The 2005-2006 Breakeven Interest Rate By William Cate
In 1952, you could buy 100 postcards and mail them for one dollar. Today, you can buy 4 postcards. In 1952, you could buy 20 candy bars for one dollar. Today, you can buy one candy bar. In 1912, you could buy a steak dinner in a good restaurant for two bits. Today, you'd spend twenty-five dollars for the same dinner. This ratio over time is true for all goods and services. The reduced buying power of your dollar is caused by inflation.
How Government Fudges the Numbers
The Government reports their lowball version of the annual inflation rate as the Consumer Price Index CPI). It's a lowball estimate because the actual inflation rate would upset the voters. Plus, a great many entitlements, like Social Security are tied to the Government's version of the inflation rate. How do you lowball the CPI? It's easy - find components that may not be widely used by Americans, but tend not to respond to inflationary pressure. Report raw food prices rather than processed foods because they don't move up in price as quickly as processed foods. The fact that most Americans eat more processed foods is incidental to the selection process. Report single family house prices, until there is a real estate boom and many local governments have fixed rent prices, so rents don't move up. So, allow rents to be the housing measure of the CPI. Gasoline prices were a great Government choice for the energy component of the CPI. Until a couple of years ago, gas prices moved more slowly than the real inflation rate from the 1950s to two years ago. Today, gas prices are the driving force behind the ballooning 2005-inflation rate. So what will the Dept of Labor do? They will replace gasoline prices with some energy source that isn't going to double in the next two years. My advice would be solar panels. They are currently $8/sq ft and the price is expected to fall over the next few years.
Few people who understand basic economics believe that the CPI reflects the inflation rate. The general business community has tended to double the CPI to get a more reliable annual rate. Before 2005, for more than a decade, the CPI has hovered around 3% and the business community has projected a 6% national inflation rate. The hard currency minority has argued that the CPI should be tripled. To date, the 2005 CPI is 4.5%. This means the real 2005 inflation rate is 9%. There is every reason to believe that Americans should expect at least a 9% inflation rate in 2005 and 2006. It could be worse!
The question is what must your investments pay you this year and next year to allow you to buy as many postcards, candy bars, steak dinners or whatever as you did in 2004? This would be the breakeven investment goal. The money you earned combined with your principal would allow you to buy the exact amount of whatever for Christmas 2005 as for Christmas 2004. The interest rate must be earned with the same level of risk that your investment earned you in 2004. Risking your money on the State Lottery isn't a wise way to try to bet the 2005-2006 inflation rate.
If you can find tax-free, low risk investments paying 9%, you have solved your problem. However, most Government bonds are paying less than 5%. A wiser choice would be to invest your money in the things you'll need for the next two years. As the prices of these things you purchased move up by 9%, you earn the 9% interest tax-free. The motto would be to buy now and beat inflation.
Lenders will take the major hit in any inflationary spiral where they have loaded their money for less than the inflationary rate. Many middle class folks have 30-year fixed home mortgages under 6%. The homeowners with these mortgages are making at least a 3%/year tax-free profit on their investment. So, if the Government can't reverse the inflation trend back to 6% or less, expect a banking crisis in a few years.
Are you among those with more disposable income than can be absorbed by buying things you regularly need now and benefiting from the 9% tax-free inflation dividend over the next two years? To pay taxes on your investments and end up with a breakeven 9% net investment profit requires a 15% interest income on your risk capital.
In 2004, if you put 20% down on a single-family residence, its value would have risen by 15% on average. However, you would have made a 75% profit for the year because your down payment was only 20% of the value of the property. Unfortunately, the Real Estate Gurus are saying the Real Estate Bubble is about to burst. Even if they are factually wrong, the widespread dissemination of their views will ensure they will come true. After all, we live in a Society of perceptions and not reality. However, given the strains that a 9% inflation rate will put on the economy, I suspect the Real Estate Gurus will prove to be right even without the media attention. The real estate sales formula of no down, little down, balloon payments and home buyers who are barely able to meet their mortgage payments is the weight that will bring down the market as foreclosures abound in the next couple of years.
The Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/] has become the largest venture capital club in the world because of an unusual investment strategy. The risk factor is less than 3%. The amounts risked on outside speculations are $6,000. Any member who works with the program for six months can't lose their risk capital. It's an option worth considering, if you have more money than you need to cover your living costs for the next couple of years.
Most Americans are like frogs in a slowly heating pot of water. The heat is being turned up and both their rights and standard of living are being lost. Like the frogs, they will eventually be boiled. For those who can see the future should act on their vision before they are caught in the cauldron that will be America in 2020.
About the Author
He has been the Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/] since 1981 and is the Executive Director of the Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/] You can email Mr. Cate at: Beowulfinvestments@Earthlink.net