip a teetering US economy into another depression. Meanwhile, countries like Germany that were familiar with the pain of hyperinflation were quicker to combat inflationary pressures. (This highlights how the collective memories of a society shape political willpower and can lead governments to create erroneous economic policies.)

For the United States, combating inflation early in the 1970s by slowing economic activity would have been political suicide. It took a decade of inflationary pain before policy-makers and the public were willing to accept that inflation was as much a threat to the economy as deflation and unemployment.

The 2008 collapse of the global financial system has parallels to the inflationary experience of the 1970s. Throughout the late 1990s and early 2000s, many policy-makers were aware of the growing threat that concentrated financial intermediaries, leverage, derivatives exposure and skyrocketing real estate values posed to the financial system. It was no secret that these elements posed massive systemic risks. However, the political will-power did not exist to do anything. As these elements of the economy had yet to cause severe economic pain, it was very difficult to get politicians, businesses and consumers to accept the preventative measures that needed to take place. Preventative measures would have slowed economic growth and prosperity – all to safeguard the economy from threat that, at the time, was theoretical and intangible. 
Similar circumstances exist with homeland security, cancer prevention, driving behavior, etc. It is extremely difficult to mobilize a population to willingly experience current pain (financial, lifestyle, effort, etc.) in exchange for reducing a potentially larger theoretical future pain.

Today, the US dollar remains a free-floating currency not backed by gold or any other commodity. Instead of being backed by gold US banknotes are backed by the full faith and credit of the US government. Currency value is predicated on the faith that governments won’t print more than what is necessary to keep up with real economic growth. However, with the largest fiscal and monetary expansion in US history currently occurring, combined with the collective global memory of an extremely painful recession/depression, the risk of inflation over the medium/long-term is very high. 

Categories
Wealth

Shortages and Inflation

The Covid lockdowns shut down businesses as people remained quarantined at home. Consequently, businesses drew down inventories as they worried about a depression-like economic environment.

What few foresaw was that many consumers would exit this pandemic richer than when they entered it. Portfolios and home prices have performed very well, while savings rates have skyrocketed. There is a lot of pent-up demand, and as lockdowns across America subside sales comps at US retailers are rising.

Rising demand coupled with depleted inventories is causing a shock-like rush to restock. Amit Mehrotra, head transportation analyst at Deutsche Bank explains:

“We look at sell-through rates of major retailers and compare them to how inventory per store is tracking. If you look at Dollar Tree for the most recent quarter, same-store comp growth was 4.9% but inventory per store was down 5.1%. That’s a 1,000-basis-point spread between sales and inventory. The spread for Walmart was over 700. At Target, it was almost 400. At Tractor Supply, it was a whopping 2,000 basis points. These are big numbers. It’s a critical sign.”

He adds:

“Inventories are flying off the shelves faster than companies can replenish them. That is why the inventory restocking cycle is still in the early innings.”

This resurgence of inventory restocking costs money and is pushing up all kinds of prices involved with manufacturing and shipping goods.

Baltic Dry Index up 428% over 1 year:

Copper up over 90% during past year:

Lumber up over 350% during past year:

What do this restocking scramble mean for you? Higher prices.

Inflation expectations have risen significantly over the past year, as indicated by 5 year breakeven rate. (The breakeven inflation rate represents a measure of expected inflation derived from 5-Year Treasury Constant Maturity Securities and 5-Year Treasury Inflation-Indexed Constant Maturity Securities. The latest value implies what market participants expect inflation to be in the next 5 years, on average.)

OK but what does this really mean for you? By some estimates the cost to build a house has risen by over $30,000. This increase is reflected in both new builds and resales. Expect to see price increases in day-to-day goods too. Proctor & Gamble has stated they will raise prices in September to fight higher commodity costs. Kimberly-Clark and Coca-Cola have also recently announced price increases. This is just the tip of the iceberg.

Categories
Wealth

8 Financial Mistakes Made by 20-Somethings

1 Holding too much cash and not investing for years. Time is on your side and the earlier you start compounding returns the less you have to save over the long run.

2 Spending too much of your money to prop up someone else’s education or lifestyle. Friendships and relationships don’t last. Especially ones formed in your twenties. I’ve seen friendships dismantled over a couple hundred dollar loan. It’s good to be generous, but you need to be investing in yourself at this stage of your life.

3 Buying daily takeout food and drinks (yes, including coffee). Waste of money. Plain and simple. A little extra meal planning and you won’t notice the difference…that is except for the extra money in your pocket.

4 Working your ass off for your employer expecting something (other than your paycheque) in return. If you get a promotion and decent pay raise, then great. But many make the mistake of overcommitting to their early employers thinking management will make them whole.

5 Paying thousands of dollars for school, before actually knowing if you’re actually interested in the subject matter and that the education leads to a desired outcome. (Education for education’s sake is for the wealthy, and much of what can be learned in a liberal arts degree can be picked up by reading a few books.)

6 Marrying too early, for the wrong reasons or to the wrong person. Being married to the wrong person is hell. Getting divorced is even worse, and it’s financially devastating.

7 Waiting too long to get married. If you think you will someday want to get married, your 20s is prime time to find a high quality, compatible mate. Added bonus: dual incomes and shared expenses (e.g. housing) makes life more affordable. Of course, divorce is super-expensive so ensure you marry the right person (stable, financially compatible, trustworthy, etc.).

8 Forgetting that you’re in your twenties. This is the decade where you have the freedom and time to do whatever you want. See the world, meet people, invest in your mind and body in multiple ways.

Categories
Life Work

UBI: A Modern Day Utopia?

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Wealth

Scott Galloway: The Algebra of Wealth

I highly recommend watching this video in which Scott Galloway breaks down the basics for building wealth. I couldn’t have said it better myself. So I won’t even try.

According to Galloway, there are four factors to the algebra of wealth: focus, stoicism, time, and diversification.