The Battle for Investment Survival
September 3, 2008
(This originally appeared in the Daily Reckoning.)
An introduction to the principle of compound interest shows that, an investment that returns a 5% or even 3% rate, over centuries, eventually attains a colossal sum. A million dollars – a decent house these days – invested at a mere 3%, becomes $136 billion in four hundred years. At 5%, it would be $299 trillion.
This doesn’t mean that it is easy to make money. Rather, it demonstrates that it is hard. I don’t know a single example of significant success with this simple strategy. Why not? Many things can happen in four centuries. One thing that seems to happen, with regularity, is currency devaluation, possibly to the point of worthlessness.
In 1935, a stockbroker named Gerald Loeb wrote a book called The Battle for Investment Survival. It is considered a classic today, and is still in print. The dramatic title might be ascribed to the dramatic period in which it was first published. Disaster-mongering books were popular in the late 1970s as well. However, in the book (which was revised in the 1950s and 1960s), Loeb makes clear that the “battle” he had in mind was with inflation. “The greatest threat to successful preservation of capital [is] the varying purchasing power of money,” Loeb wrote. People who held their cash at a “safe” 2% or 3% were sure losers in the long-term Battle for Investment Survival, Loeb argued.
Sometimes, cash was a good option. But in the long term, even just to stay even, it was necessary to speculate. The best defense is a strong offense. “Because I am personally completely convinced of the inevitability of loss when attempting to secure a safe income of small return, that I constantly suggest speculation rather than investment [investment-grade bonds] as the policy less apt to show a loss and more apt to show a profit.”
The funny thing is, Loeb lived almost his entire life under a gold standard. There was a devaluation in 1933, but that was the only one of consequence for most of his adult life. Oddly enough, money did keep its value in those days. It wasn’t until the floating currency period started in 1971 that Loeb’s worst fears began to be realized. He died in 1974. Maybe his last words were: “I told you so.”
Loeb wasn’t the only one worrying about keeping up in the Battle for Investment Survival. It is no surprise that government bonds were popular in the 1930s and 1940s, what with Depressions and World Wars and all. In 1949, the 10-year U.S. government bond traded for about 2.0%! That was the peak of the great bond boom. You might even call it a bubble, to the extent that there can be a bubble in government bonds.
People then began to come to their senses. At first, they noticed that stocks were yielding five or six percent in dividends. But, later, they listened to what was being said by their leaders in Washington, and decided that they didn’t like the way things were going. Ten-year Treasury yields ended 1967 at 5.7%. They ended 1968 at 6.03%. They ended 1969 at 7.65%. Bondholders were intensely aware of the risk that inflation – currency devaluation – posed to their capital. Their fears came true in 1971, when, after 182 years on the gold standard, the U.S. dollar’s link with gold was severed. The dollar was floated and devalued. It eventually lost about 90% of its worth during the decade.
After a twenty-six year bull market in bonds, since 1982, we now have 10-year Treasury bond yields again under 4%. This might have made sense when the dollar was “as good as gold,” as it was in 1949. However, the dollar has spent the last seven years declining against every possible benchmark: gold, foreign currencies, a basket of consumer goods, and commodities. The situation that people feared in the 1960s – currency devaluation – has been going on for years now.
It will probably continue until a Paul Volcker-like character appears to put an end to it.
Yet, there is little concern. The government’s CPI statistics are widely regarded, by big-name bond gurus like Pimco’s Bill Gross for example, as something between an honest mistake and a dishonest one. However, the entire Treasury yield curve is now trading below even this artificially low hurdle. The latest CPI readings show an increase of 5.6% from a year earlier.
Government bondholders today think they are “safe” from market turmoil, but, I argue, they are likely to be certain losers in the Battle for Investment Survival. The only safety today, as Loeb argued, is in speculation. Loeb recommended equities. That might not be such a good idea at the present juncture.
Does Loeb offer an alternative to both bonds and stocks? “In the history of the world we find the record of savings really saved through buying gold, hoarding precious stones, and other forms of ‘hard wealth’ privately secreted. In the future history of America most of us will, in my opinion, learn this lesson too late,” he wrote.
Gold, silver, and other commodities have had a tough couple months. They seem exceedingly risky, compared to the apparent safety of T-bills. For an inexperienced speculator, these wild moves can lead to catastrophic losses. For the experienced speculator, these hard assets are merely tools in the Battle for Investment Survival – perhaps the best tools for the present situation.