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Evaluating Conventional Wisdom

June 3, 2014

 

Wisdom can be defined as “the ability to live life skillfully”.  It is needed in all areas of life, especially in the financial aspect.  Financial health affects all facets of life: physical health, economic welfare, personal relationships, general reputation, future plans, hopes, and dreams.  While having and making money is not the purpose of life (relationships are: with God, ourselves, and other people), having sufficient monetary resources to provide life’s comforts, to meet needs and some luxuries, is important.

 

Conventional wisdom regarding finances can be summarized simply: work hard to prosper; spend less than you make; live below your means; save for a rainy day; don’t put all your eggs in one basket; and give to those less fortunate.  How this is accomplished is a little more complicated and involves the conventional wisdom given for saving and investing.  Conventional investment advice generally includes some simple standard admonitions, with a primary focus on financial assets: invest in bonds for interest income and greater principal preservation; invest in stocks for dividend income and/or growth potential; diversity your holdings by owning a broad range of stocks and bonds or use mutual funds for diversification; save toward retirement; save for children’s college educations; and have three to six months of income saved as cash for emergency needs. Whew, quite a ‘to do’ list!  But these ideas have helped many people achieve financial stability, and even a measure of affluence.  They have helped families accumulate assets for life’s journey and have earned the right to be deemed ‘wise’.

 

However, conventional financial and investment wisdom is based upon important, but often unacknowledged, principles.  These principles, while not exhaustive, are: the U.S. dollar is sound today, and will continue to be so in the future; fiscal and monetary policies made by government will reward those who make what have historically been considered ‘wise’ financial decisions; and, the market is ‘rational’ and efficient’. 

 

The unwise time to act on conventional wisdom is when these principles are violated.  And there are plenty of rumblings in the U.S. economy which hint at departure from these principles and others of importance. Since the ‘Great Recession’ of 2008-09, Quantitative Easing (QE) has increased the money supply to over 4 trillion dollars, up from less than 1 trillion dollars in 2007.  (The Economist, January 14, 2014) Quantitative Easing is an ‘unconventional’ monetary policy and a way for the central bank – the Federal Reserve – to create new money “by buying securities, such as government bonds, from banks, with electronic cash that did not exist before”. (Ibid) How does this affect the U.S. dollar? It affects its valuation and purchasing power, two sides of the same coin.  As for valuation, it weakens the dollar, causing it to be worth less since it expands the money supply and dilutes the value of money already in circulation.  About one hundred years ago, a one-troy-ounce silver dollar and a $1.00 Federal Reserve note (a dollar bill, or ‘greenback’), were able to buy the same quantity of goods.  Silver’s close at the time of writing this article was 1,929.20 cents per troy ounce ($19.2920).  It can be inferred from this relationship that today’s paper dollar has a value that is only 5% of the value of an ounce of silver.  This is quite a decline from the days when the paper dollar had about the same value as the silver dollar, since silver and gold backed the paper currency.  As for purchasing power, while this increase in the money supply has not shown up yet in significantly inflated consumer prices, it has shown up in elevated bank reserves and in the stock market.  Bank reserves, when loaned out, will increase the dollars in circulation, adding upward pressure on consumer prices. 

 

What about the stock market? “In an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.” (Eugene F. Fama, Random Walks in Stock Market Prices Financial Analysts Journal, September/October 1965 (reprinted January-February 1995).  With such a poor economic recovery following the 2008 recession, and continued problems with unemployment, historically low interest rates, and business profitability, the fundamental factors that drive a surge in the stock market are not there.  Compare this with the sustained bull market of 1982 to 2000 that roared along breaking record after record and mirrored the growth of the economy at large.  In inflation adjusted terms, today’s market as measured by the Dow Jones Industrial Average is nowhere near the high achieved in the year 2000.  Today’s high is a nominal high that has come about because of investors chasing yield.  There is irrationality in today’s market that belies the fundamental factors underlying it. 

 

In such a time as this, an added dimension of wisdom is required.  Efforts to accumulate assets must be accompanied by efforts to preserve assets.  Gold and silver have been used as stores of value for millennia.  Real assets, which include gold and silver, provide a way to hedge the danger that always comes with financial assets and fiat currencies (i.e., the U.S. dollar, the EU euro, the Japanese yen, etc.)  That danger is death by inflation, and all fiat currencies have historically ended this way.  There is no reason to suppose that the U.S. dollar will have a different ending in the long run, especially in view of current policy decisions.  At this point in time, the use of wisdom in finances is more important than ever; the preservation of our way of life is dependent upon it. 

 

The fact that Quantitative Easing has been official policy for economic recovery from the recession is unusual.  In prior philosophies this would have been seen as monetizing debt and would have been limited or avoided, due to fear of weakening the U.S. dollar.  Also, the sustained low interest rate policy that has accompanied QE has decimated the interest income of many savers and investors.  The thrifty, wise, and frugal have not been rewarded for their prudence.  The dollar is currently the world’s reserve and central fiat currency.  We must live within this system, so we should still plan and invest our dollars as conventional wisdom would dictate.  However, to provide hope and security for a time when our dollars and other fiat currencies may be in crisis, the prudent will embrace the broader wisdom of including liquate, real assets in their portfolios.  With interest rates currently so low, the opportunity cost of holding gold and silver is minimal.  So, embrace the wisdom of the ages, which has been proven through many trials; add gold and silver to your investment strategy. 

 

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