The Devalued Dollar and Other Dilemmas
The phone call was like so many others. Katy was assessing the last ten months while attempting to make intelligent financial decisions.
Genuinely concerned, Katy wanted input on how to invest while the Federal Reserve prints money, deficits increase and pockets of inflation bubble up. What would happen with interest rates? What would happen with taxes?
Clearly, these are questions investors should consider.
Astonishingly, 25% of all U.S. dollars ever in existence have been printed in the last nine months. The recent $900 billion stimulus package is more financial fire power than was used during the entire 2008-2009 recession! That shows the lengths the Fed and Treasury went to in supporting our pandemic-challenged economy.
This response is not without consequences.
First, if you increase the supply of dollars by 25%, you devalue the ratio of dollars to Gross Domestic Product (total U.S. productivity). All things being equal, this makes the dollar less valuable.
A weaker dollar makes it harder for Americans to buy foreign goods or travel internationally but makes American made products more affordable for export.
Will the Biden Administration increase taxes? Maybe. However, that is probably not the highest priority of a new administration inheriting a struggling economy with high unemployment. Rather, the Biden Administration will find more ways to inject stimulus throughout the economy. The impact of sending cash to most American households increases liquidity and short-term spending, while increasing deficits.
At this point Katy asked how we can spend more than we collect without tax increases. Although increasing taxes is one option, politicians don’t like it. Rarely is the goal of a politician to make intelligent decisions. Rather, most politicians focus on re-election.
Knowing that tax increases are a double-edged sword, politicians opt to print money which further dilutes the dollar. Printing money is easier for Americans as we have the world’s reserve currency, and own the printing press. Most people don’t argue much as long as they are getting more stimulus.
Although printing money is the path of least resistance for elected leaders, it is a regressive tax on savers and fixed income investors. As long as interest rates stay low, it is a boom for borrowers and holders of stock market assets.
Katy then asked questions about inflation. If currency is printed and cash falls from the heavens, won’t it result in inflation? Theoretically, yes. However, we see pockets of inflation. If you are buying a house, used cars or health care, you are experiencing inflation. If you are shopping for technology, gasoline, a cruise or airline tickets, prices are declining. Inflation calculations are complex and depend upon your station in life.
Katy then asked how long the U.S. can borrow money and increase the deficit. The answer is far longer than any of us as individuals can. Much of the borrowed money is owed to ourselves. As such, it is not as if foreign lenders will foreclose on us anytime soon.
It is instructive to think about our nation like a tall skyscraper under construction. Our nation borrows tons of money long before the high rise is completed. As floors are completed, we earn “rent.” Rent is like GDP. Right now, we borrow at historically low interest rates and continue to build unlimited floors onto our GDP Skyscraper.
As long as GDP grows faster than our cost of borrowing, our nation benefits from the “spread” and an expanding economy.
Given these dynamics, how does an individual protect and invest their savings?
Holding cash for emergencies remains a sound strategy. Holding cash for long time frames is a guaranteed loser.
Traditional fixed income investors may think they are doing the “safe” thing. Unfortunately, once taxes and inflation are factored in the safe asset is guaranteed of losing purchasing power.
You could buy gold or bitcoin. If I took a wild guess, these will perform better than green dollars over the next twenty years. However, they both have significant shortcomings.
The patient and smart long-term investor continues to buy and own businesses. A well-run publicly traded business can offer daily liquidity and profitability around the world. The managers of well-run businesses command payment in whatever currency it takes to secure their product or service.
In addition to offering appreciation, well-run businesses share profits with their owners as dividends. Dividends benefit from low taxation and often increase over time. The average publicly traded business in the U.S. pays a dividend that is double the cash flow of a ten-year U.S. Treasury note.
Lastly, consider the champagne cork. There are multiple treatments and vaccines for the corona virus being distributed throughout the world. The world will be a much better place in late 2021. If the vaccines do their job and people return to “normalcy” you can’t put the stimulus money back in the jar. Rather, we will celebrate like we did after World War II. Tremendous stimulus circulating through society, and lots of pent-up demand, will pop like a champagne cork at a party. People will spend money and financial assets will jump.
Best wishes for a healthy and profitable 2021!