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Better to be a year early than a minute late in risk management—when protection is cheap and low risk

Posted by John Reed on

Copyright 2013 John T. Reed

Today’s International Man email has this sentence with regard to preparing for hyperinflation: “It’s always better to be a year early than a minute late.”

‘Always’ is rarely correct

The “always” part of that sentence is incorrect. We actually focused on that issue somewhat at Harvard Business School.

For example, the whole idea of “just-in-time” inventory levels is that it is better to be a minute early than a year early. Whether you want just-in-time inventory levels is a function of your product margins and inventory carrying costs (the amount of interest you lose out on because you tied money up in inventory)

Product margins matter because the bigger the margin, the more you want to avoid losing a sale because of not enough inventory. With low profit margins, you are less concerned about losing a sale. And with today’s record low interest rates, you are not losing much to tie up lots of money in inventory. Matter of fact, with hyperinflation risk rising by the day, inventory is a hard asset and hard assets are the non-liquid defense against hyperinflation.

Managing risk

The context of International Man’s statement is not running a business, but managing a risk, i.e., inflation risk to your dollar-denominated assets. There the issue is like buying fire insurance. Not only is it better to be a year early than a minute late in fire insurance; it is wildly irresponsible and stupid to allow even a single minute to pass without fire insurance.

But part of the reason for that is that fire is an insurable risk with relatively low premiums and an extremely high cost of suffering an uninsured loss. We live in earthquake country, but we do not have earthquake insurance. We used to, but then the California state government got involved and the premiums and deductible skyrocketed so we let it lapse. We manage earthquake risk by choosing the right location (on the side of a mountain) and type of structure (frame house) and we have lots of things that might fall over attached to the wall. Those are risk management techniques called avoidance and mitigation.

Sell your gold now

That International Man article denounces fiat money and pushes gold. In the first edition of my book How to Protect Your Life Savings from Hyperinflation & Depression, I denounced gold quite strongly, and I still do in the second edition and here at this web site. Those who believe gold is a good hedge against inflation and/or a good barter item during hyperinflation are wrong. It is not matter of opinion, it is a matter of facts and logic. I explained it in much detail at my article on the disadvantages of gold—which also apply to all precious metals for the most part.

Let me make sure no one missed that. Anyone who thinks precious metals are a good edge against inflation is wrong. Hard assets are generally good hedges against inflation and precious metals are, indeed, hard assets, but no hard asset that is currently overpriced or that is currently and/or historically discriminated against by federal law need be or should be used to hedge against inflation risk. I’m right. If you think precious metals are a good hedge against inflation, you are wrong, and it is not a matter of opinion. It is a matter of mathematics, federal law, and historical fact.

There is fiat money and there is fiat money

Speaking of wrong, I was wrong in the first edition of my book when I also denounced fiat money like International Man is doing. But I wised up by the time I published the second edition—because I read a bunch of books about the Austrian and German hyperinflation of the early 1920s. A recent International Man interview about current inflation in Argentina asked a man named Galland about the role of gold in current Argentinian inflation. “Gold is not a factor,” he said. I believe it because the historical record in Austrian and German hyperinflation says the same thing.

The usefulness of gold in hyperinflation is a myth

There is some sort of popular myth among American gold bugs that the Europeans who were smart moved their money to gold and did great during the hyperinflation. Unfortunately for the myth lovers, the historical record does not support it. Gold is only discussed in the books of the time as a sort of price index for marking how low the mark and krone had fallen in purchasing power. It also appears in Anna Eisenmenger’s diary in one anecdote. She traded her late husband’s gold watch chain for four bags of potatoes during the hyperinflation—a great example of what a crap barter item gold is because it only comes in such high denominations and they rarely give change in barter markets. Using gold for barter is a fabulous way to grossly overpay for everything.

Gold bugs will be desperately searching for fiat money during US hyperinflation

If and when we get hyperinflation in America, the gold bugs who now denounce fiat money will spend all day every day trying to get some fiat money. How do I know this? Because I read a number of books originally written in German, by Germans and Austrians who lived through the hyperinflation. THEY spent all day every day trying to get fiat money and food and coal.

One problem with the gold bugs is they hate government. Fiat money is a government creation. Governments often abuse the trust placed in them by the public with regard to lots of things including the purchasing power of fiat money. This generalized paranoia and hatred of all government, and therefore, all fiat money, has blinded gold bugs to the undeniable fact that there is fiat money and there is fiat money.

To be sure, when hyperinflation hits the US dollar (currency code USD) Americans, including the gold bugs, will all be scrambling to find stable fiat money. By definition, during USD hyperinflation the USD will NOT be a stable fiat money. I expect that AUD, CAD, CHF, and NZD will all be stable during U.S. hyperinflation.

Good fiat money will be illegal contraband during US hyperinflation

Because hyperinflation is always accompanied by capital controls, possession and use of foreign currency and gold will be outlawed by U.S. citizens/permanent residents as soon as the hyperinflation starts here. Furthermore, leaving the US with USD or sending USD abroad by wire or mail or otherwise will be prohibited or extremely restricted.

Trapped in the US because of lack of good fiat money

Further furthermore, unless you have some stable non-USD to spend in their country, I predict border patrol personnel in Canada and most other countries not suffering hyperinflation when the U.S. is will stop assuming that all incoming U.S. tourists have enough money to support themselves in their countries, demand proof of possession or access to stable non-USD currency, and upon not getting it, will deny you a tourist visa to enter their country.

Move savings and bill-paying money abroad to the good fiat currencies

You should put your USD rainy-day savings into AUD, CAD, and NZD savings accounts in banks in those countries. Your CHF cash should be in a safe deposit box in Canada. (Americans can’t get CHF bank accounts in Switzerland and that’s okay because they pay negative interest and the CHF has been experiencing deflation lately.)

Your routine bill-paying money should also be in Canada, albeit in USD accounts. The reason for that is to avoid round-trip currency conversion costs before hyperinflation hits and to put it outside of US capital-control jurisdiction after it hits. On the day the USD dies, you go Online to your bank in Canada and move the USD into CAD immediately. It will take about 20 seconds.

If the money is still within USD in the US when the hyperinflation hits, you’re screwed. You will have great difficulty getting it out. If you can get it out at all, it will only be in dribs and drabs and the purchasing power will be plummeting while you wait permission for each drib.

Essentially, you will be forced to withdraw all your money as fast as your are allowed—probably really slowly—see Cyprus recently—and use it to buy hard assets. But hard assets are dangerously illiquid. It’s hard to buy food, fuel, household or business supplies, or medicine with hard assets.

Buying foreign fiat money before the price of it skyrockets is low cost and low risk

Back to my point about low-cost and low-risk risk management techniques being the only ones where “It’s better to be a year early than a minute late” applies.

What is the cost of moving of your routine bill-paying money to a USD account in Canada? Zilch. You have to go there in person to open the first account, but that’s it. What is the incremental cost of paying your bills out of Canada compared to paying them out of a US-based bank account? Zilch if you use a program like Bank of Montreal’s premium plan auto cash.

What is the incremental risk of having your routine bill-paying money in a USD account in Canada instead of in a US bank account? Less than zilch.

During the Great Depression, 9,000 US banks failed and zero Canadian banks did. Your money in Canada is insured by the Canadian Deposit Insurance Corporation (CDIC) which, as far as I know, is fully funded in accordance with pertinent Canadian law. In contrast, the US FDIC is not currently in compliance with U.S. law on how much it should have in reserve. Also, when the USD hyperinflation hits the fan, even the amount required by U.S. law would not be enough because there would be a run on the dollar, which is a run on every single bank in the U.S., not just the poorly-managed ones. And Canada, which has a different form of government than the US, is not currently “printing” a trillion dollars of money a year to pay bills it should not have incurred.

With regard to your rainy-day savings in a CAD savings account in Canada, the cost is low: currency conversion charges.

And there is currency risk if you intend to spend the money you put into CAD in the Canadian savings account in the U.S. If you intend to spend the money in Canada, there is no currency risk. I would expect that during US hyperinflation, Americans who were smart enough to prepare for the hyperinflation will spend their CAD in Canada either on a vacation from the US financial crisis (which would make the US an extremely unpleasant place to be) or because they have moved temporarily near the Canadian border so they can drive across frequently to buy groceries, fuel, and other needs with their CAD that is in Canada.

Well-managed fiat money is great stuff

New flash for the gold bugs and government haters: Fiat money is great stuff. It is the only kind of money currently in use in the universe. The last gold standard country was Switzerland and they are now fiat money.

  • Fiat money is accepted and preferred nearly everywhere on earth except that the fiat money of currently hyperinflated countries is shunned.
  • Fiat money comes in the most convenient denominations possible and virtually all fiat money sellers worldwide will give you change if you do not have exact change for a larger amount of the money.
  • Fiat money, except for some Australian coins, is light weight, small in size, and extremely portable.
  • Fiat money can be held in accounts and moved around the world rapidly through ATMs, SWIFT wires, Fedexed cashiers checks.
  • Unlike precious metals, there is insufficient incentive to counterfeit fiat money denominations below about $50 to $100.
  • Unlike precious metals there is no need for an assay to prove the weight and purity of purported precious metal coins or other bullion objects.
  • Fiat money is relatively easy to protect from theft or damage.

Well-selected fiat money is the best medium of exchange on earth by far. A diversified portfolio of well-selected fiat currencies is also a pretty good store of value over a relatively short term for a relatively small percentage of your net worth. The rest of your net worth for long-term store of value should be in hard assets, preferably ones that you will use yourself and/or that make good barter items. See page 200 in the “Barter” chapter of my book How to Protect Your Life Savings from Hyperinflation & Depression, 2nd edition for the list of the characteristics of good barter items.

When you “invest” in fiat money or circulating coins, there is no fee, no commission, no buy-sell spread, no transportation cost, no need to insure the money while it is in transit. When Dallas investor Kyle Bass bought 20 million nickels ($1,000,000), he paid precisely five cents each for every one of them. The Federal Reserve Bank of Dallas delivered them to his warehouse on pallets for free. When you buy gold or another precious metal or many other hard assets like real estate, there are numerous large costs involved.

Well-managed foreign currencies are ultra liquid. Failure to be adequately liquid can cause a person or entity with a positive net worth to go bankrupt by forcing them to convert hard ssets to cash at fire-sale prices.

Fiat money protects you totally during deflation. The Wall Street Journal told of an investor who bought gold in October of 2012. Bad timing. It dropped in value and he sold it in the spring of 2013 for a $7,000 loss. I’m guessing that was about $20,000 of gold. Had he bought $20,000 of U.S. nickel coins instead—made of nickel and copper—he would not have lost a penny on the coins because they have the words “five cents” written on them—even though the prices of nickel and copper probably went down during that same period.

Shhh. Don’t tell the gold bugs this. It will cause a short circuit in their already mis-wired brains.

$20,000 worth of U.S. nickels are worth the same as $20,000 worth of gold.

During hyperinflation, gold, copper, and nickel would all go way up in dollar value, and that would make minting fiat money coins out of them unfeasible. That, in turn, will cause the U.S. government to repeal the current ban of melting or exporting nickels or pennies. We went through all that with silver dimes, quarters, and half dollars around 1965. If Kyle Bass sells his 20 million nickels then at a gain (for melt value), he will pay a tax of 20% on that gain. If you sell gold that cost you a million in 2013 at a gain, you will pay 28% tax on it.

If you think gold is a better inflation hedge than a U.S. nickel, you are, in effect, saying it’s better to pay a 28% tax than a 20% tax. The mind of a gold bug works in wondrous ways.

Year early is only better than a minute late when…

Back to the main point, International Man is wrong. It is NOT “always” better to be a year early than a minute late. That statement does NOT apply to sales of many high-margin products and many high-cost risk-management techniques.

But the statement does apply to low-cost, low-risk risk management techniques like my advice on hyperinflation protection:

• get out of USD except for current routine bill-paying funds which need to be in Canada not the US
• put your money into hard assets, especially things that you will use yourself or that are good barter items and
• put rainy-day savings, which needs to be liquid, into selected foreign currencies

Actually, my advice is much more complex than that because the subject is much more complex. It took me 320 pages to explain it and I had to spend a lot of time shrinking it down to that limit.

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