The Dollar May Be Dirt, But Cash Isn't Trash

By Andrew Packer

Keep Your Powder Dry as Deflation Reigns and Inflation Lurks

Government encroachment on the control of the money supply (which culminated with the creation of the Federal Reserve) has created with it the myth that deflation is an evil bogey-man that must be stopped at all costs.

The funny thing about deflation is what a normal and healthy thing it used to be—at least back when markets were closer to pure laissez-faire capitalism.

In fact, except for three periods since the creation of the Federal Reserve in 1913: immediately after WWI, the Great Depression, and now 2008/2009…infla... has always been the rule.

And it goes without saying that large cash holdings during deflationary periods can give you access to the once-in-a-lifetime investing opportunities that emerge right after a deflationary crash, as purchasing power allows for more assets to be picked up on the cheap.

So today we’re going to look at the “lost art” of cash management…how it’s been forgotten in recent years…and how it can make a world of difference for you in the coming months and years.

Gorging the Piggy Bank

The chaos and crashes that dominated 2008 served as a “rude awakening” for American consumers. And as a result, today’s deflation is the result of shifting consumer preferences.

Instead of loading up on unhealthy amounts of debt to finance a consumerist lifestyle, we’re seeing a shift to a healthier financial diet that focuses on cutting out debt and watching the balance sheet much more closely.

This is reflected best in the trend of rising personal savings rates, now approaching 5%. What a contrast from only a few years ago when the savings rate went negative!

Savings Spike Just When the Government Wants Us to Spend More…

Why did the savings rate go negative?

Because of artificially low interest rates, of course!

By keeping rates low, the Federal Reserve compelled money that could have gone into safe cash positions into other, riskier areas—such as the housing market, where easy money and irresponsible lending ruled the day.

But a home does not an ATM make.

The returns from real estate and even the stock market entail far more risk than cash-equivalent savings. What may appear to be an investment is more likely to be a mal-investment if incentives are distorted, such as by artificially low interest rates.

Well, Interest rates are lower now than they were in 2005.

Yet with so many people burnt or scared by plunging equity, housing and job markets, there is now a widespread urge to clean up personal balance sheets. The result: higher savings rates are here to stay for the foreseeable future.

Stockpile the Dough, But Be Prepared to Move

Right now, what I really see when I look at an increasing personal savings rate and a falling CPI is a bull market…and it’s in cash.

Sure, in the long run we all know the money creation by the Fed over the past 18 months will cause some serious inflation—perhaps even hyperinflation.

But we need to work through a slew of problems first.

Most of the cash that’s being created isn’t getting into the economy in the form of new loans, capital investment or jobs. Much of it is being used to shore up balance sheets—at the bailout banks. Any stimulus plan directed at consumers, like the one in 2008, will likely have a similar effect until debt is brought down to a manageable level.

Now, how much of your portfolio you reserve for cash will depend on a lot of factors such as your age, income needs and risk tolerance. But as this bear market rally continues, it may be a good time to liquidate some positions that have spiked in recent weeks.

When a Mattress Just Won’t Do…The Best Ways to Store Your Cash

We believe that, eventually, running the printing press will have inflationary results, so we need to store cash in short-term vehicles.

In The Sovereign Individual’s ((TSI)) portfolio, we prefer the iShares Lehman Brothers 1-3 Year Treasury ETF (SHY) and iShares Lehman Brothers Short Treasury ETF (SHV) in the Chaos portfolio are better than using cash to firm up your mattress... or insulate your home. SHY sports a 3.3% yield; SHV has a lower 1.7% yield. But if deflation persists, the real yield will be higher.

Not bad for the safety of Treasuries…and our Investment Director, Eric Roseman, believes that short-term Treasury bonds (five years or less) are reaching pretty attractive levels.

But what if you’re worried about a sudden drop in the dollar?

Then stash your cash in a basket of international currencies. By diversifying across several different currencies, you’ve got the lowest correlation and the best shot at preserving your wealth. TSI already has several open positions in FDIC-insured foreign currency basket CDs.

These include EverBank’s All-Weather Portfolio and the Asian Currency Portfolio. We’ve worked with EverBank for some time and we’ve been very pleased with the results. Their world currency CD’s are FDIC-insured, their currency experts are very knowledgeable, and they’ve got great customer service.

With the recent rally in the dollar, international diversification has gotten significantly cheaper.

Keep the Powder Dry—and Get More

If I were a central banker, I’d hike rates so aggressively that I’d make Paul Volcker look like Alan Greenspan.

Of course, higher interest rates would accelerate the process of deflation. And that’s why I’m not going to be allowed anywhere near a central bank soon. But in the long run, an accelerated deflation now would be healthy for the economy. Much like ripping the band-aid off quick and getting it over with…

It would stop forestalling the inevitable. Losses would have to be taken on bad economic choices. Businesses saddled with unserviceable debt would go bankrupt or get bought out at prices far below current levels.

But, ultimately, the recovery process would be that much quicker. And bad economic choices would indeed have bad consequences… making a repeat of the previous debt excesses less likely (at least in the near future). And it wouldn’t monetize the problems (shifting the burden to future generations) or grow the size of government.

Delaying the liquidation of bad banks in the 1930s helped prolong the Great Depression.

Fast forward to today, and pumping money into banks is the rage, and government spending is going through the roof, a set of worrisome conditions.

Deflation and rising consumer saving habits compel an overweighed cash position. It’s all about CYA—covering your assets. Keep the powder dry. The opportunity to pick up cheaper assets from gold to equities and commodities will come.

So be ye patient.

Comments

[PastTense:]

With such low interest rates as you are citing (SHV at 1.7%) you might as well put your money in banks (where there are no charges to either invest or withdraw money). Look at Bankdeals Blogspot for a compilation of the highest bank rates:
bankdeals.blogspot.com/

May 13 02:31 AM

[Jasper M:]

FINALLY! An author who understands the inevitability of credit deflation in the current situation!
Kudos.

Past,
High bank rates are Not a good thing to chase. The highest ones offered will be the ones that Know they are in trouble.
Normally you'd just count on FDIC to bail you on a failure, but with the death of a megabank or two looming, who knows what time consuming complications might arise to delay your payout? Hardly worth a few extra tenths of a percent.
Rather than cursing the darkness, let me instead recommend Weiss's list of the strongest banks in the US, which can be found at thestreet.com

May 13 05:14 AM

[DONE_SONZ:]

I will stay with gold.

May 13 06:11 AM

[DONE_SONZ:]

-Why did the savings rate go negative?

Because of artificially low interest rates, of course!

-Sure, in the long run we all know the money creation by the Fed over the past 18 months will cause some serious inflation—perhaps even hyperinflation
-until debt is brought down to a manageable level. Yikes!

May 13 06:30 AM