If a person approached me with a billion dollars and asked me how to allocate it to remain more or less completely liquid and to maintain purchasing power as much as possible, I would probably allocate 80% of it to a basket of short term instruments in several stable world currencies, and the remaining 20% would be allocated to precious metals and industrial metals.

Does that sound like a reasonable allocation?

I don't think of metals as an investment, I think of it more as a place to park wealth because you believe the metal will maintain value better than anything else.

I don't think it's any worse to own metals than to hold cash. Both holdings are not being deployed in wealth creation activities.

MrBill, tell me again why the ideal deployment of wealth is in creation of more wealth through investing in production.

Would you tell the squirrel filling his tree with nuts that he should actually be planting those nuts, growing more trees and then harvesting the nuts off of those trees? Of course, the squirrel would then need to hire some less savvy squirrels to help him, and there would need to be a squirrel bureaucracy set up to protect the worker squirrels from the capitalist squirrels......

My point is that the system I describe above would be vastly more unstable than simply gathering a personal supply of nuts and stopping there. If this approach works for the squirrels, why couldn't it work for us?

I suspect the answer is "because there are too many of us", which I would agree with. But if there are too many of us, then what is the point of an inherently unstable system in the first place? Isn't it just delaying the inevitable return to some level of sustainability?

I don't know the answers to these questions, but I think it's worth noting that our consumption needs have created a production mechanism that is far more unstable than people appreciate and over the long term is structurally doomed. It's structurally doomed because it creates the illusion of stability, all the while ravaging the physical world to fuel this illusion. Once the physical world begins to resist in the form of concepts like EROEI, loss of arable land, depleted fish populations and the like, the house of bricks may turn out to be a house of brick-shaped cards.

If you think it's not structurally doomed, please discuss why.

And to top it all off, excessive consumption almost NEVER brings the happiness that the consumer anticipates. Talk about a bad deal. The fruit of a ruined earth doesn't even taste good.

Excellent post, BigTex. You never fail to deliver!

BTW, I like the squirrel analogy. The world longs for more squirrel analogies.

I don't disagree with your take on gold, Mr. Bill. I'm thinking that in a hyperinflation, even in double digit inflation, most people will not be able to buy gold. It would be absurd beyond belief to even suggest, at the present time, that the middle and lower upper classes are buying. It's right off their radar. The buyers are people who are savers, by nature, from all classes and people with mega bucks and assets. More gold may be dumped on the market, in the form of jewellery in tough times, than is purchased.

The only reason I'm holding precious metals right now is in the event we have international chaos, in the form of expansion of war in the Middle East. I think this is a strong possibility, otherwise I'd probably encourage my husband to buy land in Northern Saskatchewan in the Prince Albert hub area.

Come on TEX.....You gotta buy OIL, at least a little, what else is going to have value. Thats the new global currency. Petro Dollars

I was doing that for a while, but once I filled up half my garage with barrels of crude oil I didn't have anywhere else to put it (my wife parks on the other side).

Threadbear, our farm is in NE Alberta not far from Saskatchewan. I like farmland anywhere along HW 16 from Edmonton to Saskatoon including N. Battleford. Unfortunately, Alberta is cooling, while Saskatchewan is starting to take off, so there may not be any bargains left. However, as a hedge against future uncertainty, land up there is not a bad investment. The climate and geology are the same, but the governments are traditionally right and left of center with Alberta being more business friendly and Saskatchewan being more socialist. Something to think about when you're paying personal income tax.

BigTex. As my grandfather used to tell my father, "50% is the sign of perfect workmanship. No wasted effort." If you want to produce up to your needs, and no more, great!

Excess wealth creation may not buy anyone happiness, but it can be a hedge against future uncertainty, and therefore buy piece of mind.

The dirty little secret is that we all live in the here and now, and so do our investments. Yesterday is gone. Tomorrow does not, yet, exist. Any investment assumes that the future will more or less look something like the past. But that is an assumption. The future, by definition, is uncertain and therefore contains risks.

If you only produce what you need, and no more, then you have nothing saved against the proverbial rainy day. You also have nothing saved for your retirement or for your children. You have nothing to insulate yourself against illness or injury. As you are a retirement planner, I am sure you are an expert on these matters, so I am a little confused about from where the question is coming?

If you generate excess wealth, beyond what you need to survive to live another day, you have two choices. Only two. Either consume that wealth today or save it for tomorrow. If a wino gets a dollar today he is going to drink it. For him there is no tomorrow. Unfortunately, for many wage slaves living from paycheque to paycheque their lives are not much different than a wino's. They spend whatever they make with little or no regard for the uncertainty of tomorrow. That is why they are wage slaves. Not because they have to work.

If you decide to save you have to choose an asset. Either a income earning asset or a non-income earning asset. Precious metals are non-income earning assets, but they are considered safe. Income earning assets generate future income, but are considered less safe. Less safe meaning getting your principle back or that future income streams are uncertain.

If you believe in post peak oil resource depletion, and resulting economic decline, then those future income streams would become less certain and therefore more risky. So you may decide that precious metals offer a better store of value against that future uncertainty than, say, stocks or bonds. However, land may also be a choice as it is a natural store of wealth, and it can generate a future stream of income either through agriculture production or rental income. Of course, adverse weather and bad tenants are the flipside of those income streams, so there is always risk.

But everything is relative. No asset has an absolute value. They all fluctuate in value relative to one another. Even when the British had Sterling backed by gold they said, "seven percent interest will bring gold from the moon." What they meant is that a stable pound backed by gold that paid interest of 7% p.a. would convince the holders of physical gold to exchange it for Sterling. So neither gold nor the pound had an absolute value, but traded up and down versus one another. Gold has always had value, but it has never had an absolute value.

There is a common perception that because all currency is loaned into existence that it requires unlimited growth. Popularly expressed as P / P + I where P = principle and I = interest. This may be a flaw in our basic understanding of money. This is my clumsy explanation of why.

First of all, yes, money is created out of thin air. So are stock certificates, bonds, land titles and speeding tickets. Whereas an inventory receipt represents a specific claim against, say, one ounce of gold or one bushel of wheat, a dollar bill represents a claim against all the assets of the United States including its ability to raise taxes. So long as that dollar bill is fungible and considered legal tender. You can exchange it for stocks, bonds, land or use it to pay your speeding ticket. You can use it to buy gold or wheat. Therefore that dollar bill is not a worthless piece of paper, but a valuable medium of exchange. It may, however, not be a good long-term store of value if the government is debasing its currency through its fiscal mismanagement and monetary prolifigy.

However, even if dollars can be loaned into existence, essentially creating them out of thin air by creating an asset on the Fed’s balance sheet that does not mean we require unlimited growth. At least not in the sense that many posters here assume.

But first, the demand and therefore the supply of dollars, or new currency, is determined by real interest rates. Nominal interest rates less the rate of inflation. Currently Fed funds is 2% p.a., and the rate of consumer price inflation is 4% (officially), so real interest rates are minus 2% p.a. Not only is it free, but the Fed is paying banks to borrow. That dynamic is probably why the CEO of the Dallas Fed says, "there is a frightful storm on the horizon"? There is zero demand for money in the real economy at the moment. More accurately the ability to pay, which is the flipside of demand. Far from unlimited growth, there is no ability to repay existing loans, much less demand for new money to fund growth.

Banks cannot use Fed funds to re-capitalize because loans taken from the Fed create an automatic liability. Re-capitalize means to re-build the ratio of assets to liabilities by adding assets. Not by increasing liabilities. Therefore, these loans are for liquidity and not a bailout per se.

So you not only need a supply of money, but you need a demand for that money. Interest is the cost of money. The demand for money depends critically on the expectation of being able to repay both principle and interest. If the borrower cannot repay the principle and interest then the bank has to repay that principle and interest to the Fed out of their retained earnings or shareholders equity. That is what is happening now.

If the rate of interest represents the time value of money (and resulting risk of default that entails) then that interest represents a claim against future wealth. Wealth is created when we turn land (including natural resources), labor, capital, skills and technical know-how into value-added products that we can sell at a profit. Profit = revenues – costs. It is profits, not unlimited growth, that pay for the interest on debt. Interest is a cost. If costs exceed revenue then you have a loss. Less wealth.

For the wage earner or consumer interest is paid out of savings. If a wage earner or consumer can earn ‘X’ over their lifetime then their (maximum) total consumption is X – I. Saving shifts consumption back. Debt shifts consumption forward, but also reduces total consumption. Unless the consumer dies in debt naturally. But on a macro level interest paid = interest earned. The net amount is zero.*

*Interest paid abroad on borrowed capital represents a net outflow of wealth from the economy through the balance of payments. Balance of payments = interest earned – interest paid on foreign investments.

Some wealth creation is unsustainable and therefore finite. The best example being the extraction of oil to be turned into petroleum products and then burned. Other growth is both sustainable and unlimited. A forest harvested sustainably can create unlimited value if managed properly. A farm managed properly can produce indefinitely. Labor is a near limitless resource. But just because these resources are technically unlimited does not mean that we cannot abuse them, and through our mismanagement of those resources deplete them. The best example being over-fishing, a collapse of wild fish stocks and the destruction of marine habitats.

If we destroy our ability to create new wealth then our economy must shrink in size over time. That makes those future claims on wealth - interest on debt - higher in absolute terms. If the money supply does not shrink then you have too many dollars chasing too few assets in the real economy, which is our definition of inflation. So a shrinking economy can generate inflation or deflation depending on money supply.

Once the principle is returned to the Fed – or indeed written off as a loss – then the asset created by the original loan disappears as if it never existed. Interest paid = interest earned. And we are left with whatever wealth was created or destroyed in the real economy. Our total stock of land (including natural resources), potential labor, skills and technical know-how as well as retained earnings or capital. That capital can be assets or physical commodities. Income earning assets or non-income earning assets. Productive assets or wasting assets. Stuff.

That would, of course, include any retained earnings or shareholders equity on the Fed’s own balance sheet. Which in turn are assets on the Fed’s shareholder’s balance sheets. Which are those bank’s shareholder’s assets that represent a part of their net worth or personal capital.

So unlimited growth can be defined as finite growth at any point in time multiplied by time itself. The only alternative to unlimited growth for mankind to meet our basic needs is to die-off. But even then Nature is a living example of unlimited growth. Right up until we supernova. By the time we supernova a few debits or credits on some long-forgotten central bank’s balance sheet will seem not only beside the point, but quite absurd.

A good explanation MrBill.

MrBill, thanks for the comments. Good stuff.

However, note that my squirrel example was ALL about planning for the future. The squirrel gathers the nuts for the purpose of preparing for future uncertainty. The point I was making was that preparing for the future does not necessarily mean deploying capital in further wealth creation activities--sometimes simply preserving value is sufficient, especially in an environment where everything looks unusually risky.

For a human, gold could be considered somewhat analogous to a squirrel and his nuts. That said, I'm not a huge fan of gold, but I do like the Permanent Portfolio 25% gold allocation, based solely upon its past performance as part of that portfolio.

BTW, what I do is more along the lines of retirement plan design, as opposed to retirement planning. I work on things like how pension plans design benefit formulas, how they invest their assets, what funding assumptions they use, etc., with a focus on the tax aspects of retirement plan design (from the employer's perspective). From a macro level, I'm what you might call a "Squirrel Nut Quartermaster."

A great piece of work there M. Bill. A shame that the vast majority of Americans who need such understanding will never read it.

The one note that caught my eye in particular was "If we destroy our ability to create new wealth then our economy must shrink in size over time." In retrospect, it's easy to see how even bad aspects of the system (junk bonds of the 80's & the recent subprime mortgages) can spur growth. Of course, when such plays end badly and there is sudden and massive losses in equity (i.e. - current housing market) the folly of such plays becomes all to obvious. Though rarely mentioned at all is the wealth generated by the current price boom. Many who take shots at the Exxon's et al aren't aware of the great gains they perhaps have made themselves through the pension funds and other collective investors who own much of the oil industry equity. Add to that the royalty incomes of private mineral owners as well as local production taxes. The taxes paid on these revenue streams is obvious to most. Less obvious is the identity of the largest beneficiary of oil income in the US: the Federal government. In 2007 the Feds sold 585 million barrels of oil in the US. This oil is the royalty payments (most from the offshore leases). The number 2 seller was BP at 525 million barrels. Shell, Exxon, Chevron and the next two largest producers sold a combined total of less than 300 million barrels. It's a shame that no one in the government has pointed out to the Amercan people that they are getting at least a small rebate on their increased fuel cost. But then the people might expect some of the $35+ billion returned to them instead of being spent on an ever expand government.

It's easy to imagine the political reaction when real PO events become obvious to the general public. At least in the short term, one might expect political knee jerk reactions that could damage this new wealth -- the proverbial "unintended consequencies". I doubt the labor unions will be to happy to learn of the billions of dollars of lost stock equity should Fed actions drive down the market capitalization of the enegy sector.

The government is quite happy to tax sustainable as well as unsustainable growth. They do not care. If you earn a million this year and are broke next year that is your trouble. They want their piece of that income earned. Aside from carrying losses forward I suppose.

Ironically, the government even taxes you on capital gains that is caused by their excessive creation of money and resulting inflation. The flipside of socializing risks and privatizing profits is the government collecting royalties from oil companies and taxing gasoline, while letting oil companies take the political heat from higher prices at the pump. A nice little side step.

My understanding of P/P+I is that payments of loan principal are retired from circulation (hence money supply decreases), causing an equal decrement to both asset and liability side of the bank balance sheet , while payments of interest increase bank equity, and are respent into the economy, permitting other borrowers to acquire this money and repay the interest they themselves owe.

In other words, as long as money circulates and is not 'destroyed', a given quantity of money can technically allow the discharge of debts of many times this amount.

However, since all money is created as the principal of a loan, one person's interest repayment is another person's principal repayment. Thus we have competition among borrowers for money to repay both principal and interest. The larger the supply of money, the more gentle this competition and the easier it is for borrowers to repay, while in times of monetary contraction, the competition intensifies and loan defaults become more common.

Apologies if this is a trivial post.

Trivial? Hardly. An excellent post! Thanks. It is so hard to get one's mind around the creation of money. Perfectly logical if one borrows it from the bank. Not so straight forward to understand how someone that has never taken a loan from the bank ends up with money in their pocket. How does one change mellons into moolah?

Hey, thanks for WWI.

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