Funny Money
John Lim | May 5, 2022
DO YOU SEE THINGS clearly when it comes to money? Here’s a test to find out. Which of the following scenarios would you prefer? A 5% raise, but the inflation rate is 10%. A 3% salary cut, but the inflation rate is 0%. If you chose the 5% pay raise, you’ve fallen victim to a “money illusion.” This term describes our tendency to view money in nominal terms instead of inflation-adjusted “real” terms. In the first scenario, you would have 5% more money to spend but you’d be able to buy 5% less in goods and services, thanks to the 10% inflation rate. In the second scenario, your nominal income would be down 3%—and that would also be your loss in purchasing power, because inflation was 0%. Consider another hypothetical. Say you paid $200,000 in cash for a house 30 years ago. You sell the home for $500,000. Let’s ignore sales commissions, taxes and other expenses. Would you be happy with this investment? On one hand, you would have made $300,000 on a nominal basis. But if you assume an annual inflation rate of 3%, your $200,000 home should be worth $485,452 after 30 years. On a real basis, you’d only come out $14,548 ahead on the sale. Had you invested the same $200,000 in the stock market, assuming a 7% annualized return, your investment would be worth $1.5 million after 30 years. The money illusion stems from our view of the dollar as a fixed unit of measurement, like the inch or the mile. In reality, the dollar is a store of value that fluctuates. The value of a dollar in 1982 has shrunken to just 35 cents today. Put differently, a dollar today could only buy a third of the goods and services that it could have bought…
Read more » Resolved: Sleep More
John Lim | Jan 3, 2022
I HAVE BUT ONE New Year’s resolution: I’ll be working on a habit that promises to lower my risk of cancer, boost my immune system and decrease the odds that I’ll succumb to Alzheimer’s disease. This activity has a host of other health benefits: lower blood sugar levels, reducing the risk of cardiovascular disease and aiding weight loss. It has also been shown to improve mood, memory and creativity. What is this wonder drug and how much will it cost me? My resolution for 2022: Get more sleep. And not just more sleep, but higher quality sleep. I’ll admit that I’ve been a lifelong skeptic on the importance of sleep. Since my teenage years, I’ve gotten by with less than seven hours of sleep, sometimes far less. Like many people, I wore my sleep-deprived state as a badge of honor and a necessary evil in the pursuit of lofty ambitions. No more. My eyes were opened by a book by sleep scientist Matthew Walker called Why We Sleep. A professor at the University of California, Berkeley, and an eminent sleep researcher, Walker makes a compelling, evidence-based case for the importance of sleep and the costs we incur when we shortchange ourselves of its many benefits. The World Health Organization has declared sleep loss an epidemic throughout industrialized nations. As Walker points out, “It is no coincidence that countries where sleep time has declined most dramatically over the past century, such as the U.S., the U.K., Japan, and South Korea, and several in western Europe, are also those suffering the greatest increase in rates of the aforementioned physical diseases and mental disorders.” More than four centuries ago, the great bard himself spoke of sleep: “Balm of hurt minds, great nature’s second course, chief nourisher of life’s feast….” William Shakespeare was, as…
Read more » Whither Inflation?
John Lim | Aug 2, 2021
THE RAGING DEBATE of 2021 is whether the inflation we’ve been experiencing this year will be transitory or more permanent. The Federal Reserve’s official stance is that the spike in inflation is a perfect storm of pent-up demand, supply-chain disruptions and year-over-year comparisons that are “inflated” relative to 2020’s pandemic-induced deflation, and eventually will revert to more normal levels. Recent hotter than expected inflation data—including the consumer price index (CPI), producer price index (PPI), U.S. import and export prices and the Fed’s preferred measure, personal consumption expenditures (PCE)—have thrown a monkey wrench into the Fed’s transitory thesis. Even the Fed seems to be having doubts. Over the past 12 months, consumer prices rose 5.4%. You have to go back nearly 40 years, to 1982, to find sustained levels of CPI of more than 5%. Core CPI (CPI minus volatile food and energy prices) is up 4.5% over the past year. It’s been 25 years since it was last above 3%. In other words, few economists today remember a time when inflation was a serious threat. Is it possible that expectations for inflation have been powerfully biased to the downside by the past four decades of calm and waning inflation? Fed Chair Jerome Powell, who is age 68, didn’t begin his career in finance until 1984. Just as some people make investment decisions through a rearview mirror, isn’t it possible that economists are susceptible to the same ailment? Last November, I expressed concern that inflation was a greater risk than ever before, at least in my (short) investing career. My fear stemmed from the teachings of the late economist Milton Friedman, who said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of…
Read more » Withdrawal Pains
John Lim | Dec 9, 2021
TWO MONTHS AGO, I fessed up to my addiction to financial market news. Despite knowing better, I’ve followed the markets closely for years and would update my portfolio almost daily. Based on some comments my article received, it appears I’m not alone. In the article, I vowed not to check my portfolio until New Year’s Day 2022. How’s my experiment gone thus far—and what have I learned? My attempt to go cold turkey hasn’t been entirely successful. Though I’ve looked at my portfolio far less often, curiosity sometimes gets the better of me. Over the past two months, I’ve checked in on the market or my portfolio a handful of times. Still, compared to my old ways, I count this as a small victory. One thing I discovered is just how addictive financial market data can be. Kicking the habit has been far more difficult than I’d imagined. Some days, I felt an intense craving for market quotes that were just a few keystrokes away. Usually, though not always, I managed to fight the urge. Another revelation—perhaps obvious in hindsight—is just how difficult it is to insulate oneself from market data. Both The Wall Street Journal and Bloomberg have an electronic “ticker tape” displayed prominently across their websites. Even HumbleDollar recently implemented this feature on its homepage, displaying daily price changes for a dozen exchange-traded index funds representing broad market segments. I felt like a smoker trying to quit but being bombarded by images of cigarettes dancing across my computer screen. By the way, if anyone working for these news outlets is reading this, may I offer a suggestion? Allow subscribers to opt out of seeing dynamic market quotes. Unfortunately, I have a sneaking suspicion that such feeds drive user addiction—I mean, engagement. With regard to checking my portfolio, I…
Read more » Inflation Insurance
John Lim | Aug 23, 2021
ON AUG. 15, 1971, President Richard Nixon made the weighty decision to end the convertibility of the U.S. dollar into gold. By doing so, he drove a stake through the heart of the gold standard, a monetary system which fixed the worth of a unit of money to a specific amount of physical gold. Before that day, foreign central banks were able to exchange $35 for one ounce of gold from the vaults of the U.S. Federal Reserve. By closing the so-called gold window half a century ago, Nixon ushered in the current era of fiat money. Fiat currencies—which include all currencies in existence today—aren’t backed by anything tangible. Rather, their value depends entirely upon the collective trust of people making transactions in those currencies. If that confidence evaporates, so does the value of that money. What can lead to a loss of confidence in money? In a word, oversupply. Too much of anything can be a bad thing, and so it is with money. Print too much money and you devalue it. When a currency is devalued, inflation results. Gold is called a precious metal precisely because it’s rare and difficult to mine. Though many have tried, gold cannot be fabricated. Because of this and other unique qualities, the yellow metal has been a store of value for over two millennia. Gold’s value as an investment is far more controversial. Gold isn’t an investment in the traditional sense because it generates no cash flow. Result? There’s no way to assign an intrinsic value to an ounce of gold. In this regard, gold resembles other commodities. In all likelihood, however, gold will remain a store of value. Those who own gold, as I do, know that currencies have an uncomfortable history of being devalued. In my mind, gold is a…
Read more » Prophecy Fulfilled?
John Lim | Dec 27, 2021
QUANTITATIVE EASING, or QE, has been the Federal Reserve’s policy of choice since interest rates reached their lower bound of 0%. The brainchild of then-Fed Chair Ben Bernanke, QE was launched in the midst of the 2008 financial crisis. Quantitative easing is simply a euphemism for bond purchases—Treasury bonds and mortgage-backed securities—by the Federal Reserve. In theory, QE should lead to lower interest rates, as reflected in bond yields. Bond prices are, of course, subject to the forces of supply and demand. All else being equal, greater demand—such as from Fed purchases—drives up bond prices. And when bond prices rise, their yields fall. Lower interest rates have a plethora of effects, both on the economy and financial markets. Low rates stimulate the economy and drive up the price of financial assets, hence the term quantitative easing. QE is widely assumed to result in looser financial conditions. That’s all well and good, but financial markets are comprised of human beings, not machines. They react in ways that incorporate expectations of the future. I would contend that QE is as much a behavioral construct as it is a financial one. What does that mean for the stock market? We’ll find out in the months ahead, now that the Fed is winding down its bond purchases. The Federal Reserve acknowledges that forward guidance plays a key role in its interest rate policy. That term, forward guidance, merely refers to the collective expectation of market participants about future interest rates. The Fed guides market expectations by carefully choosing the words it uses in press releases and speeches. If the market becomes convinced that lower interest rates are on the horizon, that expectation by itself can move markets far in advance of the actual interest rate cuts. QE has a similar impact on investor psychology…
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