2011 Q3
The Money Planner – Q3 2011
Greetings Clients and Friends!
I hope this finds you well! As Always, the Money Planner's goal is to provide items of use and interest as you plan your financial future. Please share with your friends and colleagues as you feel appropriate.
With market volatility comes opportunity!
Portfolio protection. There are a number of short ETF's that can be purchased that will rise as the market falls. Used properly these can act as insurance to prevent your portfolio from declining as much as the market. Then investors will have plenty of resources to buy into the recovery.
The US Government Can Affect The Economy and Our Portfolios
This issue of Money Planner will focus on national debt and the money supply. In summary:
Over the last decade the government has spent much more than it takes in in tax revenue.
It has made up for this by borrowing (issuing treasury bonds).
There have not been enough citizens or foreign countries to buy the bonds.
The Federal Reserve has bought the excess bonds. The Fed can create as much money as it wishes to buy bonds.
The national money supply has increased as a result (inflationary).
Banks are not loaning money, greatly lowering the velocity of money. (deflationary)
The above two effects are battling each other with inflation winning by a little.
Why is this important to your portfolio? It can cause some assets to thrive and others to tank. Inflation will cause commodity and energy stocks to soar. Bonds will lose value. Deflation will favor cash or bonds.
Now for the details:
Over the last decade the government has spent much more than it has taken in. See Chart 1: US Government Budget. To put this in perspective, assume the government is an upper-middle class family: The family makes $216,000, but it is spending $359,000. By 2010 the family had a total accumulated debt of $1,415,000.
The spending has caused the government to greatly increased the national debt. Now at over $14 Trillion dollars. The pie chart below shows who holds this debt. About ¼ is held by the Federal Reserve, which means it created dollars to buy the bonds.
This in turn has lead to a dramatic increase in the money supply (see Chart 3: Monetary Base). A $1600 billion increase in money supply - roughly tripling it. This increase is highly inflationary, and has shown up with higher gold prices and gas prices.
There is an opposing effect though. Chart 4 shows the large amount of Excess Reserves held by banks at the Fed. Banks normally lend out most of their money only holding a small fraction of their reserves at the Fed. They now hold $1200 billion in reserves. This lack of lending has kept inflation somewhat in check.
There is a relationship: Congress spends more than it takes in → The Treasury must sell bonds to cover the difference → At the current relatively low interest rates, there are not enough buyers → The Fed creates money to buy bonds.
The Fed has a no-win choice: Greatly increase the money supply, or let 30-year treasury rates increase till there are sufficient buyers. High rates hurt the economy – especially housing which is dependent on mortgages.
Wise investors will prepare their portfolios or talk to their financial planner or advisor. In general, I recommend clients lighten up on CD's and especially avoid long-term bonds. Check your retirement accounts: Target year plans tend to load up on bonds as you near retirement. It may be a good time to refinance to a 30-year mortgage while rates are low. There are many other investments that pay a good income, that also may increase in value if inflation does occur.
If you would like personalized advice, please feel free to contact me. You may also email me to receive my free MoneyPlanner quarterly newsletter: Scot@scotwolfplanner.com. My specialty is creating a portfolio of securities that deliver above average income, while preserving and growing the portfolio value.
Scot Wolf
Financial Independence Planner
952-888-4991