HELPING PHYSICIANS ATTAIN FINANCIAL SECURITY
By Robert M. Doroghazi, M.D., F.A.C.C.
Low Interest Rates and the Intrinsic Value of Money
(This letter is important because it discusses basic concepts that will have a significant impact on your investments for some time to come. Make sure you understand them, even if it requires reading the letter more than once).
Everything has a value; a table, your home or auto, medical services, a movie, your food, diapers for babies, gasoline. The labor to generate goods and services has a value.
Money has an intrinsic value. Through the 18th and 19th century, Great Britain was on the gold standard. The government issued Consol(idated) Bonds, perpetual bonds with no maturity date; they just paid interest. Aside from a few blips, these bonds paid an interest rate between 3-4% for more than two centuries.
This is the intrinsic value of money. In a zero-inflation environment, where the money repaid is at least as valuable as the money lent, the return is 3-4%. You lend out 100 oz of gold: at the end of the year, you can expect to be repaid 103-104 ounces. Just as a tractor can generate income for a farmer and you generate income by working, your money can work for you to generate an intrinsic return of 3-4% per year.
You also need to understand the concept of real interest rates. If there is zero inflation, and you are receiving a 3% return, the real interest rate is 3%. If inflation is 3% and your return is 3%, real interest rates are zero. If inflation is 1% and your return is 6%, the real interest rate is +5%. If inflation is 3% and your return is 1%, the real interest rate is -2%.
Now add in the intrinsic value of money, which is the genesis of the phrase “time is money”. If inflation is 2% and your return is 4%, even though the real interest rate is +2%, your money is not generating its intrinsic value of a return of 3-4%.
Look at where we are today. The interest rate on the 6-month T-bill is 0.06%. That’s not a typo. It is such a tiny fraction of a percent that let’s just call it zero to simplify the discussion.
Now add in inflation. The government has stated an annual inflation rate of 2% is their target. But as I have noted many times, the official government statistics underestimate the real rate of inflation by (at least) 2-3% per year.
So—if the “official” government inflation rate is 2%, and the “real” inflation rate is at least another 2% higher, and the intrinsic value of money is at least 3%, and, of course, don’t forget to add in federal, state and local taxes, the return for the average investor on a one-year CD at your local bank is at least 7% lower than it should be to provide you adequate compensate for investing your money in the current environment.
Our entire system is designed to punish savers and rewards debtors. It should be the other way around. Why? Because: Who is the biggest debtor in the world?: The US government. Inflation is the cruelest of taxes. Why work hard and save your money just to see it lose value every year? Even 2% inflation per year causes money to lose 50% of its purchasing power in two decades.
The US dollar has lost 98.5% of its value since the advent of the Federal Reserve in 1913. The system is constructed for this to continue. The only honest currency, the only one beyond the manipulation of the politicians—is gold. I again suggest the core position of your entire investment portfolio be gold bullion coins in your personal possession.
RMD
Today was an ugly day in the market. XLF, the ETF of our largest financial institutions, was crushed, closing at 15.07, down 0.39. The financials often lead the market. Silver was down, the miners (except RGLD) were down, yet gold was up, closing at a new all-time high vs. the Euro, and just a few bucks off its all-time high vs. the dollar.
RMD comment: You must own gold.
This is from a Turkish subscriber: “Your recommendations on buying gold helped us earn a good deal of money recently. Thanks a lot”.
RMD comment: If there are three things I want you to learn from my financial writing, they are 1) Thrift is the most important factor in building wealth, 2) Stay out of debt, and 3) The US dollar is no longer “as good as gold”.
Barron’s 7/11/11). “One hedge fund manager points out that Wall Street is selling Wal-Mart (WMT) back to the Walton family. As WMT has bought back shares at a brisk $15B annual clip, the Walton’s ownership is back above 48% and growing every day. Grant’s Interest Rate Observer…notes somewhat facetiously that at the current buyback rate, in 15 years there will be one share outstanding…the dividend yield is now 2.7%.
RMD comment: 1) This is why the rich stay rich. 2) If you are looking for yield, the dividend of WMT can be presumed safe and almost certain to rise.
I have mentioned before I like to give gifts which last and which are cost effective.
On high school graduation, my employer, W. Carl Graham, gave me a copy of Webster’s Seventh New Collegiate Dictionary. I use it almost every day. Several years ago I helped one of my boys buy a quality tuxedo. My tuxedo is almost 25 years old, and I use it 3-5 times a year. Books are a great gift. Another idea: a US Gold or Silver Eagle.
What made me think of this is the sharpening stone my father gave me 30 years ago (I still have the paper towel he wrapped it in). I use the stone all the time, and friends often ask me to sharpen their knives. I admit; this is not even in the same universe of coolness as an iPhone of iPad or designer jeans. Likewise, they will be obsolete in 5 years (or
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