When Return Of Your Money Beats Return On Your Money

Wild absurdities are taking place in the debt markets these days.  Near impossibilities like negative real interest rates are going on at this very moment.  We blink our eyes with disbelief…but sure enough, the price for money banks are paying depositors is less than zero.  In other words, savers are loaning their money to banks at a loss.  What gives?

To review, negative real interest rates are when the inflation rate is greater than the interest rate.  It takes heavy handed government meddling with markets – like quantitative easing – to pull off such a feat.  During a period of negative real interest rates, savings accounts are penalized.  In the Fed’s best laid plans, negative real interest rates are designed to get people to spend money, to boost economic growth.

We are currently living in a period of negative real interest rates.  But what you should do about it, at least in the short term, may come as a surprise.

When we signed off last Friday morning we noted that Bank of America Certificates of Deposit are currently paying an annual percentage yield of 0.35 percent.  Several hours later the Labor Department reported that the Consumer Price Index rose 0.4 percent in April – or 4.8 percent on an annualized basis.

What this means is that in less than one month’s time, inflation will wipe out the CDs total annual real return.  What’s more, over 12 months the CD will yield a real return of minus 4.45 percent.

During normal times a loss of 4.45 percent on an investment with little risk, and with little upside, is a bad deal. But we don’t live in normal times…we live in interesting times.  For reasons we’ll elaborate on below we believe over the coming months return of your money will be far more important than return on your money.

Stock Market Real Returns

For over two years the recovery rally in the stock market has pushed onward and upward with little interruption.  Looking at a chart of the DOW the trend appears it could go on forever.  But if you stretch back the performance period to from the turn of the new millennium, you get an entirely different picture.

The first day of trading in the new millennium was January 3, 2000.  On that day the DOW opened at 11,501. Last Friday the DOW closed at 12,595.  In just over the last 11 years the DOW has gained about 9.5 percent – or about 0.86 percent a year.  In real terms, however, the returns are far worse…

Using the government’s own CPI Inflation Calculator, we find that it takes $1.31 in the year 2011 to buy what you could get for $1 in the year 2000.  Or, to put it another way, in the year 2000 it only took $0.77 to buy what it takes $1 to buy today.

In short, the dollar’s lost 23 percent of its value over this time.  Moreover, the DOW’s real inflation adjusted return during this period is minus 13.5.  In terms of gold, the DOW has been decimated…losing over 78 percent since the new millennium.

What does all this mean?

When Return Of Your Money Beats Return On Your Money

Obviously, the big trend since the new millennium has been gold up, dollar down.  In nominal terms, the stock market’s generally been flat…but with sharp drops and strong recoveries in between.

Most recently, floating the stock market back up after its substantial crash in late 2008 and early 2009 has been a flood of debt monetization.  This expansion of the money supply has also been a driving factor in the gold up, dollar down trend.  Without it, the stock market would have never bounced and bloomed to the levels it has over the last two years.

Of course, nothing moves in a straight line.  Perhaps over the long run, say 25 to 30 years, the stock market always goes up…most of the time.  But there are interim periods where the stock market can swiftly and violently fall.  Here at the Economic Prism we think we are approaching one of those times.

Since the announcement of QE2 on August of 27, 2010, the DOW has increased over 24 percent.  But with QE2 coming to an end in June does it really make sense to buy stocks now?  A quick look at price charts shows they are prone to rapid selloffs…like the one that happened in the second quarter of 2010 in the interim between the conclusion of QE1 and the announcement of QE2.

So, if stocks aren’t a buy at the moment, then what about gold?  Similar to the DOW, gold has gone up over 22 percent since the announcement of QE2 and appears to be topping out, at least in the short term.

Over the next six months anything can happen…and it probably will too.  But with the end of quantitative easing, it seems asset prices should drop and the dollar should rally.  Return of your money will be far more important than return on your money.  What we are getting at, is that even in a world of negative real interest rates, cash may not be such a bad idea.

No doubt, a significant stock market correction in the face of persistently high unemployment may prompt the Fed to do something especially reckless – like QE3.  When that happens, cash will be the last place you’ll want to be.


MN Gordon
for Economic Prism

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