finance blog, Gambling vs Investing, gold, money

Bitcoin: The Inflation-proof E-Currency of the Future, or Not

Bitcoin LogoIf I were to design a new currency I would design something very much like BitCoin.  It is a digital currency with about 6.5 million units in circulation. BitCoin will never have more than 21 million units of currency in circulation…. ever.  Bitcoin is divisible into tiny fractions of a unit down to millionths of a BitCoin and smaller.

BitCoin is digital money.  Imagine PayPal but without the hassle, or the commissions.  Image digital gold.  Gold which is mined (by computers), but has a known maximum supply of 21 Million ounces.

Gold’s value is largely related to its relative rareness.  Gold’s usefulness is pretty limited except as jewelry and a form of currency.  Industrial uses of gold consume only a small fraction of gold’s supply.  And gold can be mined faster than it is consumed.

Gold cannot be as easily traded or exchanged as BitCoins.  Yes gold ETFs can be exchanged for cash which in turn can be used for web transactions, but this is a multi-step process.  BitCoins, however, can be easily exchanged from person-to-person or person-to-business with ease.

Today each BitCoin is worth more than $13.  BitCoin valuations have fluctuated rapidly.  One person, according to Forbes, turned $20,000 into $3 million by buying Bitcoins early then selling them for a killing.

BitCoins may one day be worthless relics on discarded hard drives.  Or BitCoins may become the E-commerce alternative replacing PayPal.  Right now BitCoins seem to be priced about what the current mining cost will bear.  The cost of mining is measured in 1) electricity (energy) and 2) depreciation of the graphics cards used to mine new BitCoins.  This tends to put a short-term ceiling on BitCoin prices.  However, the BitCoin system makes the cost of BitCoin mining escalate geometrically.  Eventually, if all goes optimally, the mining cost will be come prohibitively expensive.

If BitCoins gain wider and wider acceptance I anticipate they will hold or increase in value.  However if either of the following happen they will end up virtually worthless: 1)  BitCoins simply don’t gain wide acceptance, and lose acceptance over time.  2) The algorithmic infrastructure underlying BitCoin is found to be flawed.  There is yet another alternative:  That a BitCoin-like system is created the competes with the original BitCoin.  Finally one more possibility:  various governments outlaw BitCoins.

In closing, BitCoin is a brilliant idea and a risky “investment”.  It is riskier than gold, silver, or index ETFs.  It is similar in risk to buying options, because the value can rapidly go to zero.  However, it is an interesting speculative play that is potentially inflation-proof.  Inflation-proof because, unlike government currencies, the printing presses (BitCoin mines), are held in check.  Buying 1500 dollars worth of BitCoins is no sillier to me than buying a $1500 gold coin. Just make sure you guard your BitCoins like you would your expensive gold coin… security, security, security.   Because BitCoins can be stolen, just like gold.  And they can be stolen without the thief even setting foot in your house.

bonds, finance blog, financial, Gambling vs Investing, money

Just don’t call it QE3 nor Inflationary

Drilling for stimulus, finding inflationWhether it’s Barack Obama releasing 30 million barrels of oil from the Strategic Petroleum Reserve, or Ben Bernanke saying they might buy another $300,000,000 worth of U.S. Treasurys… even after QE2.  But, no, it’s not QE3… nah.

The oil gambit was, from a purely stimulative standpoint, an interesting move.   It would have been more effective when oil was at $110 and rising rather than in the $90’s and falling.  But, perhaps there was some political hay to be made.  Short term this was not an inflationary move.  However, someday, those 30 million barrels will have to be repurchased… which will have an inflationary effect.  It was a short-term political move.  From a geopolitical perspective, it also signals a US willingness to manipulate the oil markets… rather than being truly “Strategic” (aka for military and other strategic purposes).    Ironically the Obama administration is accusing others of oil price “manipulation” while they just did just that with the SPR oil release.

And for Helicopter Ben, QE and QE2, both unprecedented;  it seems that maybe a little more magic juice is called for.  He doesn’t understand the current economic problems, other than to call them (mysterious) “headwinds”.

The situation, as I see it, is inflation-triggering non-stimulus.  The magic “CPI” may not reflect this right away.  In fact I believe inflation is currently outpacing “CPI Index” inflation by 1 to 2 percent.

I’m not fully aware of the whats or whys of QE3, I just know that I’m not supposed to call it QE3.

bond funds, bonds, finance blog, financial, Investing, money

Wired in High Finance

Stock Tickers BlueThere are two economies, the real economy and the financial economy (the financial markets). The two economies are linked, but sometimes the linkage is almost imperceptible.

Take for instance the recent run up in stocks, up ~20% in the last year, and up a total of ~40% in the last two years. This stock run up in the financial economy is in spite of the dismal real economy which was (still is?) in the midst of the Great Recession. The classic explanation for this jump in stock prices is anticipation of strong economic growth that many were guessing was just around the next fiscal quarter or two.

But continued lackluster economic growth, high unemployment, and inflation fears have the stock markets retreating 4% in the last month. QE and QE2 have driven commodity, gold, silver, and oil prices up (and the dollar down to a degree). Low interest rates have also helped fuel the commodity boom. I don’t say commodity bubble, I say boom, because I don’t believe it is a bubble… merely a precursor to higher inflation.

Further the prospects of Congressional legislation past and present loom as large economy and business-dampening prospects.

  1. Dodd-Frank Act regulating all sorts of financial and non-financial items.
  2. Obama Care.
  3. The real possibility of tax increases as part of debt ceiling deal.

The danger of Dodd-Frank, which deals primarily with the financial economy, is that it may spill over into the real economy as well — a form of fiscal contagion.   Obama Care hits right in the solar plexus of the real economy soon.  Potential tax increases are a kidney shot to the real economy.

Also on the horizon is the debt crisis in Europe, currently centered around Greece, but with dominoes in Portugal, Spain, Italy and Ireland ready to fall.

So, why on earth would I be neutral to mildly bearish (long term) on US equities?  The title “Wired on High Finance” sums it up.

  1. Wired, as is in connected, by wire, cable, fiber optics, or wireless.  The continuing computational and connectivity revolution is only accelerating.  This helps business productivity, which helps business (the real economy) and inevitably the financial economy (the stock market).
  2. High Finance.  High finance in the US eventually finds a way.  Take for instance GE which managed to pay zero income tax last year.  Big money always finds a way.   Call it industriousness, creativity, or greed… it gets things done.

Without all of the governmental fiscal and regulatory “headwinds” (as Bernanke has called them), my outlook would be bullish.  Despite them, I believe that the power of a wired world of high finance will find ways to resist the government onslaught.  Either through back-room deals (the new and no-so-new crony capitalism) or the ballot box (voters tired of 9% unemployment), these “headwinds” will be reduced, skirted, or avoided.

And while CPI stands for Consumer Price Index, most commonly, it also stands for Cycles Per Instruction — one measure of computer processing speed.  So while the mainstream CPI may understate prices, the other CPI is very favorable to computation power.  (In both cases keeping true CPI down is desirable.)

Notice I am neutral to mildly bullish on the US (and global) economy.  That is why I, personally, am increasingly invested in investments that reflect that believe — namely covered-call market-index strategies.  That is why I have switches some of my ETF investments from SPY (an S&P500 index EFT) to PBP (an S&P500 covered-call ETF).  Inflation fears and low interest rates have continued to cause me to shy away from most bonds and bond fund… with the exception of high-yield (junk) bonds.

Disclaimer: These are my personal investing thoughts, opinions, and choices as of today.  No one can reliably predict the markets (stock, bond, futures, options) or interest rates, certainly not me.

editorial, finance blog, financial, funds, home, money, mortgage

Know Unknowns: Bank Balance Sheets & The Federal Reserve

Big Money Printing Press

I consider myself knowledgeable about many things financial: ETFs, stocks, bonds, options, the stock market, for example.  I know the difference between an income statement and a balance sheet, and can read financial statements and prospectuses as a matter of course.

I’ve had little luck deciphering bank balance sheets. Income statements yes, balance sheets no.  They tend to be very opaque, which is one obstacle.  Loans are assets while deposits (other than Federal Reserve deposits) are liabilities.  Accurately determining the quantity, quality, type, and duration of loans can be difficult if not impossible… at least to me.  Perhaps some of this info can be found in the bank’s 10K statements.  Also opaque are details of the bank’s interest rate swaps and other OTC financial contracts.

Historically, the old-style (commercial) bank followed the 3-6-3 rule:   Borrow at 3%, lend at 6%, be on the golf course at 3:00.   Such a bank would take in deposits and lend out with loans (mortgages, car loans, commercial loans).  However, banks could not lend out all the deposits; banks had to keep a fraction of the cash in reserve.  This reserve helps to avoid the “run on the bank” problem, where too many depositors ask for their money — all at the same time.

Keeping all of this spare cash at the bank (about 3-10% of assets) is cumbersome, and also encourages bank robberies.  Banks can transfer much of this physical cash to the Federal Reserve and sometimes even earn a tiny bit of interest (0% to 0.25%, “the Fed Funds Rate”) on it.  Thus the Federal Reserve serves as the bank’s bank.  The Federal Reserve System (or “The Fed”) also helps clear checks (remember those?) and move money between banks simply by moving reserve deposit balances between banks.  No need to shuttle hard currency to and fro.  Deposits are moved with a pencil, or computer transaction in the Fed’s books.

The Fed also lends out money to banks.  Banks can borrow from the Fed at 0.75% (the so-called discount rate).  This system leaves a 0.5% profit for the Fed on the difference between the Fed Funds rate and the discount rate.

Classically the Fed would try to guide the economy by moving the Fed Funds rate and discount rate.  If the Fed thought the economy was overheating (generating excessive inflation) the Fed would raise rates to “cool off the economy”.  The Fed tried to adjust the rates so as to give the economy a “soft landing”.    If the US economy got too sluggish, with high unemployment, the Fed lowered rates.  The interesting thing (no pun intended) about these rates is that they are all short-term rates.  So short-term that the Fed funds rate is sometimes called the overnight rate.

I keep saying “classically” and “historically”, is this is how things used to be done by the Fed.  What’s new, since Fed Chairman Bernanke, has been the manipulation of long-term rates with “quantitative easing” QE, and QE2.  Also new (with the cooperation of US Treasury Sec. Timothy Geithner, Congress, and President Obama) are measures such as the AIG bailout and TARP.

The Fed has shifted into uncharted territory, and in the process neglected one of its two prime mandates: price stability and low inflation.  It also seems to have overlooked the concept of real economic growth (GDP growth adjusted for inflation).  Instead the Fed seems to be fluttering in a course of wide-ranging, unprecedented, knee-jerk reactions.

Today’s Fed is not my father’s Fed, nor are today’s banks.  Today they are increasingly known unknowns.  This path is new and the ticket stub is unclear.  I don’t see a destination nor ETA, but when I look close, very close, I see a dim watermark.  Subtle, like grey on grey, I believe I see in faint yet bold letters INFLATION.

finance blog, Investing, money

Improving your Credit Score

Credit scores are important because they effect the interest rates you pay on everything:credit cards, car loans, mortgages, lines of credit, etc.  Credit scores and credit reports can also effect your success or failure in landing jobs or obtaining leases on an house, townhouse, or apartment.

If you know your credit score (FICO score), and it’s 770 or higher, you have an excellent score and are in great financial shape.  If your credit score is 720 to 769, you are in good shape, but could benefit from an upgraded score.  Finally if your credit score is below 720, you should strongly consider fixing your credit score.

I have some personal experience with credit score improvement and repair.  When I met my girlfriend and eventually found out her personal finance situation I had to take a deep breath.  She had $13,000 in credit card debt and credit score of 630.  One year later she had a credit score of 750 and almost zero debt. I provided no money to her… just advice and emotional support.  Today she is kicking butt and her credit score is well north of 770.

How’d we do it?  Pretty simple.  By making minimum payments to the low-interest accounts and throwing any left over money towards the highest interest account.  After a couple months, and an improved credit score, she took out a line of credit that was lower than her other rates.  She used it to pay off her highest rate card which was charging an outlandish rate of near 27%.  She kept making timely minimum payments to her lower-rate balances, while throwing almost all leftover money at the cards with the current highest rate.  As her credit score improved she was even able to call up and negotiate lower rates with some of her credit card companies.

I am Mr. Finance.  When I initially learned of her credit and debt situation I was taken for a loop.  I called my dad, Mr. Finance Senior, and confessed my discomfort.  Wise man that he is, he counseled me on observing how she adapts to my financial advise.   Since all else with her was wonderful, I held my breath and watched and waited.  Long story short, she did great.  I am so proud of her.

Not only is she now past her debts; she is thriving.  And because she did it herself, she has learned to “grok” a healthy financial lifestyle.  We are still happily (even blissfully) together.

finance blog, gold, Investing, money

Millionaire by 40? Inflation says Big Deal!

40 years old is still several years off for me, but I it is very likely I will be a millionaire by the time I reach 40.  In fact, if you count my contributions to Social Security (including my employer’s half), the current value invested in my personal “Social Security Trust Fund” puts me there already.  But I’m certainly not counting on Social Security.

So, I’ll be rich right?  Wrong!   First there’s inflation.   Many economists say US inflation has been about 4% per year over the last century.  There’s a handy rule of 72 that says, for example, 72/4 = 18.  That means 4% inflation means that a million dollars today is only worth $500,000 in 18 years and $250,000 in 36 years.

Second, there’s taxes.  Over $300,000 of my holdings are in tax-deferred accounts such as 401k accounts and IRA accounts.  Sure this money is part of my net worth, but when it comes out at retirement I’ll likely be paying something like 30% tax on it.  That’s about $90,000 to Uncle Sam.  Poof!  Gone!

Back to inflation.  Inflation works like a stealth tax.  According to government CPI figures, US inflation increased just 1.5% in 2010.  That simply doesn’t jive with my experience.  My HOA fees increased 7%, my electric and water bill increased 8%.  Car insurance, home insurance, satellite TV, health-insurance premiums, internet, rooms at my favorite hotel, and meals at my favorite restaurant went up, by 4-10% last year.  Even the local sales tax increased almost 1%, making everything that much more expensive on top of everything else.  In Balhiser World 2010 inflation was about 4-5%, rather than the 1.5% according to the CPI.   Thus I have some new ideas about what CPI stands for…

  • Cagey Price Index  (Price? What price?  Prices are relative.)
  • Calming Price Index  (Nothing to see here. Relax. Inflation is under control.)
  • Clairvoyant Price Index  (Far away someone is substituting chuck steak for Filet Mignon.  Meat is meat.  And prices are low.)
  • Creative Price Index (2+2=3 for sufficiently small values of 2)
  • Cowardly Price Index (Please don’t be mad, prices aren’t that bad… see?)

Of course CPI officially stands for Consumer Price Index.  Let just say that for the next 72 years the official CPI is 4%, but actually inflation is 5%.  That handy rule of 72 says that at 4%, one million dollars today will be worth $62,500 of buying power.  At 5% buying power is cut in half to $31, 250.  Of a long enough time a 1 percent difference in inflation is a big deal.

So what?  Well, the CPI is used for a lot of things such as government cost of living adjustments, tax bracket adjustments, Social Security benefit increases, and money paid on Treasury Inflation-Protected Securities, to name a few.

It’s bed time so I’ll cut to the chase.

  1. One million dollars is not what it used to be, and is certain to be worth much less in the future.
  2. To try to remain solvent (and avoid unpopular austerity measures) the US Government has a powerful incentive to under-report inflation.
  3. Many investors and economists are beginning to believe that the CPI significantly under-reports inflation. Examples: “CPI Controversy”“Bill Gross says so”, “Forbes, pastries, and gold say so too”.
finance blog, Investing, money

Negotiating Financial Setbacks

We all face occasional financial setbacks.  One way to increase feeling of financial loss is to check your portfolio daily.  Since I have a private fund that I manage, I feel obliged to stay on top of it daily.  I’ve noticed that when the fund is up I feel modestly happy, but when it is down I feel doubly disappointed.

Sometimes various financial stresses come together at the same time.  Recently minor financial setbacks have converged for me:  modest potential issues with my rental business, and a few percentage points drop in my fund, and long hours at my day job.  Navigating these financial stresses involves 1) avoiding impulsive decisions, and 2) carefully considering available options.  For example part of me wants to sell the rental property in the next year or so, namely to avoid the occasional headaches of being a landlord and property manager.  Another thought is to contract with a property management company, who charges a fee, but helps manage some of the day-to-day property management duties.  Finally, I impulsively want to deleverage some of my investments.

I am approaching my latest bought of financial stress as I always do.  With contemplation and composure.  At least outwardly I am composed and seemingly unflappable.  Internally, I am stressed and a bit anxious.  This comes with the territory of managing a wide range of investments.   This occasional stress is one of the few things I dislike about finance and wealth management. Of course it too shall pass.

I simply wanted to share the fact that, at times, maintaining a financial course can be emotionally challenging.  I spend a lot of time talking about how successful investing can be easy… and in many ways it can be.  Creating a financial plan can be fairly simple, but sticking to it at times can be stressful and nerve wracking.  Financial discipline is worth it, and financial impulsiveness should be kept to a minimum.  That is what I intend to do; even when it is not so easy.