petec

I don't think I referred to the success or failure of societies. I simply said that very few if any societies have ever stuck to a truly hard currency because the discipline required to do so seems beyond us, even if (and I do mean if) the overall impact is positive. It seems to me societies start with hard currency, eventually succumb to the siren song of fiat currency, and then find that confidence is lost in the currency and go back to hard(er) currency. That seems to be a natural cycle to me, explained more by human psychology than anything else. The cheapness of smartphones, amazing as they are, is hardly a rebuttal of inflation. My contention is that, like for like, the expenses that I consider critical for my life are much greater than they were. Lucky you if this is not the case for you!

This is 100% correct for productive investments. It is not correct for unproductive investments or for consumption. The acid test is whether activity expands as fast as debt does over the long term. If not - if debt rises as a % of gdp - you are borrowing from the future. I'm not sure where the austerity comments come in. I was debating gold vs. fiat, not alternative fiscal policy in a fiat regime. I do actually agree with you that printing money is probably the least painful way out of the leverage we find ourselves in. But it will be painful, because inflation always is (and without an inflation we will not delever). My point was more that hard currency, as a rule, seems to promote more innovation, more discipline, and ultimately more wealth creation/progress. That's because it forces you to work hard. But people don't like that.

Because for most of that time we have been levering up like crazy, borrowing from the future. As you will know if you've read my posts I am not a gold bug. However, nor will I declare victory for fiat currency until we have been through a whole cycle. We have been off the gold standard for 45 years. The first 10 of those were hellish economically and since then it has taken 35 years to lever the world, which we may only have gotten away with because inflation was dampened (if indeed it was - see below) by a one-off influx of labour into the global marketplace and an incredible pace of innovation. If we can sustain this level of leverage without pain, or we can delever without pain, then fiat currency wins. No question. But finding that out might well take another 35 years. As for your other points: - there is huge inflation in the world. The cost of buying shelter (housing) and saving for retirement (assets) has exploded through the fiat leveraging cycle. Inflation hasn't reached CPI, but that may at least partly be because CPI is understated (see www.shadowstats.com for excellent work on this). I know I spend a LOT more to live than I did 15 years ago. - I don't know if you've noticed, but there is a hell of a lot of mining for gold in this world today. That's because, whether we like it or not, people know governments can't make more of it and therefore politicians can't erode its value. The gold standard doesn't encourage mining gold but printing money sure does.

Wachtwoord: the gold standard lasted LONG after gold ceased to be carried around in people's pockets, as I'm sure you know. The gold was stored in vaults and little bits of paper that said "go to my banker and he will give you gold" were traded instead. Why can that not be done digitally? This is a genuine question, not a dig! I'm fairly ignorant of Bitcoin so I hadn't considered the Bitcoin vs. gold argument very well. Richard: don't be too persuaded by my arguments. The gold standard has one fatal flaw: it works by enforcing discipline, and humans don't like discipline. Politicians don't like it because it enforces fiscal discipline on them. Populations don't like it because every now and again, when it enforces discipline on them, it hurts (briefly). And populations like policies that the gold standard just can't co-exist with, like the minimum wage. The gold standard doesn't work because no society has ever had the discipline to stick to it.

Jim Rogers in Investment Biker makes the opposite argument. He says that if governments persistently devalue to keep the economy competitive, companies don't innovate. By contrast, governments that sustain a hard currency force their companies to innovate to compete, and by doing so create real wealth (as distinct from money). Europe would appear to be an excellent example: every single one of the Eurozone currencies devalued against Germany in every single one of the five decades before the unified currency. By contrast the mark was one of the hardest currencies in the world. Which Eurozone country has the strongest companies, the most innovation, and is the wealthiest? Inflation does not create wealth. Mainstream economists hate deflation for three reasons: 1. They think it delays purchases. TCC has rebutted this very well - I would just add that if the money in your pocket keeps getting more valuable, aren't you more likely to spend it because you find you can afford things you always wanted? I know I would be. 2. They blame it for the Great Depression. 3. If they accepted hard currencies and market primacy they'd all be out of jobs in which they teach how clever macroeconomic management can prevent the terrible consequences of hard currencies and market primacy ;) Concentrating on #2: First, deflation can be caused by innovation in a hard currency environment or it can be created by a deleveraging event. The first is not dangerous; the second can be. Second, deflation was a symptom of the great depression, but not the cause. Many people thought it was the cause then, and many still do, but if you understand that money is simply a way of measuring activity then you'll understand that price changes can't really be very causal in driving activity. (Relative price changes do drive activity because they signal economic need and guide the allocation of capital, but general price changes don't.) In the 1920s there was a huge credit expansion, meaning money got created through fractional reserve banking etc. This drove prices up (more money chasing roughly the same amount of assets and produce). Starting in 1929, this process went into reverse and prices started falling. This process doesn't have to be harmful to most real activity. What it does do is show who's been using debt to invest in bad projects, as so often happens in a credit boom. And to the extent that those bad projects stop, there's a temporary impact on real activity. Now, if you allow prices to fall in this situation you're ok: less money, broadly the same activity level, lower prices. But you have to allow prices to fall. If you organise labour to keep wages up, and organise pools to buy commodities to keep their prices up, you will cause chaos. As prices of goods fall companies must be able to cut labour costs or go out of business. As market prices of commodities fall, you need to get to the point where they are so cheap people want to buy them, but stockpiling prevents this by a) holding up the price and curbing demand, and b) causing a huge overhang which does cause people to delay purchases. Hoover did everything he could to stop prices falling, because he believed that falling prices was the cause of the problem. He organised labour and commodity pools. Yet in fact, deleveraging and money destruction was the cause of the problem, and falling prices was a natural consequence of that - and a very healthy one, if left to operate properly. A similarly rapid deflation fixed itself in 18 months in 1921, because nothing was done to interfere with markets clearing. It's important to understand that a deleveraging/deflation episode must come to a stop. This is because while deleveraging can destroy all credit-created money, it can't destroy base money, so the amount of money in the system will never fall to zero. If prices keep falling, they will eventually look so cheap that buyers will be motivated to buy, and prices will stop falling. Credit deflations end themselves naturally if markets are allowed to clear. The other alternative solution to excessive leverage is inflation to make the debt go away. This involves price controls (like the minimum wage and inflation targeting, which I think is a really dangerous idea) and rapid creation of new fiat money to offset money destruction via deleverage. This is politically popular - people don't like wage cuts or having to pay their debts by working hard - but as Rogers argues, it probably impairs innovation and wealth creation, and it also means ever-higher levels of debt. In the next 20 or 30 years, we will find out whether fiat money and stunning debt levels are worse than hard money and less debt. Sorry for the long and very off topic post!

Why is deflation in the situation you describe a problem? This is the situation that ruled in the US from 1776 to 1913 (and arguably 1936 or even 1971). Those were, overall, pretty good years. There is absolutely nothing wrong with structural deflation of the type you describe. What *is* a problem is financial inflation (credit boom) followed by financial deflation (credit bust) when prices are not allowed to fall. If you allow money to be destroyed through deleveraging, you must allow prices to fall. Eventually they will stop falling because the process of deleveraging and destroying money will slow. Preventing prices from falling during a rapid deleveraging (as Hoover did in 1930-32) is disastrous. I found reading Jim Grant's book on the 1921 depression and Murray Rothbard on the great depression, one after the other, very instructive on this topic. There is a solid case to be made that if Calvin Coolidge has been President in 1930, the great depression would have lasted a couple of years only. (There's also a solid case to be made that if the Fed hadn't existed, the credit boom that preceded it would never have happened either.) Bottom line for me is that you either need to allow occasional rapid painful recessions under a gold standard, complete with deflation including wage deflation, or you need to go for a fiat currency on the understanding that you can probably prevent wage deflation and the really painful parts of the cycle but you'll destroy the value of the currency over time and you'll probably dull the wealth creation process a bit through capital misallocation. Both work. The former is more attractive to hardline market theorists, but the latter is easier politically, so it is where most societies end up over time and it is where we are now. I'm not arguing for one or the other, but it's crucial to understand what system prevails and it's clear which one does!

I totally agree that QE should be spent in the real economy, not the financial asset economy. Problem is, I don't trust government to allocate the capital particularly smartly, so I'm less sure it would be great for growth. But it would be better than what's been done.

Yep. Amazes me how few people know this (and how few mention it when explaining the inflation of the 1970s).

Global QE is at all time highs (Europe and Japan) and money is leaking to the US, is my guess. Plus China stimulating like crazy and I suspect money is flowing out.

Driven by?

Mine would be: 1. China. So far every time they slow they stimulate like hell. One day it might not work. 2. Japan. A slo-mo car wreck and possibly the place that first demonstrates that central bankers are not all-powerful. 3. A common-or-garden US recession, driven by the fact that recessions happen sometimes. 4. Rate rises - although QE is currently at an all time high globally which may render this irrelevant. 5. More sellers than buyers. What happens if a few more people start thinking this way? 6. Europe - several elections coming up and the future of the EU will be a topic in all of them. 7. Inflation or deflation. Both would be nasty.

Why? It's better to be optimistic about these things than pessimistic; even if you get a lot of zeroes you also hit crazy multibaggers part of the time. Obviously Theranos isn't public, but the same principle applies. Doubters and minor-league thinkers don't really accomplish anything. People like Elizabeth Holmes are the ones who move the world forward, for better or worse. she lied about how good her products were and allowed defective products to be used on real, live, people - with the potential for serious harm. Dreamer - or psychopath?

I think it's especially important to read in depth if you're new. As you get more experienced you'll learn what to look for and I can now go through the average 10K in an hour or two finding the things I need to look for, and I really enjoy it. But the process of getting to that point - learning what is what, and how to spot what matters - was absolutely invaluable. Don't get demotivated. - If you find one too hard, try another! - When you get stuck on something, forget about investing in the stock and make it your goal to understand that thing. One by one you'll master the common complexities until you start finding it easy. - And also remember, some of these things are deliberately done/written in a confusing way. As a rule avoid these stocks!

No but I might look if I have time.

Good post SD, although I used a different framework to own a couple of these (not using margin). 1. I bought at a substantial discount to par, implying a good chance of capital uplift if something goes seriously wrong with the company. Why? Because both have significant cash flows with which to pay down debt if equity holders pressure them to do so. There's a solid chance the prefs are money good and in a liquidation I get paid back up to par, not up to my purchase price. The possibility of doubling your money in a bankruptcy represents decent downside protection. 2. I bought at a yield that exceeds the long run historical (and in my opinion the likely long run future) total return of the broad *common* stock market. These yields can't drop much because they are calculated as spreads over government rates that a) are already low, and b) can't go negative because in both cases I own (or can convert into) prefs that pay a spread over the 3-month T-bill, which is too short term to have a significantly negative yield. Of course, that assumes that the prefs are money good and again in my opinion they are. 3. I bought two of the very few securities available globally that are genuinely positively geared to inflation. Inflation will hurt nominal bonds and also stock multiples. However, it will also allow interest rates to rise. When that happens my yield is very levered, because the dividends are calculated as rate*par, and par exceeds my purchase price. For example, a 1% rate rise on par value of $25 gives a 2% yield increase on a purchase price of $12.50. The capital is likely levered too, as the price would rise towards par as the payout rises. Both companies would also likely/possibly benefit in a general inflation too, so their ability to pay would not be impaired. Overall, so long as I'm right that the prefs are money good, I get: 1. Good downside protection. 2. A very solid return whether monetary and economic conditions turn deflationary, remain stable, or turn inflationary. Clearly the "money good" caveat is a huge one but I don't spend a lot of time worrying about why I've seen an opportunity before others have. To be a value investor you have to believe this is possible, and so I'm not too sceptical when, every now and again, it happens. These are slightly esoteric securities belonging to complex companies that aren't very liquid and that have seen payouts drop a lot as rates have reset, so I don't find it hard to see why they might have been sold off too far.

So is this essentially a straight transfer of value from the convert holders to the equity holders (lower interest payments)? Edit: not so simple, hadn't noticed the convert holders were getting 106.7.

I do wonder whether these relationships break down at interest rate extremes. If not, then 50x earnings with rates at 2% is the equivalent of 33x earnings with rates at 3%, which seems a little crazy to me! And we all know that stocks wouldn't stay where they are if earnings dropped, say, a mere 30%.

Ok that's true, but shouldn't then P1 be discounted again to P0? According to an admittedly simplified Dividend Growth Model: P0 = D1/(r-g) ~ (D2/(r-g))/r ? The point is, could the market in the 1960s e.g. had predicted current earnings from 2016 and then discounted them correctly. It would be cool to have 40y rolling eps predictions to see the possibly permanent underrating of g or overrating of r. I think you are still confused. Even if market correctly predicts and discounts all the growth and earnings, the value at year zero (e.g. 1960) is different from value at year 1 (e.g. 1961). For some reason you keep thinking that if you make perfect predictions, then value doesn't change as time passes. However, it does. Play around with DCF calculator (this for example http://moneychimp.com/articles/valuation/dcf.htm ). Write your own. Maybe that will convince you that what I say is true. :) E.g. plug in into DCF calculator, FCF of 1, the growth of 5%, discount rate of whatever, 30 years of growth, then no growth. That gives you the value of security - in your case the whole market - at year zero. Then plug in into DCF calculator FCF of 1.05 (it grew 5% as you predicted), same discount rate, 29 years of growth, then no growth. That gives you the value of security at year one. Have fun +1

Ha - credit risk in the US equity market might be non-existent looking back, but securities aren't priced looking back, and there is always plenty to worry about looking forward. If you are 100% confident that the future will look like the past, and you're happy to accept (say) a 5% return, then you'd pay a lot more for the equity market in aggregate than I would. Also the market, in aggregate, is not really priced by investors. It is much more the case that individual stocks are. And there's *plenty* to worry about with each of those. So yes, if you assume that investors correctly estimated cash flows for 100+ years the implication is that the discount rate was c. 7% for equities, which includes a risk free rate and an equity risk premium. (I believe that long term return number also includes inflation.) The reason that the market goes up over time is that every year you get one year closer to your cash flows, so you can dispense with a year's worth of discounting.

The time value of money is your answer. Cash flow X, to be paid on date Y, gets discounted by rate Z to give its value today. As time passes, you discount by less time and so the value today rises, even if your assumptions for X and Y were perfect. Uccmal's point about population growth feeds into GDP, which feeds into the growth rate you assume in calculating future cash flows. But I think your original question was less about what drives cash flows up, and more about why (if the market has already efficiently estimated and discounted future cash flows) the inflation-adjusted price rises over time. The answer to that is the time value of money.

A good point I hadn't considered.

Wine most nights.

Fair point. Then, make voting on pay compulsory and implement automatic rejection unless e.g. 67% of shareholders agree. Plus, institutional shareholders should have to report to their clients every year on which pay deals they voted in favour of, and why. And yes, yearly. Finally and more controversially, I'd consider requiring 50% of employees to vote in favour, too. Probably not a good idea (I haven't thought through the unintended consequences) but interesting to consider - they will have as good an idea as anyone whether the CEO is good, and it will increase the incentive of the CEO to treat them well which, IMHO, is likely in the long term interests of shareholders. Ultimately I as a shareholder hire the CEO to control employee pay amongst other things; why not hire the employees to control CEO pay? If this is happening everywhere there's no incentive for a CEO to leave. Not if shareholders start voting, they won't. Ultimately the goal for me is not to reduce CEO pay per se, nor the pay gap. It is to ensure that interests are aligned which they are clearly not at the moment (most glaringly because stock options=no downside risk and because institutional ownership=beneficial owners don't vote).

My view is that you can't decide whether the increase (or absolute size) of the gap is relevant until you understand what causes it. A few ideas might be: a) globalisation/technology = rising competition for "average" jobs, at least temporarily. b) low interest rates. CEOs get paid with stock options and stocks have probably been rising a lot faster in the last 30 years than they would have if rates hadn't gone to zero. c) increasing institutionalisation of the shareholder base. Fund managers earning millions probably don't find it odd that the CEO earns millions. d) momentum. CEOs sit on each others' boards and compensation committees. There's a comparative/circular element to rising salaries. How about the following: a) CEOs can only be paid in cash and they must spend 50% of this buying stock at market, with a 10-year lockup. Intended consequence: shareholders feel the true cost of pay, and CEOs have downside as well as upside, like a normal shareholder does. (Unintended consequence: an amusing incentive to talk down your stock and not juice your earnings.) b) CEO packages can only be approved if shareholders vote in favour. Otherwise, they default to 100x the lowest full-time salary paid by the company. Intended consequence: shareholder activism is more likely to work, and CEO's have a bigger incentive to engage. (Unintended consequence: CEOs are a little more likely to increase their lowest wages.) Not perfect, I'm sure, but maybe better aligned? EDIT: to be clear the aim of this is not necessarily to lower the gap. I have no idea what the gap should be. My interest is: how do we set the right pay and incentives for a CEO?

There are other forms of collateral than a house. Of course. But, a) none that I know of that can be borrowed against so cheaply, and b) the OP specified not buying property, which I (rightly or wrongly) took to mean not having to have collateral.