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Interpreting Risk, Profit and Real Gains on the Markets

The way the Fed normally judges dollar inflation officially is by comparing the dollar exchange value against a key basket of six other major fiat currencies in the dollar index. And so if the average devaluation in terms of purchasing power of this basket of currencies over 2010 was say 17% and the dollar has devalued over the same 2010 period by 20% then then this will perpetuate the illusion that the dollar has really only devalued by only 20 - 17 = 3%. 

However when the US dollar is compared against the solid worth of an actual commodity like gold in Feb 2010 versus now -- this tells a completely different story -- this calculation tells us that the dollar has actually been devalued by 18% by the beloved Fed, between last year and now (calculated from kitco.com historic charts). 

And if we now go extreme and calculate the dollar's devaluation in purchasing power against gold between Feb 2001 up till now, then we see that the dollar's purchasing power has already been eroded and devalued by 81% over this 10 year term !!

And for all those keen long and medium term US investment punters out there, here's another calculation of interest which might bring you back to Earth with a dull thud. By my calculations, the total rise in value (and therefore profit) from the Dow Jones Index between Feb 2010 and now works out to about 15.4% profit. Yaaaay!!...Horray!!...Yipee !!....Ah but against that you must also subtract the actual devaluation through real inflation of your profit in terms of dollar purchasing power -- which is 18%. This works out to about 18 - 15.4 =  -2.6% profit. So if you didn't make more than 18% profit last year on the markets -- then you made a loss in terms of the purchasing power of the dollar. Pretty tough for medium to long term punters starting out with a profit handicap of -18% purchasing power depreciation. With the Fed still pumping out the QE paper as never before, I have absolutely no reason to believe that there will not be a very similar dollar devaluation occurring this year in the markets.  

So the dollar's purchasing power will most likely continue to rapidly decline in value and drop like a stone with perpetual QE, while sham excuses and denials fervently continue to spew forth from a totally unchecked and unaccountable Fed. 

So, the lesson here is that an increase in dollar digits tells you nothing about the true purchasing power of your greenbacks. So watch the real inflation ball carefully.

Purchasing power never ever lies...



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.