The fallacy of inflation

We are told by our government and the Federal Reserve that inflation is an enemy that we have to watch closely. That it is attacking us on all fronts and that they are working and watching diligently to keep it from getting us too far in its clutches. In fact, their stated goal is not even total defeat of inflation, but instead they aim to hold it to “only” 3-4% per year.

Just to put that in perspective, inflation of 4% per year means that whatever you can buy for a dollar this year will cost you $1.04 next year, the year after that it will be $1.08, and 20 years from now it will be $2.11. So basically, if you’ve calculated the amount you need to retire on in 20 years, and you haven’t included inflation yet, you’re probably going to need twice as many dollars as you believe you will.

But inflation is real right? I mean that’s really the way it is. The old penny gumball machines are now $0.25. And the $0.50 cokes machines of not too long ago are now $0.60 or $0.75. So it’s real, inflation really does exist. But the question is does it naturally exist or is it a fabricated enemy?

Of course my stance is that inflation is a fabricated enemy, completely created and enacted by the government and the Federal Reserve. But to show that inflation is not real, I first have to take the dollar out of the equation because manipulation of the dollar is how they pull this trick off.

What Is a Dollar Really?

So what are dollars? They are the representation of a days worth of work. You do some work, and you are paid for that work in dollars. You can then take those dollars and buy the product of someone else’s work. So in effect you are trading your work for someone else’s work. You make shirts. They make food. You effectively trade shirts for food. This easily transported store of value (the dollar) is what makes the modern form of commerce and trade possible. (So to be clear, I don’t dislike money in general; it’s the manipulation of its value by the government that I find appalling.)

So think about that. Dollars represent a day’s worth of work. So let’s say you and your neighbor have the exact same house design. Your neighbor comes over one day and asks if you would help him paint his house. In return, he offers to help you paint yours. Yours doesn’t need it right now, but it probably will in about 5 years. So you agree, and you both head off to paint his house. Fast forward 5 years. You tell the neighbor that you’re now ready for him to help you paint your house. So you both start painting, but at 85% done the neighbor drops his brush, cracks open a beer, and stops working.

You gave him a completely painted house, and he’s given you an 85% painted one. That doesn’t quite seem fair. But this is exactly how it would have worked if he had paid you by the hour with dollars instead of making a straight trade. Say it takes 10 hours to paint a house of that design (remember they are the same design). He offers to pay you $10/hour, and so ends up paying you $100 for the job. Then 5 years later, you offer him $10/hour, but by now inflation has upped the going rate to $11.70/hour. So now you would have to pay him $117 to help paint your house. If you wanted to use the same $100 he paid you, then you would only get 85% of your house painted.

So where did the other 15% of your house painting work go? If you can’t trade the $100 for 100% of the house painting that it represents, who has the other 15% of that value?

If Inflation Isn’t Natural, Then What Is?

Before we answer that, let’s take this a step further. It’s my actual belief that not only does inflation not exist naturally, but that the natural way of things is deflation. That something today should cost less tomorrow (not more as we have been conditioned to believe). I know the fallacy and it still sounds funny to me. This is how sinisterly the doctrine has been embedded in to our society.

So why do I think deflation is the natural way of things? Consider that pre-historic humans spent their entire days searching for enough food to survive. So they spent an entire day of work looking for food. Let’s fast forward to two hundred years ago. At that point something like 85% of the population was engaged in farming. So they spent most of their time creating food and 15% of the population was able to do something else with their time (like come up with ways to make farming easier and faster). Now jump forward to now. I don’t know any farmers, but I can go to the store and spend 3% of my pay to buy all the food I need. Assuming I work an 8 hour day, that means I only spend roughly 15 minutes per day in the pursuit of food. The rest of the day’s labor goes towards my other desires.

So the production of food to sustain life has gone from taking almost 100% of a person’s time to taking only 3% of a person’s time. So I now have 97% of my labor available to accomplish other tasks. These gains in efficiency have been provided by technology. Instead of having a mule pull the plow, we now have tractors. Instead of tractors that need drivers, we now have tractors that drive themselves. Instead of people having to pick each crop, we have harvesters that do it. The people that previously did this work are now free to go and complete other tasks. There are countless other advances in technology that have made the production of food more and more efficient over the years. So technology provides efficiency, and efficiency provides deflation, or in other words, doing more with less.

Think of all the things you have today that didn’t exist even 50 years ago. 50 years ago people put in the same 40 hour work week as we do now, but they didn’t have all the things that we now can buy with the same 40 hour work week. We have houses with air conditioning, CD players, CDs, computers, internet service, fast food, shoes, clothing, prescriptions, refrigerators, washers, dryers, microwaves, and much more. Now some of these things may have been available 50 years ago, but they weren’t as prevalent as they are now. So if your same 40 hour work week now buys more things (and has continued that way throughout history), then the actual natural trend of things is toward deflation.

So if deflation is the natural way of things, and we’re being told that the Federal Reserve is trying to keep inflation down to “just” 3-4% per year, that doesn’t quite smell right. Basically they are screwing things up so badly that they are canceling out the natural course of the advancement of society. So how are they doing this?

The Government’s Unseen Theft

They do this by manipulating the money supply, by keeping the interest rates unnaturally low, and by providing banks with the ability to lend more than their reserves. Without going into too much detail, all of these things put more dollars in people’s hands. But the same amount of goods exist as before, so people now pay more to outbid other purchasers for the more sought after goods. The producers of the more sought after goods now have more dollars to outbid the people they are bidding against for the goods they want. This continues until all the prices have been raised to match the new number of dollars floating through the economy. This is continually occurring and so all of this taken together affects the value of a dollar and makes it worth less and less each year.

But why would they do this? This means that the guy that diligently saved and tried to provide a nest egg for himself to survive on later in life is now being cheated out of his full day of work. He may not actually be able to support himself with the value that will be left in that nest egg in the future. As a society, don’t we want people to be self-sufficient and able to take care of themselves? So again, why would they do this?

Why Would the Government Fabricate Inflation?

There are two reasons I can think of. The first is that Keynesian economics says that this is the way you should run a government. That the government should make borrowing easy during hard times and spend money to jumpstart the economy. The correlation to that, which always seems to be forgotten, is that in good times the government should pay back the loans and not spend as much. Of course this never works. The second you start a relief effort, the person receiving it becomes dependent on it and rather than eventually shrinking, the effort is usually expanded to encompass more. And at this point (and even more than 50 years ago) the Keynesian theory of economics has been debunked any number of times as a broken way for government to run an economy.

My honest opinion is that the government is quite aware of this, but they use this as a smoke screen and justification to hide the real reason they advocate inflation, which is reason number two. Reason number two is that the government owes too much money. It owes so much money that if it stopped inflation and let the reality of deflation take hold, it would never be able to pay it back. But the absolutely criminal thing here is that they haven’t stopped spending. In their eyes, there’s no reason to. If they want to spend more, they effectively just print more money. When they print more, it dilutes the savings that already exist, and presto, they stole the value right out of your bank account and you can’t do a thing about it. They don’t even really have to raise taxes to do it. They can collect at least a 4% tax from you without you even knowing it. And they’ve trained you to believe that they are doing you a favor by keeping it that low.

How Can You Protect Yourself From Inflation?

So what do you do? I wish I could say I would write a post about that in a week and reveal the secret to avoiding inflation, but I can’t. I don’t know a way to avoid it entirely. There are things that have traditionally been put forward as being inflation hedges, but I haven’t found one that I really put my trust in yet.

Gold is the traditional inflation hedge, along with other precious metals, and jewelry. But I get uneasy buying something that doesn’t have an intrinsic value to me. I mean if it can’t do something for me, then the only reason someone else would buy it from me is because someone else might buy it from them. I don’t like that reason. There are some industrial uses for these metals, but how long before someone figures out how to use a cheaper material and suddenly your investment is worth quite a bit less. Right now diamonds can be created in laboratories so flawlessly that the only way to tell that they weren’t created by nature is because they are so flawless. So depending on how many diamonds are created this way they won’t be as rare as they used to be, and so by supply and demand, they won’t hold their value.

Another traditional hedge is real estate or land. But again the government sticks its fingers in the pot and gets you with ever increasing real estate taxes.

There’s also inflation indexed bonds, where you lend money to the government and they promise to pay you back your money plus inflation plus a little more. But really, these are the guys causing inflation, the guys telling you how much inflation was, and the guys purporting to be fighting inflation. So do you really trust them to pay you the real rate of inflation? In my opinion, you trust a person to follow their own self-interest, not what you would hope they would do. So I would trust the government to cause a bunch of inflation, then tell me its only a little, then pat themselves on the back for doing such a good job at keeping it so low, and then pay me back in dollars that won’t buy half the stuff they would have bought when I lent them to the government.

The only solution I have come up with is that you have to outrun inflation. You pick an investment that you think will do well over the years and just hope that it will beat the government’s printing press over the long run. For me right now, that’s stocks, but that’s not really a perfect answer because it’s no guarantee the value will be there when I need it and all companies are based in money which can be manipulated by the government, not to mention the fact that the government can decide to raise taxes all of a sudden and tax a company out of existence.

What you’d really want as a store of value is to purchase a promise to return the same amount of value that your purchase represented at the time. Like in the house painting example where you would trade a 100% painted house now for a 100% painted house in the future. Recently there was a stamp that was being sold that was a forever stamp. Meaning it could be used to mail a letter regardless of how much postage had gone up “due to inflation”. That’s a pretty good example of that, but how many letters do you really need mailed?

So, unfortunately, I really don’t have an answer just yet.

By the way, if you’d like to read more about the economic tricks that the government plays on us and our money, check out “Economics in One Lesson” by Henry Hazlitt. But I warn you, it was written in 1946 and republished again in 1979, and all the things in it are still going on and many have gotten worse, so it may just end up making you angry.

Inflatable Dividends Real Time Example Trades

We’ve been asked by one of our subscribers to provide some examples of how we would use the Inflatable Dividends data. So I’m going to go choose a few examples and track them in our blog posts here. These are not recommendations of any kind, just examples. In fact, the trades I choose might blow up in my face and all go down as losses, but we’ll see.

So I take a quick look at the current Inflatable Dividends. The first on the list, with an option expiring in roughly 13 days, is GM. Since an Inflatable Dividend investment can still go down, I feel I must vet the company and make sure that it is one that I would want to own. GM is not a company I would want to own. (In fact, full disclosure, I am betting it will go down, so I actually own puts on it, but that’s not a recommendation either.) So I move on.

SPG Inflatable Dividends Specific page

The next on the list is SPG (SPGEB.X), so I click the link to open the Inflatable Dividends Specifics page for it (see link above). I’ve never heard of this particular stock before, so I look a little deeper. (As an aside, never having heard of a stock is a good thing for me because it means that the stock hasn’t gotten a lot of attention, meaning that news won’t be throwing the stock price all over the place, so I can get my return and get out.)

I click the stock symbol link to Yahoo and take a look at the chart for it, and it seems to be trending generally up for the year from bottom left to upper right. I then go back to the Inflatable Dividends Specifics page and glance down at the Historical Dates and Amounts. They seem to be steadily trending up and are very regular. So this company is paying regular dividends and raising them as well. Not much indication that it will all of a sudden not pay the dividend or that its share price will all of a sudden drop. That’s a good sign of strength to me.

So then I drop down to the Suggested Stop Loss. It says $109.15. And the option expiration is 5/18/2007, so again about 13 days. A quick look at the chart again shows that this stock hasn’t been below $109.15 since March 30th. So I would be betting that the stock wouldn’t drop below that point over the next 13 days and it hasn’t been that low for more than twice that long (almost 3 times as long).

Glancing at the Returns section of the Inflatable Dividend Specifics page I see that I should make 0.77% (less than 1%) on this trade. The annualized return (meaning if I could do this same trade every 13 days) is 21%.

So I’ve pretty much convinced myself that I’m willing to risk money on this particular trade. I head over to my Fidelity account where I have options trading privileges. I click the “Trade Multi-Leg Options” link. And I enter a buy/write transaction where I buy stock of SPG and sell to open SPGEB.X. I expect a net debit (meaning I will be paying money for this transaction). The close of the stock was $113.35. There is/was a bid for the option of $4.20. So I put in a limit price of ($113.35 – $4.20) $109.15. That leaves $0.85 of premium in the option, and the dividend is $0.84 (both as reported on the Inflatable Dividends Specifics page). I opt to purchase the minimum that Fidelity will allow me to do with a buy/write which is 500 shares of the stock and sell 5 contracts of the option. I also choose to have the trade in for one day which means after the close of the market on Monday, the trade will be canceled if I can’t get my price of $109.15.

When I hit the preview order button, I get the summary of my trade. Before commissions and fees I’ll be investing ($109.15 * 500) $54,575. If I’m expecting to make 0.77% on that, then I expect a return of about $420. The commission is estimated at $3.75 and I expect to get called out of the stock at option expiration which will normally cost me $10.95 for the execution costs. So total, I expect to make about ($420 – $3.75 – $10.95) $405 in 13 days. (I have no idea why that first commission is so low. Generally I get charged something like $10.95 per trade, so I was expecting to pay that times two for a stock and option trade plus a little more for the per contract charge. Basically I expected ($10.95*2 + 5*$0.75) $25.65.) (Click the image for a larger version.)

So now I wait until Monday and see if the trade gets done. If it does then I’ll own 500 shares of the stock and be short 5 contracts of the option. I’ll then need to watch the stock and make sure that the price of the stock stays above my mental stop loss of $109.15. If it doesn’t, then I know from experience that I need to sell the stock and buy back the option immediately. I’ve been in the situation before where I’m just hoping the stock comes back up, and that is a recipe for going broke.

So there’s a pretty detailed trade using the Inflatable Dividends data. I’ll quickly pick two more (as I’ve about written a book with this post so far), and then we’ll track these picks over the coming weeks.

If it happens that none of them get executed at my desired prices, then I’ll have to pick some other ones, and continue doing so until I get the trades at the price I want. Again from experience I’ve learned you never chase a price. That’s how the Indians used to run buffalos off cliffs. And it’s how the lemmings control their population. Don’t be a lemming.

ALSK Inflatable Dividends Specific page

So the second pick is ALSK (ULOJC.X) at $14.45 with a potential gain of 2.98% over 167 days (or 6.5% annualized) with the expectation of two $0.22 dividend payments before the option expires on 10/19/2007.

AEE Inflatable Dividends Specific page

For the third pick, I’ll go with AEE (AEELI.X) at $44.31 with a potential gain of 4.3% over 230 days, or 6.82% annualized. I expect three dividends of $0.64 each before the option expires on 12/21/2007. The mental stop loss here is at $44.31, and the stock hasn’t been that low since August 2004.

So we’ll see if we can get into those on Monday and then see where they go.


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