Having taught, lectured and broadcast for almost 40 years, it never fails to amaze me how Wall Street, Mainstream Media and Financial Advisers in general continue to misinform the average citizen about the power of cash. It goes something like this:
You don’t want to hold cash because it earns nothing, has no rate of return and is not understood to be a long term investment.
I agree with the preceeding in an inflationary environment where cash and credit are abundant, or as you learned in Econ 101, too much cash chasing too few goods.
However, in a deflationary environment, like that which is sweeping the world and will continue for several years to come, the rules are reversed. In this environment actual cash and credit are hard to come by, or again Econ 101, too little cash chasing too many goods.
Instead of going into an economics dissertation, which would make you roll your eyes, let’s use a Jack and Jill example to help clarify. Financial Advisers please pay attention.
Jack and Jill are twins who live next to each other. Their houses are the same size. The furnishings the same. The floor plans identical. Jack and Jill both want to redo their kitchens and each want to take a vacation. Jill wants to go to Hawaii and Jack to Las Vegas. The cost of each trip, $5,000.
Both Jack and Jill received a $20,000 windfall from a deceased aunt. Jack being the aggressive type (Vegas vacation) decided to open a brokerage account that focused on inflation, since he was young, for the future. Commodities, small cap growth stocks and precious metals were recommended.
Jill, on the other hand, understood the deflation that is sweeping the world and the power of cash and decided to keep her windfall under the mattress – figuratively speaking.
The cost of a new kitchen was $20,000 but that was down from $22,000 a few months earlier. Apparently the builders were experiencing a price war. Not enough business for everyone. That happens in deflation.
Jack and Jill decided to wait before redoing their kitchens. Both thought that investing the $20,000 inheritance could hopefully make enough to also pay for much, if not all, of their vacation. So Jack simply couldn’t understand Jill’s reasoning for keeping hers in cash with no rate of return, or so said his broker.
After the past six months, Jack’s commodity, precious metal and small cap account was down 25% and worth $15,000. The good news for Jack, however, was that the builder’s price war got so vicious, several went bankrupt, that the kitchen redo had now fallen to $15,000. A nice new kitchen for Jack but Vegas would have to wait. Jill, on the other hand, simply went to the mattress and extracted $15,000 of her $20,000 inheritance and put the builders to work. In addition, with the $5,000 left over, Jill was able to say
“Aloha and don’t forget to let the cat out!” to her brother.
According to my figures a 25% return on Jill’s cash. In deflation it’s all about purchasing power and cash in deflation is powerful, very powerful indeed.
“What time is the Luau?”