Economic Statistics and Investing 101

Well we are approaching the final trading days for 2010 on Wall Street.  As this year comes to an end I wanted to go over the move we have seen in commodity prices since last July:

Sugar +106%
Cotton +75%
Corn  +72%
Silver  +67%
Wheat  +65%
Coffee  +49%
Copper  +48%
Rice  +45%
Soybeans  +43%
Oil  +33%
Gasoline  +20%
Gold  +18%

These price increases have taken place in the last 6 months.  Now the pundits on CNBC and other financial publications claim that these rising prices prove the economy is in the begining stages of an incredible rebound.  I hate to be johnny rain cloud here but the economy isn't going anywhere.  Lets take a look at some statistics on how the economy is doing.

Since December of 2009 we have added on average 79,000 jobs per month.  The population growth in the United States on average is 175,000 per month.  We are not even creating enough jobs for people entering into the work force.  Baby boomers who were planning on retiring have now come to the conclusion that they are going to need to continue working since their 401k's have taken large hits and their homes they were planning on selling have decreased 20-50% depending on the location.  This means younger adults entering the workforce will not be able to slide into jobs that are being vacated by recent retiree's.

Unemployment is still near 10% using government statistics, but probably closer to 20% if you take the underemployed and discouraged workers into account.

While it is true that companies are reaping big profits, these profits are mostly coming from the growth of emerging markets in Asia.  Many U.S. companies are hiring, but the jobs are being created over-seas where there is less regulation, less unionization, less taxes, and more growth.  This is one of the reasons the stock market continues to do well despite a struggling U.S. economy.

Consumer spending is up here in the United States, but most of this spending is from wealthy Americans who have invested in the financial markets.  They have made big returns this year, especially if they have been using leverage which can maximize your return by a couple hundred percent.  The Federal Reserve's policy of Quantitative Easing has made it pretty much a sure thing to make money in the stock market.  The wealthy are the people who benefit most from this since they have the capital to be able to invest in companies and commodities that will benefit most from stimulative monetary policy.  I can personally attest to this, using leverage in the futures market I was able to produce a 150% return this year.  The problem is most people aren't educated in the field of finance in order to take advantage of monetary policy coming out of the Federal Reserve.  The top 10% wealthiest Americans own 98.5% of all stock in the country.  The other 90% have stagnant or non-existent wages, rising costs for fuel and food, continued falling home prices, and rising debt levels.

In 1970, jobs in the goods producing sector accounted for 31% of all jobs, today they account for only 13.8% of all jobs.  In 1970 we were also a net exporter (we shipped more goods to other countries than we brought in), now our economy is a consumption based, debt fueled economy.  This is a classic late stage trait of declining empires. 

Using Federal Reserve monetary policy, the wealthy continue to position themselves to do well in the financial markets even if the U.S. economy is struggling.  Many people, especially on the left believe that rich people are to blame and should pay a higher percent in taxes.  I don't blame the rich at all for taking advantage of monetary policy and increasing their net worth using the financial markets.  I did the same thing.  The blame should not be on the rich, it should be on government using manipulative policies causing prices of assets to rise only because of an increase in the money supply.  The only thing higher taxes will do is push more jobs overseas and increase the demand for CPA's to help more people find ways to shelter their incomes from taxes. 

In my opinion, the increase in the prices of the commodities I mentioned above are not because the economy is now firing on all cylinders, it is because of the printing of money by the Federal Reserve.  The last time the Federal Reserve had a stimulative monetary policy was in 2001, most of the printed money went into the housing market.  Today, the Federal Reserve has an even more stimulative policy.  But this time, I see the money flowing into the commodities market instead of the housing market.  Once bubbles burst (such as the housing market), they take a long time to come back.  The tech bubble of 2000 as measured by the NASDAQ, still isn't anywhere near the level it was when it burst.  So in my opinion, investors are not going to speculate in the real estate market for at least the next decade.  As evidenced by the last 6 months, commodities look like the place to invest.

You don't have to be a rich person in order to participate in the upside in commodities.  You can open up an individual brokerage account at a discount broker like Scottrade, Schwab, etrade, or Ameritrade.  The cost to buy any amount of shares of either a stock or Exchange Traded Fund is under $10.  It literally doesn't cost anything to invest, it only costs you a considerable amount of money if you need advice.  Their advice typically also has a lot of conflicts of interest.  Being a stock broker, I can attest that brokers will try and steer you into funds that make them the most commission.  Here are a few examples of some picks I like that will give you exposure to commodities, but before buying these you should consult your financial advisor to see if you have the risk tolerance and time horizon to ride out the volatility.

For exposure to the agriculture sector which I believe will do well with continued inflation and stimulative monetary policy:  MOO  (this is the ticker symbol, go to finance.yahoo.com and type this symbol in to see a quote.

For exposure to Gold you can use the ticker symbol GLD.  This fund holds physical gold and tracks the price of gold.  If you want to take additional risk then you could use UGL.  This is the double long gold fund.  So if gold goes up 1% you will make 2%.  This fund uses leverage (borrowed money to increase returns), so make sure you understand the risk before investing in UGL.

For exposure to Silver you can use the ticker symbol SLV.  This fund also holds physical silver and trades like a stock.  If you want to take more risk you can use the symbol AGQ.  This is the double long silver fund, which means you will double the percentage gain silver makes, but also double your loss.  So again, make sure you understand the risks before investing in AGQ.

For exposure to oil I like the Canadian Energy trusts.  Their are a few that trade here in the U.S.  I like these over U.S. oil companies since I believe that energy companies here in the U.S. will most likely have excess profit taxes placed on them once gasoline passes $4.00 / gallon which I believe will happen by summer of next year.  These Canadian energy trusts will be converting to corporations in Jan 2011, but I still believe they will continue to do well with where oil prices are at.

Those are just a few ideas that I think are good plays for the next 5 years.  You can buy all of these funds by opening up a brokerage account at any of the brokerage houses I mentioned above.  Most of them you can open an account with as little as $500.  Its time for the rich to  not be the only ones who benefit from the financial markets being manipulated higher.  Take the information I have given you here as a starting point for additional research.  A few books I would recommend to get you started are Peter Schiff's, "Crash Proof 2.0", Jim Cramer's, "Real Money, Sane Investing in an Insane World."  After reading these books I am confident you will understand the financial markets and the economy enough to get started.

Since I am a licensed securities representative it is important you read the disclosure below:
Strategies or investments discussed may fluctuate in price or value. Investors may get back less than invested. Investments or strategies mentioned on this website may not be suitable for you. This material does not take into account your particular investment objectives, financial situation or needs and is not intended as recommendations appropriate for you. You must make an independent decision regarding investments or strategies mentioned on this website. Before acting on information on this website, you should consider whether it is suitable for your particular circumstances and strongly consider seeking advice from your own financial or investment adviser.

Legalizing Marijuana

One major difference between Libertarians and Republicans is the difference in opinion on whether or not to legalize marijuana.  Let me first start out by saying that I have never tried marijuana, nor any other illegal drug.  My mom worked for a hospital in the chemical dependency department so I knew I had no chance of getting away with it.  But I knew many people that habitually smoked marijuana in high school and college. 

The media has done a great job of confusing us on what we should be focusing on.  I don’t think the question is whether or not we should legalize marijuana; the question we should be focusing on is whether or not it is the government’s role to tell me what I can put into my own body.  Our founding fathers believed the government should be as small as possible, believing in personal responsibility.  The founders didn’t write the constitution with the intent of having the government taking on the role of parenting.

In my opinion the founders wrote the constitution with one specific goal, that the federal government exists to protect the rights and freedoms of the American people…period.  So when the legislature writes laws, we need to start asking ourselves if the specific law being created is designed to protect our liberties.  It seems to be a pretty tough case to make that banning the use of marijuana is needed to protect freedom.  You’re probably thinking, “if laws should only be created to protect the individual rights and freedoms of the American people, then most of the federal laws written shouldn’t even exist.”  I would say you are right.  A common argument people make is that traffic laws wouldn’t exist if we were to take this approach.  Here is where I disagree.  Traffic laws are state laws, which mean the people of that state have a say in how the traffic laws are enforced.  So if you don’t like the 65 mile an hour speed limit in CA, you can vote with your feet and move to Texas where on the open roads the speed limit is 80 mph.  The state that has more stringent laws will lose more and more people to other states; this in turn would cause CA to reconsider how strict their laws are.  But if you have the federal government creating laws, there is no way to move to another place to get around it, unless you have dual citizenship. 

Prop 19 was recently voted down in the state of CA.  This would have legalized marijuana for recreational use.  While I disagree with the outcome, I do like the fact that the people got to vote on it.  What I don’t like is the federal government already has passed a law that makes it illegal to use marijuana.  So even if Prop 19 passed, it still would be against federal law to smoke marijuana in CA.  If you understand the 10^th amendment it is clear that the federal government has no constitutional right to tell CA they can’t legalize marijuana.  The constitution was shredded a long time ago in D.C.  But what bothers me is that if we think the constitution is outdated and we should no longer be bound by it (which I disagree with that), then let’s have that argument.  Let’s not pretend we are upholding the constitution, when every politician knows they don’t even take a second look at it after swearing before taking office to uphold it.

I know a lot of people disagree with my stance on legalizing marijuana.  And you know what, 2 years ago I would have thought there is no way I could ever support legalizing it.  But in my last few years of studying history and politics, I have realized how corrupt, self centered, arrogant, and manipulative politicians can be.  I have come to realize we must keep government as small as possible to minimize the effects these corrupt people have on the United States.  They will literally sell their soul to make sure they pay back those who donated to their campaigns in order to get even more donations for their next campaign. 

I know there is a possibility that there could be some deaths related to people who were under the influence of marijuana and killed someone in a car crash.  But freedom isn’t free.  Benjamin Franklin was quoted as saying, “those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety.”  The TSA doing unreasonable searches on innocent people looking to board an airplane start to come to mind also when thinking about this quote. 

Let’s look at some of the benefits of legalizing marijuana.  For one, drug cartels get an incredible amount of cash flow growing and distributing marijuana in the black market.  If we legalize marijuana, it would be equivalent to repealing prohibition which is widely believed to be the reason organized crime no longer exists.  You could no longer purchase marijuana from your buddy down the street who got it from the local drug dealer; it would force everyone to buy it out in the open.  You would have to show your ID to prove you are over 18 or 21 (depending on state law) in order to purchase it.  The price for marijuana would come down dramatically. 

States would also benefit because there would be an incredible amount of tax revenue from the regulation of marijuana.  CA especially could use the additional tax revenue to help fund Sea Otter research and all the other bogus programs we like to fund in this ridiculous state. 

I know people consider marijuana to be a gateway drug, and they are probably right.  But if we give the government the power to control what we can put in our bodies, we open up the door for them to make it illegal to put other substances in our body.  We all know that there is no way we have enough money to fund government controlled healthcare.  Some sort of rationing is going to have to take place; there just isn’t enough money to go around.  Mark my words, government is going to make it either a crime, or create a large tax on sugar to try and raise the money to fund healthcare.  We can’t allow government to continue to make additional power grabs to take more control over our lives.  It must stop now.  We must reverse these ridiculous laws that might save a few lives, but sacrifice the principles that we were founded on.  When it comes to erring, we must error on the side of freedom.   

The new FDA Bill

They’re at it again.  The Senate passed the Food Safety Modernization Act (S.510).  It is heading over to Obama’s desk for his signature to become law.  You can all now rest assured that Food Safety is now more “Modern.”  What a joke.

I read about 100 pages of this bill (http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:s510es.txt.pdf).  In my opinion this bill is another major power grab by the federal government.  It gives the FDA total control of our food supply.  Probably the most scary part of this bill is allowing the FDA to force companies to recall their product if the Secretary has deemed there is a “reasonable probability” that the product could potentially cause death to animals or humans.  This bill also is going to cost farmers a lot of money due to the extra cost of having to fill out additional paperwork. 

I have seen rumors floating around the internet saying that this bill makes it illegal to grow, sell, or trade your homegrown food.  I went searching through this bill to see if I could prove that.  There are no specific comments about growing your own food that I could find.  But that doesn’t mean it’s not possible for this to happen.  Numerous times this bill mentions that the Secretary can create rules as he goes in order to carry out the purpose of the bill.  So basically a single person has the power to create rules that the rest of us have to follow.  This completely goes around Congress.  Land of the free…what a joke.   This bill also names the Department of Homeland Security to work side by side with the FDA to enforce this bill.  That should raise a few concerns.

This bill benefits the larger food companies.  It’s no surprise that Monsanto, Kraft, and Nestle all supported this bill and gave large campaign contributions to its sponsors.  The larger companies have the capital to cope with the additional paperwork and any adjustments needed to be made to their factories.  This again puts smaller companies at a disadvantage, and in fact, will probably force some smaller companies that were already struggling to close their doors.

It is laughable that people are blaming Capitalism for the cause of small businesses being shut down.  WAKE UP PEOPLE!  Capitalism hasn’t gotten a fair shot in over 100 years in the United States.  Large companies are buying off politicians to make sure they continue to have a competitive advantage over small business.  We are too busy watching Jersey Shore, trampling people on Black Friday to buy a T.V., going to clubs, going to sporting events, ect.  I can’t understand why so many people continue to bury their head in the sand.  This country reminds me of a bunch of people dancing on the deck of the Titanic as it’s broken in half about to go to the bottom of the ocean. 

This country was set up by the founders with most of the power being in the state governments, with a lot of power also given to local governments.  This was their way of making sure that the people were the ones in control of their government.  Can we honestly say today that the power still resides with the state and the people?  Or has the federal government become the supreme ruler of the nation?  We must spread the word of what is happening to our nation.  We are already going to experience a lot of pain in the next few years, but let’s come out on the other side proud of what we accomplished in the face of disaster.  Make sure you’re not one of the people begging the government to help you once things get bad.  I can guarantee that the next set of bills to take away what’s left of our Liberty are already written, they are just waiting for the next emergency to be put to a vote.  If we’re prepared, then we can think rationally and stand up to these bills.  I guess Benjamin Franklin summed it up best, “Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety.” 

Why Politicians Love Inflation

Within the business world there is lots of talk about how we are seeing price inflation in a lot of different commodities.  Recently General Mills, Kraft Foods, Domino's Pizza, and United Technologies said that they will be increasing the prices for their products (http://online.wsj.com/article/SB10001424052702304741404575564400940917746.html).  So I think the question on a lot of peoples minds is...why print more money if it causes prices to rise?  Who benefits from this?

The government loves inflation because over time peoples income goes up with inflation pushing them into higher tax brackets, this means more tax revenue for the government.  But the main reason that government loves inflation is because politicians like to continue to expand government programs yet they lack the spine to raise taxes in order to pay for it.  Why be truthful to the American people about having to raise taxes when you have a Federal Reserve who can print the extra money needed?  This is exactly what they do.  Since the Federal Reserve was created in 1913, we have had a steady decline in the value of the dollar.   Inflation is a hidden tax, plain and simple.  This is a tax that the politicians know they can get away with.  It is no coincidence that public education teaches very little about Finance and nothing about how the Federal Reserve works.  If we were all to learn about how the value of our money is being destroyed we would put an end to it.  They must keep us distracted with T.V shows, Football, Movies, Pornography, going to bars, buying new cars, ect. If they can keep us distracted with materialistic items, and also keep the political focus on Republicans blaming Democrats and vice versa, then they can continue to get away with this 100 yr heist that has done nothing but cause us to work harder and harder for less pay. 

Why do you think back in the early to mid 1900's families were able to make it on just one income?  Is it because evil Capitalists don't pay their workers enough?  Well if this was the case then the average profit margin for corporations should have gone up dramatically over the last 60 years or so.  For those who don't know, a profit margin in plain English means the amount of profit a company makes per dollar of sales.  So if greedy corporations were just trying to keep more profits for themselves instead of paying their employees more, then obviously profit margins for corporations should be going up dramatically in the last 60 years.  But this just isn't the case.  According to the Commerce Department, the average corporate profit margin ratio in 1940 was about 27%, in the year 2000 the average ratio was 29%.  For the 60 years between 1940 - 2000 the ratio stayed between 25-33%.  In my opinion this data proves that  corporations are no more greedy in the year 2000 than they were in 1940.  Yet it is nearly impossible to survive on only one income these days.  The reason that it takes two incomes is because the value of our dollar has been slowly eroded due to the expansion of the money supply. But to be fair, families these days do buy a lot more items that they don't really need...does everyone in the family really need a cell phone?  Do we need a T.V. in every room of the house?  Do we really need a 30k dollar car when a car for 8k would do just fine?  So in all fairness, most Americans can definitely live cheaper.  But even going without these luxuries it is still pretty much impossible to pay for the necessities on just one income. 

Keynesian Economists argue that a devaluation of the dollar is not the cause of needing two incomes to make ends meet.  They claim if you look at the Consumer Price Index (CPI) that incomes have pretty much gone up right along with inflation.  But then we need to look at who calculates the CPI, and what metrics are they using.  The Bureau of Labor Statistics computes the CPI.  And yes, the Bureau of Labor Statistics is a government organization.  The CPI is used to determine how much of an increase Grandma is going to get on her Social Security check.  If the CPI shows we are having say 3% inflation, then next year Grandma is going to get 3% more from her Social Security.  The U.S. government also issues Treasury bonds that are inflation protected.  These are called TIPS (Treasury Inflation Protected Securities).  Here's how these work.  If the CPI shows we are having 3% higher inflation than we were last year, then your Treasury Inflation Protected Security bond will pay you 3% higher interest that year.  So as you can see, the government has an incentive to make the CPI look like it isn't increasing as much as it really is.  If they can manipulate the CPI then they can save billions in interest payments on TIPS and making sure Grandma doesn't get nearly has high an increase in her Social Security payments.  This is exactly what they do.  Sickening isn't it?

The CPI tracks the prices of a fixed basket of goods bought by a typical consumer.  So you would assume that the items always stay the same, such as the average home price, average rent, average car payment, average cost of meat, milk, wheat, corn ect.  Well the government likes to manipulate these items to make sure the CPI stays as low as possible.  For instance, once the values of homes started to rise in the early to mid 2000's, the CPI stopped using the value of real estate since prices were skyrocketing.  What they did instead was replace it with owner equivalent rent.  They used the average price of renting an apartment/home instead.  During this time people were leaving apartments in droves to buy homes.  So the average cost of renting went down since most people were buying.  So while home prices were going up, the CPI actually showed a decline in the area of real estate.  They use the same techniques when it comes to food.  If meat for instance is showing a huge rise in price, they will give more weighting to chicken if it hasn't risen as much as meat has.  Remember back when gas stations had an attendant who pumped your gas, washed your windshield, and checked your oil for free?  Well services like these that have been cut are not taken into account in the CPI as well.  There are other techniques such as geometric weighting, hedonics, and other gimmicks the government uses as well.

People need to wake up to the fact that inflation is not a good thing.  It causes us to work harder and longer hours just to maintain the same standard of living.  It is just like a tax.  We need to have some honest discussion on whether or not the Federal Reserve is an institution for the people, or is it an institution for the government to silently raise taxes.  I believe that raising taxes is the way to enslave the general population.  We are halfway to Serfdom, but there still is a chance to turn this around.  Lets just hope people wake up.

The Fed's Reason for Printing Money

Once again I find myself having to write again about what the Federal Reserve is doing.  Recently Chairman Ben Bernanke of the Federal Reserve has been getting quite a bit of criticism…and rightly so.  Sarah Palin has been in the news the last few days because of her outspoken criticism of the Federal Reserve pumping another 600 Billion into our economy.  She claims that this will cause inflation.  Palin speaking out is a sign that times are definitely changing.  History has shown that there has been very little talk when it comes to politicians and the Federal Reserve.  I think this is mainly because like most Americans, they didn’t understand how the Federal Reserve worked.  Although, Texas Congressman Ron Paul has been an outspoken critic of the Fed for as long as he has been in office.  But his outspoken criticism never really generated much interest from the mainstream media or the public.

I’m sure a lot of people are asking the question, “why is the Federal Reserve printing more money, what do they hope to achieve?”  That is the purpose of what I am writing about today.  In Ben Bernanke’s (Chairman of the Federal Reserve) own words he claims that the printing of more money is going to cause interest rates to decline, which will cause homeowners to refinance their mortgages.  He also claims these lower interest rates will force people to put their money into risky assets (because you will earn less in interest in CD’s, savings accounts ect) causing the stock market to rise (http://seekingalpha.com/article/234822-bernanke-explains-qe2).  This rise in the stock market Bernanke thinks will cause people to feel better about their financial situation and start spending money again.  Since our economy is 70% consumer spending, he thinks if he can get people spending again it will get us on the way to economic growth. 

I think Bernanke is misguided on so many levels.  Lets take it from the top.  Bernanke thinks that getting interest rates .25% lower is going to cause people to refinance their mortgages.  But the facts show that most people who have equity in their homes have already refinanced.  30 year mortgages are already at 4.5%, is 4.25% really worth paying all the closing fee’s to refinance your home again?  I believe this will have little to no affect on the number of refinances. 

Bernanke claims that pumping money into the economy to lower interest rates will force people to put their money into the stock market looking for a higher return on their money.  CD’s are only returning around 1%, high yield savings accounts are around 1%, and corporate bonds aren’t much better.  Bernanke thinks that if he can make the stock market go up then we will see what he calls the “wealth effect.”  Basically we will all feel better that our 401k’s are going higher, which means we will be more likely to go to the mall and spend.  But in my opinion, the way to get out of our recession isn’t about tricking people to spend money.  I thought everyone has pretty much agreed that over-spending is the reason we got into the mess we’re currently in.  We bought homes we couldn’t afford, encouraged by low interest rates caused by the Federal Reserve, and also by exotic mortgages requiring little to no money down.  In my opinion the root of our problem is because our economy is driven by consumer spending.  The cure is moving away from a consumer driven economy to a more sustainable economy driven by manufacturing. 

Bernanke is trying to encourage spending money we don’t have.  This was what got us into the problem we are now in.  We became consumers, not producers.  The Federal Reserve’s policy of trying to spur economic growth by “tricking” us into spending money will only exacerbate the problem.  This is what Washington does best, it kicks the can down the road.  They can’t tell us the truth, if they did, we would realize that we have to cut spending dramatically.  While this is the tough medicine we need, it virtually guarantees that the incumbents in Washington will be voted out.  It will be obvious that their policies have failed, and they would pay a heavy price at the ballot box.  If there is anything that I have learned about politics, it is that Politicians love power and they are willing to do almost anything to keep it.  Convincing the public that everything is fine gives them the best chance to stay in office.  While the Federal Reserve might succeed in prolonging our day of reckoning, mark my words, the day of reckoning is coming. 

So where do we go from here?  We need to become a nation of producers once again.  That means DRASTICALLY removing regulations so businesses can return to the United States.  Everything from taxes, red tape, to environmental laws must be repealed.  I don’t pretend to have all the answers, but I do have common sense.  About 75% of our budget here in the U.S. is Defense, Social Security, and Medicare.  Another 8% is interest on our debt.  The politicians can talk about cutting pork barrel projects, but this is just political satire.  It will do pretty much nothing to get us out of the mess we’re in.  In my opinion we need to completely abolish Social Security and Medicare.  We must encourage market based solutions to these programs.  Freedom is not giving a portion of every paycheck to the government and then expecting them to take care of you once you retire. I do believe we should continue to pay full benefits to anyone within 10 years of retirement.  But after that it must be completely phased out and fast.  Personal responsibility means we need to save throughout our working lives in order to be able to afford our retirement and medical bills.

Medical bills would come down drastically if our doctors weren’t billing insurance for the treatments we received, but were billing the client directly.  Because we know our health insurance will cover our treatment, we don’t shop around for which doctor has the best prices.  In this type of environment, of course doctors are going to jack up their prices if they know there is no risk of losing the customer.  Medical insurance needs to be more like fire insurance, you only use it in unforeseen emergency situations.  This would keep medical insurance premiums extremely low since it would very rarely be used.  With low insurance premiums everyone would be able to afford it.  With over half of all bankruptcies being caused by unforeseen medical issues I believe this type of insurance would help dramatically.  Standard medical costs will also stay under control since consumers would seek a combination of the best doctor for the best price.  In this environment a doctor would not be able to jack up his prices without risking losing customers.  Can you imagine how much auto insurance would cost if every time you went to get an oil change they billed your auto insurance company?  There is no difference between this and the doctor billing your insurance for a standard check up.  While much more discussion and thought is needed in this subject, I believe it is a place to start. 

Do we really need over 150 military bases stationed across the world?  If that isn’t a military industrial complex I don’t know what is.  Can you imagine if Russia had a military installation in San Diego?  Or how about China having a base in Atlanta?  I would be pretty pissed off.  I’m sure this is how most of the world feels about our military bases throughout the world.  It’s time to pull our troops out of all of those countries and secure ourselves and our borders at home.  Our military budget for the year is over $750 Billion.  This could be cut dramatically by bringing our troops home from around the world.  Some of those troops can be used to secure the Southern Border, the rest could be discharged and used in a more productive capacity in the private sector work force.

We can either start to put these plans into action NOW or wait for the crisis to hit.  If we wait for a crisis to take action, odds are the solution will be more government intrusion and control of our lives.  I don’t see our bond market holding up any longer than 2 years if we don’t take action.  Let’s make the hard decisions now, or risk the International Monetary Fund (IMF) and George Soros making them for us.

Understanding the Federal Reserve

Today the Federal Reserve announced their highly anticipated program that Wall Street calls QE2 (Quantitative Easing 2).  The Federal Reserve said today that they will buy 600 Billion dollars worth of treasury bonds, they also said they would re-invest 250-300 Billion in proceeds of bonds they purchased with their first round of quantitative easing (QE as they call it on Wall Street). 

The first thing I want to explain is what the role of the Federal Reserve is and how it accomplishes this.  Most Americans don’t have a clue what the Federal Reserve is or does.  This is intentional; I received my Finance degree and only learned briefly about the Federal Reserve.  The Federal Reserve is a quasi-government organization that is comprised of un-elected officials that are appointed by the President of the United States.  The reason it is a quasi government organization is because nobody really knows who owns it.  It is supposed to be watched by Congress, but Congress for the most part is not allowed to look at the books of the Fed (short name for the Federal Reserve).  There was a bill that Ron Paul (R-Texas HR 1207) brought to the floor that would have forced the Fed to open its books up to Congress and the public.  This bill (HR 1207) was sponsored by over 300 members of Congress.  Funny thing is, once Ron Paul brought this Bill to the floor for a vote, the bill didn’t pass…hmmm.  With over 300 sponsors this should have passed with ease.  So what happened?  Well there must have been some back room deals going on, because about 117 Congressmen who sponsored the bill ended up changing and voting against it at the last second.  By the way…all 117 sponsors who changed their vote were Democrats (see this link for the list http://florida.tenthamendmentcenter.com/2010/07/hr-1207-hall-of-shame/).  Politics is truly a dirty business. 

The Federal Reserve has 2 main goals: to maintain price stability and full employment.  Now how does the Fed accomplish this?  They use the FOMC (Federal Open Market Committee).  The FOMC is the policy making arm of the Federal Reserve.  They meet 8 times a year to discuss the current market conditions and then decide what to do.  The main way that the Fed tries to manipulate the economy is through the Federal Funds rate.  This is the rate that banks charge each other to borrow money.  The Fed controls the Federal Funds rate by effectively printing money.  It is basic economics.  If there is more money floating around in the economy then banks have more money to lend.  If banks have more money to lend, then supply and demand tells us that interest rates will come down.  This is known in Finance as the Loanable Funds Theory.  So with the Fed lowering interest rates this leads businesses to want to borrow money to grow their businesses.   This also leads regular people like you and me to put our money in the stock market since our money is earning basically nothing in interest at the bank.  This is the way the Fed tries to spur economic growth, by effectively forcing you to take risks with your money.  With all this new money going into the stock market asset prices rise.  Only problem is…this is just paper wealth, the real economy hasn’t really gotten any better.  People just feel a little better seeing their portfolios rise.  Now if businesses take out loans to build factories, this can lead to jobs.  But these are typically temporary jobs since eventually interest rates have to rise or we will see massive amounts of price inflation.  Eventually these factories have to lay off people.  This is the cause of our boom and bust economy.  It is basically the Federal Reserve that causes these bubbles.

Now I want to explain a little about how the treasury market works.  Wall Street likes to use big words to make us feel stupid.  That way we need to pay gigantic fees for their advice.  Well trust me, it’s not that complicated.  The basic concept is the government needs cash to finance its day to day operations.  They do this by issuing Treasury Bonds.  They range from short term to long term, and go out as long as 30 years.  If you would like to purchase these bonds you can do so through the Treasury department directly at www.treasury.gov (though I highly recommend NOT BUYING THOSE).  So the Treasury issues these bonds to the public and also institutional buyers.  Mainly China, Russia, and Japan are the buyers of these bonds.  So essentially they are the Bankers of the United States.  Now as you would expect, our economy looks pretty shaky right now, so these Countries are becoming more and more worried about buying our debt (loaning us money).  Well what happens when creditors become worried about the credit worthiness of the borrower?  They demand a higher interest rate for the increasing amount of risk.  That is exactly what is about to occur and the Fed knows this. 

So now where are we at today?  The Federal Funds rate is at an all-time low of zero (officially the Federal Funds target rate is 0-.25%).  This is an all-time low.  But businesses and consumers still are too shell shocked to borrow money or put their money back in the stock market.  The economy still appears to be on the brink of collapse.  Our creditors (China, Russia, Japan) see this and are starting to scale back the purchases of our bonds (or in other words they are scaling back loaning us money).  Well with less people interested in buying our bonds, interest rates will have to be increased by the Treasury in order to compensate these countries for the extra risk.  But can you imagine how our economy would react if interest rates started to go up?  Think of how bad the housing market is right now, now think how bad it would be if a 30 year mortgage rate doubled from 4% to 8%.  This is why the Fed came out today and said they will be purchasing 600 Billion dollars worth of Treasury bonds over the next 2 quarters.  They are trying every trick in the book to keep our interest rates where they are at. 

Only problem is that this extra money WILL lead to price inflation.  It is just a matter of when.  This will devalue the dollar.  The Federal Reserve has a mandate that they are supposed to maintain price stability.  Well, since the Federal Reserve was created (1913) the dollar has been devalued by over 97%!  How’s that for price stability?  Their other mandate is to maintain full employment.  Employment rates are officially 9.6% in the United States, but if you count all the people who are too discouraged to look for work that rate goes up to about 17%.  Any way you look at it the Federal Reserve has been a colossal failure. 

Over the last 2 years the Fed has pumped 2.5 trillion dollars into the system to try and keep housing prices from coming down and interest rates remaining low.  This will create a massive amount of price inflation.  We are already seeing it in the prices of essential items like food and energy.  It is a shame that for the last 100 years there has not been a safe place to keep your money.  If you want to keep your money in the bank, it will be devalued by the Federal Reserve.  This forces you to put it into the stock market, real estate, or other risky assets.  The older generation is really susceptible to having their money devalued by falsely thinking it is safe inside a bank.  Bill Gross (largest bond fund manager in the world) recently said that with the Federal Reserve’s announcement of QE2 that the dollar will be devalued by 20%.  That means the money you have in the bank will be worth 20% less most likely within about a year. 

Prices soon will start to rise.  Look for it first at the grocery store and at the gas station.  The first thing our elected officials are going to do is start demonizing the Oil companies for raising prices.  They are going to blame speculators, such as myself, for causing the price of food and energy to go thru the roof.  This is because people like me will try to protect ourselves by buying commodity futures (this is basically a leveraged bet on the price of oil, gold, silver, wheat, ect increasing).  The reason prices rise is because traders closely watch the amount of inflation and start buying real items such as oil, wheat, gold, silver ect when they see the government being irresponsible with our monetary system.  So while the Federal Reserve and our elected officials overspending will be causing the increase in prices, they understand that the American people are not educated in Finance.  They can easily deflect public anger away from the real cause and blame Capitalism and Wall Street greed for the reason there is a rise in prices.  Don’t fall for this.  Get prepared yourself by only having enough cash in the bank for an emergency and start putting your money in real items such as exchange traded funds that are backed by silver, gold, oil, agriculture ect.  Yes, there is a risk to investing in these items.  But there is also a higher risk of having cash in the bank as long as you have a reckless Federal Reserve and politicians hell bent on spending our way out of a problem caused by over-spending.