Oops, I did it again: An investment experiment

For those of you who don’t know, I want to start by describing my first ever “investment experience”: around 6 years ago, right after I started working at a small company in the Netherlands, I felt the need to think about my financial future. As part of that process I looked into options for how to invest the small amount of savings I had at the time, as well as the part of my salary I could afford to put out the side. But I also felt much less qualified about economic decision making back then. So I ended up going to my regular bank and bought into a fund product that closely tracked with the popular German stock market index, DAX. After an initial period of a few months, where I would check the fund value relatively often, I just assumed I had made a good decision needing little further thought.

In early 2008 I moved to New York, but kept my fund account in Germany–I yet needed to figure out: would I want to stay in the U.S. for longer, maybe forever? But 2008 turned out to be the year of the financial crisis. Already in 2007 the markets seemed to have hit an invisible ceiling, but that was nothing compared to the market shock of 2008. At the beginning of that year the DAX had already fallen from about 8,000 to under 7,000 points and, with great volatility, remained at that level for a while. What made me “get out” of the market then? Maybe the fact that my “capital” was so far away and I could only watch it decline slowly but steadily from across the Atlantic… Or maybe some “sense” told me that my savings might well be in danger. Anyway, around mid-August of 2008, at a time where the DAX had already lost around 20 per cent of its 2007 peak value, I asked my bank to sell my fund shares for good. One of my best financial decisions ever!

Only a few short months later, after the Lehman Brothers bankruptcy had happened, the DAX crashed and with it the value of the fund I had kept buying over the 2-year period from mid-2006 through mid-2008. In the end I got an averaged annual return of about 1.2 per cent out of that investment, but only because the lump sum had been put into the fund account at the very beginning. Had I sold at the peak period I would have made a nice cut, but had I remained in the market until 2009, I might as well have lost half of my savings! In short, I had been extremely lucky and kind of promised myself never to “play” with financial investments again.

To this day, government officials both in the U.S. and Europe but also the people responsible for our currency at the Federal Reserve as well as the European Central Bank seem to believe that a problem caused, in my opinion, by too much liquidity in the financial sector can be solved by increasing liquidity even further. For instance, if you look at the 10-, 20-, and 30-year gold price chart, you can see that 2001 was a year of “change”. Ever since 2001 the price for an ounce of gold has climbed from around $280, the average price in the years 1999, 2000, and 2001, to an astonishing $1,770 by the end of last week. At the time right before the financial crisis the price was already at $900, three times as much as only 7 years earlier! And after an initial dip down to $700, all that the financial crisis since then has added to the chart is extreme volatility.

Whenever representatives of the government or the Fed talk about the fact that we do not have higher-than-usual inflation rates, yet, the only relevant quantity they refer to is inflation as measured by the consumer price index, short CPI, which indeed has not yet climbed above what people might think of as an acceptable rate. But at the same time, in the years since the Lehman Brothers collapse at least, commodities have increased a little less than 100 per cent–here’s an explanation for a commodity price index. And I think that even people who never look into stock or commodities price charts are beginning to wonder whether and how much more “liquidity”, now again provided with the Fed’s QE3 program, is supposed to help the (job) market.

I’m not trying to paint a picture of either “our financial system is about to crash” or “our currency will fail soon”. What I want to say is that there is some inflation in our currency, but that this inflation has not yet occurred on the consumer price side. So far, the additional liquidity has found its way mostly into financial products, such as derivatives, but to some extent also wandered into the commodity markets. This means that those markets–including the price for gold and silver, for sure–are subject to a “bubble”. The price level seems unrealistically high. But I think it is at least fair to say that the additional money did not go into increased production and hiring of workers…

And now, finally, after this very long preamble, I can come to the experiment I am doing: since I do not trust the stock market any longer–the price of most traded stock seems to be based more on the fantasy of the shareholders and potential buyers than some “real value”–I decided to put a small fraction of my savings, about $6,000, into precious metals, mainly silver. From my own research over the past few days, it seems that most “experts” recommend that 10 to 15 per cent of savings are put into precious metals.

Not that I’m saying that I necessarily trust these expert opinions… Instead I will try to give a few reasons why, for me, owning just a little bit of silver might not be the worst of things. To be clear, I am not expecting any particular outcome of the economic and global financial situation. If anything, I am trying to be ready for all possibilities. What could happen? Well, first of all, nothing could happen, nothing at all. Maybe the banks and governments are right, and after another period of slow growth and getting the more practical problems straightened out the global economy will be “back on track”. Then again, there is also the possibility that, with all this additional liquidity having been created, governments and banks have very few popular options to “take it back”, to effectively remove money from the system again. Still, any bubbles that exist in some of the markets must, eventually, burst or spill over into the real economy: people will want to spend their “capital gains”, consumer prices might finally show substantial inflation. This increase in spending could be triggered by several factors, one of them being a loss in faith in the stability of the currency. I don’t want to guess, but even with an inflation rate of between 5 and 20 per cent per year, prices for food and other items of daily value could easily double in like 10 years, but also in as little as 4 years, a final-term presidency for sure…

The solution I personally prefer for handling this surplus liquidity would be to truly remove the money–and debt, given that our money is nothing but debt, one way or another–from the system. But that would, of course, require that some people, particularly the better-off, those who profited most from the policies of the past 10 years, must be willing to give up a significant part of their wealth, finally re-distributing from rich to poor. And that isn’t something that, in my mind, could currently be “sold” to the American or European public. So, I do not see anything like that coming. As I said above, yes, the prices of gold and silver are, in all likelihood, already above their “true value”, at least when compared to what a dollar can still buy “on the street”, but…

The current estimates of silver mining, reserve availability, and industrial use, such as data presented as part of the U.S. Geological Survey–and for those of you who know German, here’s a table that contains industrial usage data–say for instance that if “things were to stay the same” as today, we might run out of silver being minable at known locations with currently available technology in about 25 years. Naturally, a lot of previously mined silver is still readily accessible, such as in actual silverware or coins. And when the price for silver were to grow due to shortage in production, I am sure that people would start, in masses, to scourge through their possessions, hoping to find a silver fork or spoon which could then, literally, feed them for a day, at least once it’s sold or bartered. And or course new silver reserve deposits might be found or better techniques developed.

Yet another important datapoint is that, even with already inflated prices of about US$35 per troy ounce today, the silver production of one whole year would cost only a little shy of $27 billion dollars. In other words, the amount of money the Fed is prepared to pump into the market on a monthly basis would already suffice to buy the entire silver production of a entire year. Put differently, the worldwide production of a year is just enough so that each and every American could roughly buy two or three one-ounce silver coins, like the American Eagle–luckily not that many coins are minted! Otherwise, the perfect recipe for a perfect bubble…

Finally, silver has become an essential component in many industrial products. Being the metal with the best electrical conductivity properties at room temperature and little corrosion, it is kind of irreplaceable in quite a few contexts. While exact numbers seem hard to come by, the fact that there are many applications and around 38 per cent of the annual production already is put to industrial use, it is safe to say that silver will always find a buyer. So, despite any possibly existing bubbles in the market, the price will never go down to $0.

And while gold seems much more appropriate with a currency crisis in mind, it is unfortunately far less easy to barter with. Even a relatively small gold coin weighing 1/20 ounce costs already around $100 in today’s market. And gold also has a bad reputation for having seen either official or informal prohibitions, up to confiscations, in the past. Silver on the other hand can be traded or bartered in relatively small units. In times of a possible crisis, which would most likely be very temporary in nature, owning a little bit of silver might come in handy if, for instance, I would want to “pay” for some urgently needed good or service, such as some pain killers from a stranger.

Now, do I actually believe the currency will crash? Not anytime soon, no. But it will need serious effort and, possibly, reform to regain the trust and faith of people before we can come back to a fully functioning economy. Unfortunately, current policies are still rooted in the neoclassical and neoliberal theories of monetary markets. The idea that the job market can be “eased” by flooding the economy with money will hopefully die soon, maybe after the next failed experiment or two. But I want to be prepared for each of the following three situations:

First, nothing could happen. In that case, my investment experiment in buying some silver means neither loss nor gain. Second, the currency/financial markets calm down and the silver bubble bursts. My own estimate for a then realistic silver price would be somewhere around $15 per ounce. I would then have lost around 5 per cent of my savings–although, in the future, these coins might very well still become an investment, I just have to hold on! Third, however, the currency might crash for good. In that case, I will have a small amount of “wealth” (i.e. real value!) in form of silver coins, which I can then barter with until a new currency has been established.

And when it comes to a “new currency”… As a thought for another, future blog post maybe: I still think the best way to organize the “creation of money” would be by simply accepting the notion that money is nothing but our way of doing “double book keeping” with each other. In that case, whenever some actual wealth (i.e. value) is produced or a service is rendered, the person generating the value should simply “create” the money for that value with it. That would give the money creation privilege into the hands of those who also create the value: the people! It’s a little bit like time sharing.

Naturally, people would have to trust one another and, for many tasks, some kind of rule-of-thumb would have to be found as to how the “valuation” of doing that task can be done. At the very least, we would unlikely get back to the current system where people earn so disproportionately based on their jobs. Oh, and making money out of money would of course not work. That would be like making money out of thin air–exactly what banks are doing everyday right now! 😉

Change? Yes, we can!

Over the past week, I’ve spent a considerable amount of time “brooding” over the amount of debt the American people have accrued, both the nationally but also the privately held debt. It is almost as if I can literally feel that debt weighing down on me as well as on many other people. I even began by writing this very blog entry dedicated to putting together a lot of exact numbers–back in high school I was fairly good at math, maybe that’s why I liked the idea–but then I realized: it is actually relatively unimportant how large the debt exactly is. What matters is the effect that “being so deeply in debt” has on people. For the most part, I would say that being in debt comes with a feeling of “not being able to afford something I usually would want to get and could pay for”. And sometimes the things people cannot afford to buy can be very important things… But being as deep in debt as we are at the moment probably comes more with the feeling of being “owned” by whoever I am indebted to.

Naturally, there are still quite a few Americans who do not yet personally suffer from the effects of either the national debt or their personal debt, should they have some. At least the way in which they suffer is probably very subtle, almost invisible even, and has not yet reached levels that affect their day-to-day activities let alone their ability to buy enough food to live off. But there are yet ways in which this kind of indebtedness affects everybody: by reducing our freedom in a considerable way, slowly eroding it. My assumption is that, if the amount of debt keeps increasing, the American People will, in the end, be “enslaved” by policy decisions made solely based on fiscal arguments. Even in the current presidential race, few people seem to ask the question whether or not any of the budget items for which candidates suggest cuts are useful or essential. The fact that “we need to save money” seems like all that matters. And another aspect is that not only those people with little money and potentially monetary debt will be enslaved, but also those with considerable wealth will be enslaved to follow “the rules” the financial markets dictate.

I’m now trying to step back from any concrete problems and instead attempt to describe the intersection of the society and economy I live in as I see it… It seems a fair assessment that, based on the division of labor and the highly specialized processes required to produce many if not most of the goods we have grown used to, we simply need a way of ensuring that the wealth that is being produced by the people through some form of work is, somehow, distributed. And I want to make it clear that I do not refer to wealth only as physically graspable goods, such as food, clothing, or cars, but also other accomplishments that increase our general quality of life and welfare, like education, public safety, and the rule of law! On the other hand, I sometimes have very strong doubts that some of the services provided by parts of the financial industry can ever be described as “generating wealth” of any kind, at least not when it comes to “commonwealth”, which is just a translation of the word republic!

Over time, the pre-dominant way that developed to determine the distribution of goods and services, in general, is based on a token-based, free-market economy. In such an economy, goods and services are “swapped” for currency based on a price that is, at least in theory, determined by supply and demand, which then automatically provides each individual participant of the economy with the greatest value, hence maximizing the overall wealth. For one, it ensures that goods of “lesser value” with the same requirements for resource use are, over time, removed from the market place. Importantly, the reason this system is chosen by the government, the democratically elected representatives of a republic, is not to benefit the few and allow individuals to get rich, but rather so as to generate the greatest benefit for society as a whole! It is also important to take into account that if the profit margin of anyone providing services, such as in case of education, or producing goods, such as in assembling cars, becomes too great, the price should be considered too high, such that the general population certainly does not get the “greatest value” in return…

As far as I can see, this description does not contain any information on how the required currency is provided, nor does it give any detailed rules as to how some of the less individual but rather society-based desires can be satisfied. And at this point I would like to describe my most recent thoughts based on a few observations:

In almost all market-based economies, the idea of having a central bank, which is as far as possible from government influence, that provides the currency seems being considered as without alternative. To the extent to which I understand economics, this is however by far not a proven fact, but rather it is the currently favored, and thus accepted, hypothesis or model. While some past occurrences have indeed shown that by simply giving the right to create money to the executive branch of government can lead to disaster, I don’t think that any proof has been presented that would allow to draw the conclusion of the opposite, namely that putting money creation into the hands of privately run banks is necessarily “in the interest of the people or society”. And given that this privilege of creating money seems to come with at least “some power”, I must admit I am quite surprised that the Supreme Court of the United States hasn’t yet found that allowing private banks to “create money” is unconstitutional.

In addition to the idea that a central bank is organizing the monetary supply, the idea that interest has to be paid for a loan seems equally without alternative. And what’s more, in the current flavor of monetary lending practices, the interest is not only paid on the original loan, the principal, but on all subsequently accrued interest-based debt, that is to say compound interest, in other words a possibly exponential growth of debt. Funny enough, I would at least see several ways in which the currently existing system could be “extended”. I’m not necessarily saying that each of my thoughts would be an improvement, but to say that “things have to be the way they are” simply seems to easy. For one, Congress could set rules prohibiting extremely high interest rates beyond, say, 10 per cent. And in cases were such interest rates yet seem reasonable, such as where the risk for the borrower is indeed very great, legal provisions could enforce that interest rates have to decline over time automatically and that compound interest is only legal for very low interest rates. In other words: if my history demonstrates a high risk of me being a potentially defaulting loan recipient, I might initially have to pay a high interest rate, say 25%, but once I have made regular interest payments over a certain period of time, the interest rate either would have to be lowered substantially or, alternatively, any interest that was not paid will not be added to the amount on which I have to pay that interest rate, as this amount was not part of the initial risk of the borrower anyway. And finally, if someone giving out a loan makes some profit with receiving interest, I find it not only fair but essential that this person than also truly carries the risk in the case of a default on the loan.

Why do I see those issues as problematic to begin with? Well, starting with the second area that is not covered by the description of a free-market society, I would argue that there are many desires which a society might express as a whole rather than individually. For instance, in the United States some of these desires are put expressly into the Declaration of Independence:

“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.–That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, –That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.”

I would argue that, naturally, the pursuit of happiness is certainly something every individual has, but on the other hand it might not be necessarily true that each individual wants to guarantee this for every other individual equally, which is why it was made something government shall try to achieve. In a way, this principle is somewhat contrary to the idea of some of the elements in our very economy insofar as competition, in the sense in which it is used in sports like the Olympics, requires equal chances and footing. Obviously if someone owns a lot of capital, mostly in form of currency liquidity, that person does not have to “struggle” as hard as someone else if they wish to pursue their happiness–or pursue anything else for that matter, so how can that be considered fair competition. Furthermore, it seems to me that while none of the people heading the “too big to fail banks” has been elected by “The People”, banks and other financial firms are beginning to exercise a great amount of influence over political decisions, to the point where I would question to what extent the actual government is still “in power”–and if that were not the case it would almost seem like a constitutional duty to attempt to abolish any form of government that has not been given the consent of the governed.

Now, please, don’t get me wrong. I’m not a fan of socialism or another kind of systems that wishes to simply “equalize” monetary means among participants of a given economy. But the idea that some participants of our economic system can consume goods and services in pursuit of their happiness simply by owning “excess capital” and living off interest payments made by others who require some of this excess capital to be able to participate in the economy at all seems not only strange but outright dangerously close to violating some of the principles the Founding Fathers wanted to see granted for every person living in the United States. The King of England was considered overbearing at the time, and in my mind at least the financial industry is playing an every more important role in how our daily lives are shaped.

As part of living in a society that, I would hope, is a civil society with a basis in the ideas of some of the greatest philosophers, my vision is that each and every member of society should participate on both sides: giving and taking. And the giving should not be limited to having one’s money “do the work”–which is a true misnomer in my opinion: money cannot work, it can simply be used to suck up someone else’s contribution to society in form of interest payments…

Do I see any hope? Well, yes, of course! But the vision I have would require people to give up quite a bit on the idea of “owning” an entitlement that is counted in forms of a dollar amount, at least when it comes to amounts that, by far, exceed what they could ever spend on regular consumption goods in the foreseeable future. So long as someone has the ability to “conserve” effort that was put into the economic system for very long periods, and pile up this conserved effort to ever higher mountains, the system will always carry an incalculable risk of failure. In that sense, I actually believe that re-designing some of the government-run programs, like Medicaid and Medicare, into a system that, within reasonable contraints, promises to pay for people’s basic needs and medical expenses when their insurance doesn’t cover for it or they simply don’t have an insurance, but that doesn’t do so in form of expressly stating dollar amounts is a necessary step to fix things. More generally, holders of U.S. Treasury Bonds would have to give up at least part of their entitlement, which next to Medicare and Medicaid also includes debt held by retirement funds, private investors, and investment firms.

But another big contribution that has to be made is that banks need to return to an actually useful business model: that of providing required services to society, not a way of providing the people working at banks with the means to get rich for their own sake, which then is rather a disservice to society. Financial capital is meant to serve the people, not the other way around…

Do I blame anyone involved? Not at all. If anything, I would say that the mantra of “if I just had a little more money, I’d be so much happier” works a bit like a virus. Once it infects our minds it almost is like taking over control of our lives. Involuntarily I am reminded of a movie from the 80s: They Live. A zombie-like world where many people have been brain-washed and are no longer seeking true happiness in their lives. And just as in the movie, at the very end, no-one in our society, not even someone who seemingly benefits from this way of organizing our economy, truly wins. Maybe we should step back a little from the numbers and think about what we, as a society, want our lives to look like, and what our government’s functions are supposed to be and then find ways for us to strive towards that goal and our government to fulfill those functions.