Tag Archives: inflation

Inflation and the Stock Market; Alice in Wonderland and the Federal Reserve; Recommended Blogs

Alice in Wonderland

“Well, in our country,” said Alice, still panting a little, “you’d generally get to somewhere else — if you ran very fast for a long time, as we’ve been doing.”

“A slow sort of country!” said the Queen. “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”
(Through the Looking Glass, Chapter 2)

Inflation and the Stock Market

It appears to me of preeminent importance to our science that we should become clear about the causal connections between goods. –Carl Menger, Principles of Economics.

A Reader asked about why I should be bullish about stocks with inflationary dangers like rising money supply numbers present and the Fed’s zero (0%) interest rate policy.

My reply is that I would rather own franchises that can pass along their costs (inflation pass-through) than just a basket of stocks. In severe inflation the goal is to lose less in real terms than holding other assets like bonds. We all lose as a society with rampant inflation, especially the poor and those on fixed incomes.  Also, in general, the context in which stocks rise is important.  See below.

The Stock Market and Inflationary Depression (page 938 in Capitalism by George Reisman—in VALUE VAULT).

The fact that inflation undermines capital formation has important implication for the performance of the stock market. In its initial phase or when it undergoes a sufficient and relatively unanticipated acceleration, inflation in the form of credit expansion can create a stock-market boom (Now in January 2012 we are seeing a NOMINAL boom not a REAL boom in stock prices). However, its longer-run effects are very different. The demand for common stocks depends on the availability of savings. In causing savings to fail to keep pace with the growth in the demand for consumer’s goods, inflation tends to prevent stock prices, as well as wage rates, from keeping pace with the rise in the prices of consumers’ goods. For a further explanation of this phenomenon go to Man, Economy and State by Murray Rothbard to read about the structure of production: pages 319 to 508 in the VALUE VAULT.  Also, The Structure of Production by Mark Skousen

The same consequence results from the fact that inflation also leads to funds being more urgently required internally by firms—to compensate for all the ways in which it causes replacement funds to become inadequate. At some point in an inflation, business firms that are normally suppliers of funds to the credit markets—in the form of time deposits, the purchase of commercial paper, the extension of receivables credit, and the like—are forced to retrench and, indeed, even to become demanders of loanable funds, in order to meet the needs of their own, internal operations. The effect of this is to reduce the availability of funds with which stocks can be purchased, and thus to cause stock prices to fall, or at least to lag all the more behind the prices of consumers’ goods.

When this situation exists in a pronounced form, it constitutes what has come to be called an “inflationary depression.” This is a state of affairs characterized by a still rapidly expanding quantity of money and rising prices and, at the same time, by an acute scarcity of capital funds. The scarcity of capital funds is manifested not only in badly lagging, or actually declining, securities markets but also in a so-called credit crunch i.e., a situation in which loanable funds become difficult or impossible to obtain. The result is wide-spread insolvencies and bankruptcies.


As a review and emphasis, read Buffett’s take on inflation and stocks: http://www.scribd.com/doc/65198264/Inflation-Swindles-the-Equity-Investor

Let’s take a step back from what you just read. If you know that money functions as a medium of exchange, then you realize in a modern society that money helps support the specialization of production and hence improves productivity. However, inflation—like dollar bills dropped into the jungle—does not per se increase savings and capital goods (stocks are titles to capital goods). Inflation, if unanticipated, artificially boosts stock prices and then eventually causes a decline because of the limited availability of real capital (bricks, trucks, machines) to reinvest (maintenance capital expenditures) into businesses AND, at the same time, consume consumer goods. In a finite world, you have to choose between mending your fishing nets or fishing to eat; you can’t do both unless you have a cache of fish saved.  Perhaps in the delusional world of a Federal Reserve bureacrat you can have your fish and eat it too–just print more.

Do not blindly believe inflation is “good” for stocks.

Other Views on Inflation and Stocks



Alice in Wonderland and the Federal Reserve


“The Federal Reserve, declaring that the economy would need help for years to come, said Wednesday it would extend by 18 months the period that it plans to hold down interest rates in an effort to spur growth.” (New York Times)

Illogic 101: Artificially low interest rates helped produce the crisis. Therefore the Fed will fix the economy by holding down interest rates for the foreseeable future.  (Give the drunk more booze to cure the hangover!)

The article below will help clarify the points made at the beginning of this post.

Interest Rates and the business cycle: http://www.thefreemanonline.org/columns/interest-rates-and-the-business-cycle/

by Glen Tenney • November 1994 • Vol. 44/Issue 11

The cause of the business cycle has long been debated by professional economists. Recurring successions of boom and bust have also mystified the lay person. Many questions persist. Are recessions caused by under consumption as the Keynesians would have us believe? If so, what causes masses of people to quit spending all at the same time? Or are recessions caused by too little money in the economy, as the monetarists teach? And how do we know how much money is too much or too little? Perhaps more importantly, are periodic recessions an inevitable consequence of a capitalist economy? Must we accept the horrors associated with recessions and depressions as a necessary part of living in a highly industrialized society?


New Money Gives a False Signal

Money is primarily a medium of exchange in the economy; and as such, its quantity does not have anything to do with the real quantity of employment and output in the economy. Of course, with more money in the economy, the prices of goods, services, and wages, will be higher; but the real quantities of the goods and services, and the real value of the wages will not necessarily change with an increase of money in the overall economy. But it is a mistake to think that a sudden increase in the supply of money would have no effect at all on economic activity. As Nobel Laureate Friedrich A. Hayek explained:

Everything depends on the point where the additional money is injected into circulation (or where the money is withdrawn from circulation), and the effects may be quite opposite according as the additional money comes first into the hands of traders and manufacturers or directly into the hands of salaried people employed by the state.2 [2]

Because the new money enters the market in a manner which is less than exactly proportional to existing money holdings and consumption/savings ratios, a monetary expansion in the economy does not affect all sectors of the economy at the same time or to the same degree. If the new money enters the market through the banking system or through the credit markets, interest rates will decline below the level that coordinates with the savings of individuals in the economy. Businessmen, who use the interest rate in determining the profitability of various investments, will anxiously take advantage of the lower interest rate by increasing investments in projects that were perceived as unprofitable using higher rates of interest.

The great Austrian economist Ludwig von Mises describes the increase in business activity as follows:

The lowering of the rate of interest stimulates economic activity. Projects which would not have been thought “profitable” if the rate of interest had not been influenced by the manipulation of the banks, and which, therefore, would not have been undertaken, are nevertheless found “profitable” and can be initiated.3 [3]

The word “profitable” was undoubtedly put in quotes by Mises because it is a mistake to think that government actions can actually increase overall profitability in the economy in such a manner. The folly of this situation is apparent when we realize that the lower interest rate was not the result of increased savings in the economy. The lower interest rate was a false signal. The consumption/ saving ratios of individuals and families in the economy have not necessarily changed, and so the total mount of total savings available for investment purposes has not necessarily increased, although it appears to businessmen that they have. Because the lower interest rate is a false indicator of more available capital, investments will be made in projects that are doomed to failure as the new money works its way through the economy.

Eventually, prices in general will rise in response to the new money. Firms that made investments in capital projects by relying on the bad information provided by the artificially low interest rate will find that they cannot complete their projects because of a lack of capital. As Murray Rothbard states:

The banks’ credit expansion had tampered with that indispensable “signal”-the interest rate—that tells businessmen how much savings are available and what length of projects will be profitable . . . . The situation is analogous to that of a contractor misled into believing that he has more building material than he really has and then awakening to find that he has used up all his material on a capacious foundation, with no material left to complete the house. Clearly, bank credit expansion cannot increase capital investment by one iota. Investment can still come only from savings.4 [4]

Capital-intensive industries are hurt the most under such a scenario, because small changes in interest rates make a big difference in profitability calculations due to the extended time element involved.

It is important to note that it is neither the amount of money in the economy, nor the general price level in the economy, that causes the problem. Professor Richard Ebeling describes the real problem as follows:

Now in fact, the relevant decisions market participants must make pertain not to changes in the “price level” but, instead, relate to the various relative prices that enter into production and consumption choices. But monetary increases have their peculiar effects precisely because they do not affect all prices simultaneously and proportionally.5 [5]

The fact that it takes time for the increase in the money supply to affect the various sectors of the economy causes the malinvestments which result in what is known as the business cycle.

Government Externalizes Uncertainty

Professor Roger Garrison has noted another way that government policy causes distortions in the economy by falsifying the interest rate.6 [6] In a situation where excessive government spending creates budget deficits, uncertainty in the economy is increased due to the fact that it is impossible for market participants to know how the budget shortfall will be financed. The government can either issue more debt, create more money by monetizing the debt, or raise taxes in some manner. Each of these approaches will redistribute wealth in society in different ways, but there is no way to know in advance which of these methods will be chosen.

One would think that this kind of increase in uncertainty in the market would increase the risk premium built into loan rates. But these additional risks, in the form of either price inflation or increased taxation are borne by all members of society rather than by just the holders of government securities. Because both the government’s ability to monetize the debt and its ability to tax generate burdens to all market participants in general rather than government bond holders alone, the yields on government securities do not accurately reflect these additional risks. These risks are effectively passed on or externalized to those who are not a part of the borrowing/lending transactions in which the government deals. The FDIC, which guarantees deposit accounts at taxpayer expense, further exacerbates the situation by leading savers to believe their savings are risk-free.

For our purposes here, the key concept to realize is the important function of interest rates in this whole scenario. Interest rates serve as a regulator in the economy in the sense that the height of the rates helps businessmen determine the proper level of investment to undertake. Anything in the economy that tends to lower the interest rate artificially will promote investments in projects that are not really profitable based upon the amount of capital being provided by savers who are the ones that forgo consumption because they deem it in their best interest to do so. This wedge that is driven between the natural rate of interest and the market rate of interest as reflected in loan rates can be the result of increases in the supply of fiat money or increases in uncertainty in the market which is not accurately reflected in loan rates. The manipulation of the interest rate is significant in both cases, and an artificial boom and subsequent bust is inevitably the result.


Changes in the supply of money in the economy do have an effect on real economic activity. This effect works through the medium of interest rates in causing fluctuations in business activity. When fiat money is provided to the market in the form of credit expansion through the banking system, business firms erroneously view this as an increase in the supply of capital. Due to the decreased interest rate in the loan market brought about by the fictitious “increase” in capital, businesses increase their investments in long-range projects that appear profitable. In addition, other factors as well can cause a discrepancy between the natural rate of interest and the rate which is paid in the loan market. Government policies with regard to debt creation, monetization, bank deposit guarantees, and taxation, can effectively externalize the risk associated with running budget deficits, thus artificially lowering loan rates in the market.

Either of these two influences on interest rates, or a combination of the two, can and do influence economic activity by inducing businesses to make investments that would otherwise not be made. Since real savings in the economy, however, do not increase due to these interventionist measures, the production structure is weakened and the business boom must ultimately give way to a bust. []

  1. For a detailed discussion of the phenomenon of interest and the corresponding relationship to the business cycle, see Ludwig you Mises, Human Action, 3d rev. ed. (Chicago: Contemporary Books, 1966), chapters 19-20; Murray N. Rothbard, Man, Economy, and State (Los Angeles: Nash Publishing Corporation, 1970), chapter 6 in Value Vault; and Mark Skousen, The Structure of Production (New York: New York University Press, 1990), chapter 9.
  2. Friedrich A. Hayek, Prices and Production, 2d ed. (London: George Routledge, 1931; Repr. New York: Augustus M. Kelley, 1967), p. 11.
  3. Ludwig von Mises, The Austrian Theory of the Trade Cycle (Auburn, Ala,: The Ludwig von Mises Institute, 1983), pp. 2-3.
  4. Rothbard, Man, Economy, and State, p. 857.
  5. Richard Ebeling, preface to The Austrian Theory of the Trade Cycle by Ludwig von Mises, Gottfried Haberler, Murray N. Rothbard, and Friedrich A. Hayek (Auburn, Ala.: The Ludwig von Mises Institute, 1983).
  6. Roger W. Garrison, “The Roaring 20s and the Bullish 80s: The Role of Government in Boom and Bust,” Critical Review 7, no. 2-3 (Spring-Summer 1993), pp. 259-276.

Recommended Blogs

Here is an investor who has the guts to put his work in the public domain. This is one way to track your thinking and investment progress.


For those who want to dig deeper, here are notes on Competition Demystified from an “Austrian” Value Investor.


Value Investing Conference in Copenhagen, Inflation and Clueless Pols.

“All for one!” “One for all!” “Every man for himself!” – Larry, Moe and Curly (Restless Knights, 1935)

Good luck on your case studies. Please stay with your efforts or else: http://www.youtube.com/watch?v=Ux3j-8iMi6s

 Value Investors Conference in Copenhagen (thanks to a reader)


Various presentations and videos on value investing and the market in 2012. Scroll down and read: The five things you didn’t know about value investing by SKAGEN Global portfolio manager, Torkell Eide.

Economic Growth and Inflation


Power corrupts and absolute power corrupts absolutely. See the video of Ron Paul’s speech condemning the Patriot Act.http://www.tomwoods.com/blog/ron-paul-floor-speech-on-ndaa/

Repeal 1021 of the National Defense Authorization Act which codifies into law rules allowing the President to arrest and hold American citizens indefinitely without any due process rights or protection of the Bill of Rights. Heil Obama!

Economic articles on impending inflation:

  1. http://mises.org/daily/5875/How-Deflationary-Forces-Will-Be-Turned-into-Inflation
  2. http://mises.org/daily/487/The-Value-of-Money

The Fed and Europe

Update on Value Vault

The gnomes are working overtime to upload the 17 videos and other materials. About 2/3rds completed.

Fed Joins Other Central Banks in Monetary Easing  December 01, 2011

“The Federal Reserve and other major central banks moved on Wednesday to help foreign banks more easily borrow and lend money, seeking to forestall a breakdown of global financial markets and giving Europe more time to wrestle with its debts. The latest round of interventions by central banks, including the expansion of an existing Fed program that lets foreign banks borrow dollars at a low interest rate, reflects growing concerns that Europe’s financial problems are hampering growth.” (New York Times)

In light of the Fed’s record, this should fill us all with confidence.

FEE Timely Classic  “‘F’ as in Fed” by Sheldon Richman (www.fee.org) is a recommended blog to learn about economics.

We have a report card on the entire Fed era that strongly supports the view that we’d be better off without it. At the very least, as the authors suggest, the burden of proof is squarely on those who would retain the central bank.

The report card comes in the form of a working paper from the Cato Institute: “Has the Fed Been a Failure?” by George A. Selgin, William D. Lastrapes, and Lawrence H. White.

The authors state in their abstract:

As the one-hundredth anniversary of the 1913 Federal Reserve Act approaches, we assess whether the nation’s experiment with the Federal Reserve has been a success or a failure. Drawing on a wide range of recent empirical research, we find the following: (1) The Fed’s full history (1914 to present) has been characterized by more rather than fewer symptoms of monetary and macroeconomic instability than the decades leading to the Fed’s establishment. (2) While the Fed’s performance has undoubtedly improved since World War II, even its postwar performance has not clearly surpassed that of its undoubtedly flawed predecessor, the National Banking system, before World War I. (3) Some proposed alternative arrangements might plausibly do better than the Fed as presently constituted. We conclude that the need for a systematic exploration of alternatives to the established monetary system is as pressing today as it was a century ago.

The dollar has lost 95 percent of its value since the Fed came into existence.

More on how debasement destroys economies:


If Germany and France push the ECB to ease and buy (without sterilization) EZ government securities, markets in Europe will be very strong. If announcements along these lines do not occur, the Euro is history.

For those interested in European Stock Markets: http://www.scribd.com/doc/74371203/European-Stock-Market-Valuation

Investment with Upside and No Downside

Why Kyle Bass Acquired $1 Million Worth Of Nickels


Kyle Bass, who runs a hedge fund called Hayman Capital Management in Texas, is gaining notoriety as an investorwith the foresight to anticipate today’s growing sovereign debt crisis. 

If eurozone governments ultimately write down their debt because the weight of supporting their banks becomes too great, Kyle Bass will go down as one of the earliest to recognize and position for that. His worldview is dire, and it’s apparently prompted him to take some strange precautions such as acquiring $1 million nickels (20 million coins) because their 6.8 cents value as scrap metal exceeds their monetary worth.

I listened to an interview yesterday on BBC Radio HardTalk in which he defended his views. The UK media tends to take a more populist stance with regard to hedge fund managers. It’s now 14 years since George Soros’s bet against Sterling preceded their leaving the European Monetary Union and ultimately declining to join the €.

How fortunate that decision looks today, but at the time UK tabloids blared that George Soros had “broken the Bank of England” and financiers have never been fully trusted in the UK ever since. So the BBC’s interviewer adopted a combative stance, for instance accusing Bass of causing the collapse in Greek bonds through his bets on credit default swaps. Her attempts to portray him as a manipulating hedge fund manager exploiting opportunities for no benefit but his own were deftly handled with facts and figures. Kyle Bass has a point of view worth considering.

I went back and reread Bass’s investor letter from February, “The Cognitive Dissonance of it All”. He reaches a similar conclusion to Jim Millstein in Tuesday’s FT, although he focuses more on government revenues, debt and interest expense.

Japan, given its shrinking and aging population combined with high levels of debt could not afford to borrow at the levels of other AAA-rated nations (such as France) because their total interest expense would exceed their revenue. As Bass says, “The ZIRP trap snaps shut.” (ZIRP is Zero Interest Rate Policy, pretty much what we have in the U.S. currently).

I know people have been betting on a disaster in Japanese bonds for literally twenty years, and it has so far been a disastrous bet. But it does increasingly look as if it still is just a matter of time before we reach the tipping point. After reading what Kyle Bass has to say it’s hard to feel comfortable owning long-term government bonds issued anywhere in the world.

Read more: http://inpursuitofvalue.wordpress.com/2011/11/18/why-kyle-bass-hoard-nickels/#ixzz1eAZaNlwu

Surprise! Inflation Rising and One-Half of the Investment Equation

Predicting the Market

God developed a computer to determine the IQ of the human race. The computer would be able to tailor a question based on the IQ of the respondent.

The most difficult question was, “How does Stephen Hawkins’ Theory of Relativity compare to Einstein’s?

The question of moderate difficulty was, “Who do you think will win the World
Series this year?”

The question designed for the lowest of intelligence was, “What do you think of the stock market?”

Inflation & Debasement and a False Boom

Predicting the direction and timing of the market is a fools’ game, but not to be aware of the underlying forces in the economy will hurt you as an investor.  Right now, (October 18th, 2011) the Federal Reserve is hoping to ignite a (nominal) boom in asset prices. The stock market may go up, but the real return relative to other asset prices may not be as great. If you understand the
Austrian Business Cycle Theory, and you observe the Federal Reserve’s actions,
then the boom in producer prices is not a surprise. For the past 39 years the
world’s currency system has not been anchored to something of intrinsic value. We live in a world of fiat currencies (the PhD Standard) and fractional
reserve banking—Ponzi Finance—so not to be aware of what is occurring is financial suicide.

Half of the Investment Problem

As you take a dollar out of your pocket to invest in a company, you hope that when you sell your investment, the share(s) of stock, the dollars that you receive
will purchase a similar or greater basket of goods and services. You spend
hours studying a company as an investment, but why not spend a minute thinking about what gives value to the dollar in your pocket? What effects that dollar is one-half of every investment decision.

Today Producer Price Index rose 0.8% or 9.6% annualized. How would you like to own 30-year government bonds generating 3.5%? Ouch!  How could anyone be surprised if you saw these statistics from the Federal Reserve:

Pct. Chg. at seasonally adj. annual rates      M1                    M2


3 Months from June 2011 TO Sep. 2011         36.6                  21.4

6 Months from Mar. 2011 TO Sep. 2011           24.9                    14.8

12 Months from Sep. 2010 TO Sep. 2011         20.0                    10.2

The growth in money supply is just one-half of the equation, the other half is the
demand for money based on loan demand and banks’ ability and willingness to
lend. However, seeing half the cards while you opponent sees none is an
advantage. More importantly, you need a theory to understand economic laws of cause and effect that will give you understanding of where you are in an investment cycle.

Inflation & Debasement and Investing

I have been warning about inflation here: http://csinvesting.org/2011/09/19/current-inflation-charts/

I posted an article on investing and inflation here: http://csinvesting.org/2011/09/16/inflation-hyperinflation-and-investing-with-klarman-buffett-and-graham/

Learning About Austrian Economics

Oh how I wish when leaving the University with a BA in Economics I was told to unlearn every lesson and study Austrian Economics.  It’s what you think that’s so that isn’t so which KILLS YOU.

The best way to learn about how the economy works, booms and busts and what affects the value of your money would be to go here:

A course in economics: http://www.tomwoods.com/learn-austrian-economics/   An incredible learning resource

I consider one of the finest books on understanding how the world really works is http://mises.org/Books/mespm.PDF  and Study Guide: http://mises.org/books/messtudy.pdf

If you are ambitious, then further study here: http://www.capitalism.net/

More on Inflation

For an update on inflation: www.economicpolicyjournal.com)

The Producer Price Index for finished goods rose 0.8 percent in September,
seasonally adjusted, the U.S. Bureau of Labor Statistics reported today.
Keynesian economists polled by Reuters had expected prices to increase 0.2 percent. The PPI climbed 6.9 percent for the 12 months ended September 2011.

In September, the increase in the index for finished goods was broad-based,
with prices for finished energy goods rising 2.3 percent, the index for
finished goods less foods and energy moving up 0.2 percent, and prices for
finished consumer foods advancing 0.6 percent.

The index for finished goods less foods and energy moved up 0.2 percent in
September, the tenth straight increase. Prices for finished consumer foods climbed 0.6 percent in September, the fourth consecutive monthly increase.

Price inflation continues to intensify, something that Keynesian economists
can’t explain with their models. Only an understanding of money flows and its
impact on the economy, something only understood by Austrian economists, can
explain what is going on now. Note to Keynesians: The price inflation is going
to get much worse.

Currently, Bernanke is printing money (M2) at very aggressive double-digit rates. It is this money printing that is fueling the manipulated boom. Since Keynesians don’t watch or understand the role money creation causes in the Fed created boom-bust cycle, they don’t see the manipulated boom coming until it is actually reflected in the economic data. That’s why, at present, the data are surprising them to the upside. The new Fed created money is pushing the economic data higher, but since they don’t understand Austrian Business Cycle Theory or “ABCT”, they won’t understand what is going on in the data until months of data role in showing the change in trend.

Inflation, Hyperinflation and Investing with Klarman, Buffett and Graham

Investing and Inflation

Americans are getting stronger.  Twenty years ago, it took two people to carry ten dollars’ worth of groceries. Today a five year-old can do it. – Henry  Youngman.[1]

The best investing article on investing this editor has ever read:


If you  grasp what Buffett is saying, your results will improve. Inflation is the major  concern of any investor. You should measure your investment success not just by  what you make in nominal terms but by how much you keep after inflation. Take out a dollar from your purse or wallet. You  are taking a dollar today to invest  in a claim in a capital good (stock or bond of a company) to be able to consume  the same or more goods and services in the future.

An  interesting blog discusses Buffett’s above article and comments further on
inflation here: http://www.valueinvestingworld.com/2009/06/warren-buffetts-comments-on-inflation.html  and click on the pdf file (100 pages) which
aggregates all of Buffett’s writings on inflation and investing. http://www.chanticleeradvisors.com/files/107293/Buffett%20inflation%20file.pdf.

After reading those  articles, take a minute to download the 50-year charts on

Proctor & Gamble (PG): http://www.scribd.com/doc/65206655/Proctor-Gamble-50-Year-Chart

Coke (KO): http://www.scribd.com/doc/65206606/Coke-50-Year-Chart-SRC

US Steel (X):  http://www.scribd.com/doc/65207037/US-Steel-50-Year-Chart-SRC

Goodyear Tire & Rubber: GT: http://www.scribd.com/doc/65207109/GT-50-Year-Chart-SRC

I recommend going to www.srcstockcharts.com and consider
subscribing to their 35-year or 50-year stock charts as a way to understand the
long-term cyclicality of businesses. You might be amazed at the differences in
performance and persistence between good and bad businesses. As the world
focuses more on the short-term, I urge you to develop more long-term analysis.
Stocks are theoretically perpetual ownership interests unlike bonds.  It’s silly to focus on next quarter’s earnings and think that will have a major impact on intrinsic values.

Four companies is not a statistical relevant example size. Also, one has to be careful of hindsight bias and fitting a theory to the facts, but how does Buffett’s
article tie into these empirical results? What can you use from your analysis
to become a better investor? Thoughts? Hint: I learned to go where the living is easy not to solve tough problems.

Understanding the dangers of inflation is critical now
because of the monetary and credit distortions building up in the world’s
monetary system as the links below will show. A true understanding will require
a huge effort, but you have no choice if you wish to understand the challenges
and conditions you face as an investor.

Many traditional value investors believe an investor should avoid macro forecasting and just do bottom-up company-specific analysis.  I don’t believe you need to forecast markets but one must understand the current dangers and risks confronting him or her when valuing businesses. Not to have been aware of the unusual credit conditions in the housing market during 2003 to 2007 would have meant attaching unusually high normalized earnings to homebuilding stocks while in a housing bubble.

Hindsight bias? A stopped clock is always right twice? Several investors were screaming from the rooftops about the  bubble building in housing. Go here for a ten minute clip: http://www.youtube.com/watch?v=tZaHNeNgrcI.
For a more in depth analysis of the causes of the housing bubble by the same
analyst: http://www.youtube.com/watch?v=jj8rMwdQf6k.
By the way, the point is not the successful prediction but the reasoning behind his analysis. If you don’t understand economics you are like a one-legged man in an ass-kicking contest. Thanks Mr. Munger.

No greater value investor than Seth A. Karman in his introduction to Security Analysis, 6th Edition (2009) writes on pages, xxxii to xxxiii:

Another important factor for value investors to take into account is the growing propensity of the Federal Reserve to intervene in financial markets at the first sign of trouble. Amidst severe turbulence, the Fed frequently lowers interest rates to prop up securities prices and investor confidence. While the intention of the Fed officials is to maintain orderly capital markets, some money managers view Fed intervention as a virtual license to speculate. Aggressive Fed tactics, sometimes referred to as the “Greenspan put” (now the “Bernanke put”), create a moral hazard that encourages speculation while prolonging overvaluation. So long as value investors aren’t lured into a false sense of security, so long as they can maintain a long-term horizon and ensure their staying power, market dislocations caused by Fed action (or investor anticipation of it may ultimately be a source of opportunity.


Now for the current (2011):

A  monetary tsunami is coming: http://mises.org/daily/5597

Defining inflation: http://mises.org/daily/908

Just don’t believe what you read, go to the primary sources:

Current Money Stock Measures which are rising as fast as they did in the 1970s: http://www.federalreserve.gov/releases/H6/Current/

You need understanding to place those statistics into context.  The effects of inflation are rising prices in general or a decreased decline in some prices absent money printing. The effects are not just a result of the increased supply of money but the demand to hold money.

The pernicious effects of inflation:



Why gold prices are so high: http://mises.org/daily/5652/Why-Are-Gold-Prices-So-High


I am not  implying impending hyperinflation but understand the worst case scenario. The US has suffered two hyper-inflations (The
Confederate Greenback and the US Continental Dollar). The dollar’s exchange
value has declined as shown here: http://mykindred.com/cloud/TX/Documents/dollar/
and for further clarification go here: http://www.financialsensearchive.com/fsu/editorials/dollardaze/2009/0223.html

As  investors we must also be prepared to understand worst case scenarios like hyperinflation. See video http://www.youtube.com/watch?v=DzV9WZhhKrM&feature=related.  The Weimar hyperinflation destroyed the
wealth of Germany’s middle class. The social devastation helped usher
in http://www.youtube.com/watch?v=VCwV75obpYk&feature=related
Hitler. May we never forget the lessons of history.


THE best book on understanding the causes and effects of hyperinflation is The Economics of Inflation by Constantino Bresciani-Turroni, download the book here: http://mises.org/books/economicsofinflation.pdf

When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany by Adam Fergusson (1975, Reprint
2010). This is the “narrative description” of Bresciani’s book. The horror. Finally, another good read: Fiat Inflation in  France by White: http://mises.org/books/inflationinfrance.pdf

If you live in the USA or Europe and are not aware of the current dangers and what could happen, you are living a high-wire  act.

[1] Intelligent Investor, Chapter 2: The Investor and  Inflation by Benjamin Graham.