-- Posted Monday, 16 March 2009 | | Source: GoldSeek.com
By Howard S. Katz
Actually, dear reader, the title of this article does not have any meaning. It is complete and utter nonsense. But that makes it a perfect title for an economics piece in the 21st century because pretty much every word written on the subject nowadays is complete and utter nonsense.
But the subject of the article (as opposed to the title) is going to be hard nosed and realistic. You want to retire, correct? Well, first you need to understand some realities. (I should say that, for the vast majority of economists, who prefer illusion to reality, there is nothing for you in this article. It will only get you upset, and you are better off turning to something like Peter Pan or Alice in Wonderland.)
What is retirement? Retirement is a period, near the end of one’s life, when one stops working and lives off of income generated from one’s productive years.
Retirement began as an institution in Britain and America near the beginning of the 19th century, and it was due to a political reform which was carried out by Noah Webster (in America) and Jeremy Bentham (in Britain) in the 1780s. Webster and Bentham succeeded in repealing the anti-usury laws, which had prohibited lending at interest. Since very little lending was going to go on if the lender did not receive his interest, this worked out to a pretty effective ban on lending (except for the king, who usually made himself exempt from the anti-usury laws).
Once people could legally receive interest, they began to save. Banks would collect the savings and lend them to businessmen who, in turn, would build factories and equip them with the latest machinery.
This machinery was fantastic. A machine would be invented which could enable one worker to do the work of 10. Then another machine would come along 5 times as good as the first. There was a tremendous outpouring of wealth. The wages of workers went up. The prices to consumers went down. Profits went up. And there was sufficient wealth left over so that the bank could pay the saver interest, which for most of the 19th and into the early 20th century was about 5%. (The American South, by the way, lagged behind in repealing their anti-usury laws, and this is the main reason they were so much poorer than the North at the time of the Civil War.)
Now what happens if you can get 5% interest on your savings? Let’s take the average working man, who today makes $30,000 per year. If he saves 15% of that, this amounts to $4500 per year. Suppose he receives 5% and does this for his 49 year working lifetime (and to make the problem simpler we will assume that he keeps making the same wage).
This is a problem in compound interest. You did this in 8th grade math class. You receive 5% interest on $100 for 1 year, and at the end of the year you have $105. But then you receive 5% interest for a second year, and you don’t wind up with $110. No, in the second year you are getting 5% interest on $105 = $5.25. So you wind up with $110.25. It only seems like a little thing.
But your next year’s interest is $5.51¼, and it keeps going up – at a faster and faster rate. Keep saving for long enough and it is like the story of the grain of rice given to the inventor of chess by the King of Persia. He asked for 1 grain of rice for the first square, 2 for the 2nd, 4 for the 3rd, etc. The King quickly granted his request, thinking that it was a small thing. But by the time he got to the middle of the chessboard, he realized that there was not enough rice in his whole kingdom.
That is the way compound interest mounts up. The people who worked with interest and savings in the 19th century were so impressed with this that they called it “the miracle of compound interest.” If you save 15% of a $30,000 annual salary every year of your (49 year) working lifetime, then you do not come out with 0.15 x $30,000 x 49 (equal to $4500 x 49, which equals $220,500). No, the effect of compound interest at 5% working over 49 years is to multiply the whole amount by 4.25. And you come out with $220,500 x 4.25 = $937,125.
Now what would you rather do? Retire on $220,500, or retire on $937,125? Let us see if we can work that out? Case I: If you retire and put your money in a savings bank, again at 5% interest, you receive an annual income in retirement of .0.05 x $220,500 = $11,025. Case II: If you retire and put your money in a savings bank, at 5% interest, you receive an annual income in retirement of 0.05 x $937,125 = $46,856. That is, if you are allowed to receive interest at 5%, then you can retire on an income 50% higher than you made when you were working.
But my happy story has a sad ending. By the early 20th century there were some people who did not like prosperity, freedom, new inventions, etc. They liked to drive in automobiles and fly in airplanes, but they did not like the system which had given us automobiles and airplanes. They wanted to keep the effect but abolish the cause.
One of these men was John Maynard Keynes. He talked Franklin D. Roosevelt into taking the United States off the gold standard. Since that time the Government (in conjunction with the bankers) has printed money so fast that prices rose as rapidly as the rate of interest. For example, if you invest $100 and are receiving 5%, then at the end of a year you have $105. But under FDR, prices also rise by 5%. This means that your money, at the end of the year, has the exact same buying power it had when you started. You seemed to be getting interest. You thought you were getting interest. But at the end, all you had was what you started with. In real terms, you got no interest at all.
If you compute the rate of interest on safe instruments (such as T-bills) since 1933 up to 2008 and compute the rate at which prices have been rising over that period, THEY COME OUT ALMOST EXACTLY THE SAME. In reality, you received no interest.
Are you ready for the sad ending? IF THERE IS NO INTEREST, THERE IS NO RETIREMENT. Ask Noah Webster. It looks as though your quest for retirement is doomed. A person who is retired is consuming wealth, but he is not producing wealth. If large numbers of people try to do this, then where will the wealth come from?
The modern answer to this is that the wealth is taken from the younger workers. The young support the old. Isn’t that something? In the 19th century, the old did not take from the young for their retirement. Exactly the opposite. The old provided savings, which created machines which vastly increased the productivity of the younger worker. The older, retired person made possible a raise in the younger worker’s salary. It was a wonderful system because nobody took from anybody else. More wealth was created, and everybody benefited.
But that system has died. It died in 1933. An attempt was made to revive it in 1944-71, but Richard Nixon killed it for good on Aug. 15, 1971. Whose fault was it? Everybody who voted for the Demopublican Party. With a few exceptions, almost every President over the past 75 years has printed money and spit on the gold standard. (The exceptions were Truman, Eisenhower, and Clinton.)
But there is a way. There is no way for the vast majority to retire. But there is a way for a few good men to defeat the system made up by Keynes. You know that last week we talked about speculation. And you know that many people are trying to take their retirement out of the stock market. They are trying to make a speculative gain in the stock market and in this way make up for the money stolen from them by Keynes.
In this analogy, Keynes is like the gambling casino. He takes his cut off the top. Then all the players try to beat each other out for what is left. Of course, the vast majority of them are losers. However, there is one difference between a financial market and a gambling casino. Gambling is luck. You can’t count on it repeating. But financial markets follow the laws of economics. If you have a superior knowledge of economics, then you can wind up a winner.
Now the stock market is not a way for most people to retire. The stock market is a market of capital goods. When stocks go up, all it means is that the relation of capital goods to consumer goods has changed. It does not mean that there is more wealth. For an entire generation of post-65-year-olds to retire, there must be more wealth in the world. These people needs cars to drive, apartments in which to live, clothes to wear, food to eat, as well as a few of the amenities of life. Where will these come from?
Under the, Noah Webster system, machines increased productivity, and there was more wealth in the world. But that was the old system. Under the new system, the government prints money and eases credit. This makes the stock market go up, but it does not create more wealth in the world. So retirement becomes impossible – for the vast majority.
But let us see if we, the rational minority, can apply our superior knowledge of economics to make a speculative gain in the financial markets. First, we observe a very interesting phenomenon.. The increase in prices in American history can be dated with the Kennedy tax cut of 1963. (This was one of the great economic blunders of the 20th century, and, wouldn’t you know it, the conservative movement has embraced it for its own.) The tax cut of 1963 established a peacetime program of printing money as a regular part of the American economy (whereas, prior to that time paper money was only issued during war).
In the first, relatively mild, round of paper money, from 1963-71, the money supply rose. Consumer prices rose. But commodity prices did not rise at all. In real terms they went down. By 1971, commodity prices were extremely undervalued in real terms. Then they made up for this by exploding during the 1970s. The Commodity Research Bureau Index went from under 100 to 337 by November 1980.
When commodity prices underperformed (’63-’71), it exerted a moderating effect on consumer prices. But when commodity prices outperformed (’71-80), the higher commodity prices fed through into consumer prices. Ultimately consumer prices started rising at a double digit rate, and the nation was up in arms about “double digit inflation.”
This is the commodity pendulum. First the Fed prints money. Consumer prices rise, but commodity prices lag behind. Finally commodity prices get so undervalued that they explode to the upside. This feeds through into higher consumer prices. Finally, the Fed is forced to tighten sharply to bring prices under control, and the stock market turns down from the tightening.
This commodity pendulum was repeated in the ‘80s and ‘90s. The Fed printed money at a horrific rate, but commodity prices were going down. So this moderated the rise in consumer prices (which was given the name “disinflation”). Finally, commodities got so undervalued that they could go no lower, and in 1999-2001 they hit bottom in the 180-185 area (CRB).
The next step in the commodity pendulum is for commodities to rise so dramatically that it feeds through into consumer prices. This was starting to happen over the past decade. However, the prevailing orthodoxy says that prices are now going down. This is wrong as all we are having are some intermediate declines within the context of a giant, multi-decade rise. The economic establishment is like those people who cannot see the forest for the trees. They are up too close to events, and they have lost sight of the big picture.
With this analysis, it is easy to see where we are on the commodity pendulum. Commodity prices have been rising for some time. The rate of rise of consumer prices (according to the BLS) went from 1.6% in 2001 to 4.2% in 2007 and was over 5% in mid-2008. However, Ben Bernanke and all of the high muck-a-muck economic advisors of the Demopublican Party can only see the “dangers” of deflation. These idiots are living in the 1930s. Quite frankly, the best economist of the 1930s was the singer Eddie Cantor:
“Tomatoes are cheaper.
Potatoes are cheaper.
Now’s the time to fall in love.”
This means that the clever speculator has an almost sure play. The Fed ought to be tightening credit to fight rising prices, as it did in 1973-’74 (during the first upswing of the commodity pendulum). Instead, it is easing credit and printing money to fight an imagined decline in prices. What will be the result? Commodities will form bottoms, as gold has already done, regain their losses of last half 2008 and go on to new highs. What will it take to knock commodity prices down (really knock them down)? It will take a Fed tightening such as the above mentioned ’73-’74 tightening or the Volcker tightening of 1978-’80.
Is such a tightening on the horizon? All you have to do is listen to Ben Bernanke. He is living in Never-Never Land. The chances that he will tighten are very slim. And if he does, we would have plenty of warning to get out of any bullish positions.
So the clever speculator plays the odds. He watches the Fed. He listens to the Fed. He bets on the Fed to do what it says it is going to do and what it is actually doing. The lag time in the markets between the Fed’s actions and the different effects gives him plenty of time to get into a good position.
This is an example of the type of analysis I do at the One-handed Economist ($300 per year). It is based on the cause and effect relationships between the interference (with the free market) by the Fed and the resulting behavior of the various markets. If the money supply doubles, then prices have to double. Average commodities will double. And gold is the most representative commodity and easiest to trade. I also blog on political and social events (from an economist’s viewpoint) at my website, www.thegoldbug.net (no charge). I stepped aside from my gold stocks on Feb. 23 and am looking for a chance to jump back in.
Note: I criticized the New York Times for losing 90% of $2.7 trillion. My mistake. It was $2.7 billion. Still a good piece of change.
Thank you for your interest.
-- Posted Monday, 16 March 2009 | Digg This Article
| Source: GoldSeek.com
