Protecting Asset Values in Times of Trouble

Can the value of assets be protected in times of economic trouble? In the free market system, asset values are under the consumers’ diktat. In this environment, one can only succeed at maintaining or growing asset value if one serves consumers better—asset values are never secure. In Western countries (let alone elsewhere), the state often adds uncertainty to that which exists in markets. The current situation is perhaps a good example of state-generated uncertainty. An important question is what to do to protect one’s own assets from (state-generated) inflation and economic turmoil?

What to do will depend on (a) how severe the meltdown is and (b) whether the rule of law and the institutions remain in place as the country goes through the crisis. Here are some ideas:

• Buy non-perishable commodities that hold value and can be stored and protected easily. Gold comes to mind immediately. Gold has been a good hedge against inflation in the last few decades.
• Buy and hold real property for a long time, plus diversify asset location. The Economist, which this week has an interesting article discussing the subject (p. 84), mentions buying a sheep farm in New Zealand. Other countries come to mind: Australia, Hong-Kong, Norway, Singapore, Sweden, Switzerland, and United Arab Emirates. There are others. Check the corruption index and the strength of the rule of law. Holding real property for a long time is a good way to go through the ups and downs of the market without losing money.
• Buy a basket of currencies from Central Banks with a solid (anti-inflation) reputation. Countries that have current account surpluses such as Japan (the Yen) and Switzerland (the Swiss Franc) are mentioned in the article. The New Zealand and Australian dollars could also be considered even though both countries have run current account deficits in the past decade because they are net borrowers and growing. The Euro should also be considered (as long as the Germans are in charge of it) as well as the British Pound. Another issue to consider is where to keep the money. Opening bank accounts in foreign countries is not terribly difficult these days and can be managed remotely easily via the Internet.
• Buy blue chip securities in the same countries you would buy land or currency from, and hold on to them for many years. As Jeremy Siegel has shown, stocks in the long run are a good hedge against inflation and many other economic woes. (And make sure your securities are in your name and not in “street name” so that if your brokerage firm goes bust, you are the true owner.)

Other suggestions? While it may be possible to protect oneself partially from a severe financial meltdown, ultimately, there isn’t much individuals can do to avoid losses when institutions break down.

Comments

[DPrychitko]

"As Jeremy Siegel has shown, stocks in the long run are a good hedge against inflation and many other economic woes."

Yes, but he doesn't recommend betting on individual stocks.

[Leonardo, Ihc]

"Central Banks with a solid anti-inflation reputation" Do they really exist?
The lesser evil is no way the good, 'tis evil anyway: you can protect against inflation in relative (i.e. euros, or NZ dollars) terms, whilst still suffering of your hedger's own inflation (e.g. euro M3 rising), which keeps you still far from protecting your wealth in goods (e.g. food) terms (and you ate eat and will eat goods, not euros).

[Jeffrey Friedman]

As a noneconomist, I have a question for you guys.

Assume for the sake of argument that alternatives to central banking would not get rid of "business cycles." I wonder if, in compensation, anybody with money to invest could be assured that by buying bonds, they would get a stable return. Thus, bonds--rather than inherently speculative equities, and other alternatives such as those mentioned by Frederic--would be what people who were trying to provide for their old age would buy. Granting the argument of Keynesians, then, people would be more economically insecure in the short term, but less so in the long term. (I.e., those people who were not so poor that they could not afford substantial investments of any kind.)

If this is true, it would seem to be an underused argument for alternatives to central banking, even setting aside whether the alternatives would do better in preventing business cycles.

Jeff

[DPrychitko]

Jeff: One consideration: the market value of bonds themselves change; one can enjoy capital gains or suffer capital losses on bonds.

[Frederic Sautet]

Agreed with David Prychitko's and Leonardo's comments.

Jeff. I am not sure why government bonds (and I assume that's what you are referring to) would be a more secure alternative. In the U.S. T-Bills are considered the least risky security. They are short term bonds. Treasury bonds generally mature over much longer periods, such as 30 years. Over that period, their market value can vary depending on the interest. Clearly the risk of default of the U.S. government is close to non-existent over 1 year and is very small even over longer periods. But were that risk to grow, it would have an impact on the value of bonds. If the public debt in the U.S. were to become such that the government's capacity to borrow further was jeopardized, it would surely impact the value of T-Bonds. Also, the Treasury offers quasi risk-free bonds in part because the state can always reduce its debt and liabilities through inflation (although the Treasury offers inflation protected securities as well). So in the absence of a central bank, the capacity of the state to offer quasi risk-free debenture would diminish.

[Vedran]

Frederic Sautet,

I don't think that I would truly consider gold an inflation hedge. I would consider it more of a safehaven for money during tumultuous economic times especially associated with high inflation. However, gold does not actually hedge against inflation at all times.

But I agree that it's still a good investment for today. The peak in the early 80's after inflation based tumultuous years was something around $850 which is about $2400 in today's terms. I think Gold has a long way to go maybe even 1400 to 1500.

[Leonardo, Ihc]

@Jeff

You can consider that a fix rate bond gives you a "stable" return during time. If you'd have a 30 years horizon and buy a 30 years fix rate bond you avoid both market and interest-rate risks.

But you keep gathering proceeds in money-terms, hence being exposed to inflation risk with the sole hope that your fix rate can compensate your money depreciation.

If you'd buy a floating rate bond, you still remain unhedeged though, as you'd gather lower coupons during inflationary periods as the Central Banks would be struggling to keep interest rates low. And you keep gathering monetary coupon, not goods coupon.

Have I answered you?

[fundamentalist]

Jeff,
If we run into a period of high inflation, which is very likely, you'll lose a lot of money on bonds.

Currently, I'm in an FX managed fund. I should make some money if the dollar continues to fall (due to continued Fed monetary pumping) and more if it recovers.

For those who like stocks, I would recommend timing the market using the info in the Austrian Business Cycle Theory.

[Mario Rizzo]

Take a look at the "Permanent Portfolio," a fund originated by Harry Browne with a good track record and lots of diversification.
http://permanentportfoliofunds.com/perm.htm

[Jeffrey Friedman]

Gentlemen--I didn't make myself clear. I wasn't asking what to invest in. I was asking whether, *under an alternative to central banking,* where inflation risk might be lower but, arguably, deflation risk would higher, a neglected benefit would be that people could plan for their retirement by investing in bonds without so much inflation risk.

I didn't specify government or corporate bonds, which is an obvious problem. Nor was I asking whether bonds would be a better investment, all things considered, than equities under such a scenario. I was just asking if people might better be able to minimize their risks than under the status quo.

In my admittedly amateurish way, I am trying to address the fact that people (like me) are generally ignorant about the future; but that under central banking, a new uncertainty is (perhaps) added: the value of the currency in which one has one's savings.

Jeff

[Steven Horwitz]

I think your last point is right Jeff. If monetary institutions are notably less likely to produce inflation, one source of investment uncertainty is reduced. But the problems caused by inflation apply to more than just bonds.

In fact, I think there's a more general point here that I have made in the past: central banks in general add to social uncertainty by forcing actors to include one very large and unpredictable institution in their calculations about the future. That is, they add to the epistemic burden faced by actors because they add (unnecessarily) to the total amount of uncertainty they must deal with. Not only do actors have to anticipate the future of market variables, they must anticipate the Fed. (This also parallels Roger Koppl's work on central banks as Big Players.)

So yes, in a world where the risk of inflation is very low and central banks as institutions are not part of the epistemic burden, e.g., under free banking, investment becomes that much less uncertain.

[Jeffrey Friedman]

Steve--Maybe you made that point in Critical Review and it's been lying dormant in my brain until now?

Jeff

[Steven Horwitz]

I actually can't remember exactly where I made the point I was thinking about Jeff. In my "The Cost of Inflation Revisited" paper in the RAE in 2003 I make a version of the argument:

"Inflation also changes the kind of knowledge entrepreneurs must have. Assume an economy that has historically been inflation-free. Entrepreneurs have built up years of contextual market experience that enables them to formulate their expectations of future prices in order to make capital-relevant decisions. If inflation appears, accurately envisioning the future constellation of prices now requires the kind of knowledge they already have, plus a new kind of knowledge about the likely behavior of the monetary authority and the possible effects of its policies. There is no reason to expect that this kind of knowledge can be easily acquired by existing entrepreneurs who have invested in acquiring other kinds of knowledge. At the onset of a period of inflation, monetary calculation will be undermined by this shift in the kind of knowledge necessary for choosing profitable production processes. The obvious effect of this shift is that actors will now begin to invest in acquiring more of the new kind of knowledge. In the meantime, however, they are likely to make more errors with respect to capital decisions than they would in monetary equilibrium, and some portion of the costs of those errors will be irretrievable, thus constituting waste from a comparative institutions perspective."