Copyright 2013 John T. Reed
There used to be a mutual fund called the Dow Theory Investment Fund. It is now called the Salem Fund and I do not know what theory it operates on.
Charles Dow was the first editor of the Wall Street Journal. After he died, three of his followers promulgated the Dow theory of stock investing based on his writings. The Dow Theory Investment Fund bought the stocks his theory said to buy.
Lately, I have encountered many who have a lot of money in pension accounts like IRA’s, 401(k)s, SEPs and so forth. (For the rest of this article, I will use the acronym “IRA” to mean all types of tax-deferred pension accounts) I told them to withdraw the money and move it to hard assets or selected foreign bank accounts. Many refuse because they believe they may someday be in a lower tax bracket and that would be a better time to withdraw.
I say that if their pension assets are dollar-denominated, they are likely to lose everything if hyperinflation hits before they withdraw the money, in which case the taxes will pale in comparison to the loss. Also, there are rumblings from Washington about imposing financial repression rules on the pension accounts. Those are laws that essentially force Americans to buy U.S. government bonds that have too much risk or too little yield or both such that the free market refuses to buy them.
But, many people won’t listen so I want to come up with a way for them to stay in their IRAs but reduce their hyperinflation risk.
Many will immediately say that they can invest IRA funds in hard assets and foreign currencies because the only prohibited assets are life insurance policies and collectibles.
Uh, sort of.
The problem is not so much the asset classes limited by law but the assets that trustworthy custodians or trustees are willing to manage.
Pension accounts do have a possibly valuable bankruptcy exemption. Although in hyperinflation, essentially no one goes bankrupt.
People will tell me you don’t need to use the big name custodians who refuse to do real estate or foreign currencies outside the U.S. You can do a “self-directed” IRA.
Uh, sort of.
Crudely speaking, it appears to me that “self-directed” IRA is a misnomer. All pension accounts are self-directed as to who decides what asset classes to invest in. You always decide that.
The actual difference between so-called “self-directed” IRAs and normal IRAs is your custodian in a “self-directed” IRA is Ned Nobody and your custodian in a normal IRA is Charles Schwab or Well Fargo or USAA or Vanguard.
I do not want Ned Nobody to have control over much of my life savings. I am afraid he will steal it.
So setting that debate aside for the moment, I will now try to help readers who want to keep their current IRA, etc. money in their IRA.
Basically, my advice on protecting yourself from hyperinflation and depression is to buy hard assets, especially hard assets you will use yourself or that are suitable for barter, and to have enough liquidity to pay routine and rainy-day type bills. The only way I know to have liquidity during USD hyperinflation is foreign currency in foreign banks in foreign countries.
If you can make the payments, you should owe fixed-rate USD. Note that’s owe, not own. You do not want to own any USD-denominated assets until the U.S. debt-to-GDP ratio goes down to about 35% or lower. The last time it was at that level was around 1981 so don’t hold your breath. But owing USD denominated fixed-interest rate debt is fine as long as you can make all the payments out of your normal income. Do NOT borrow USD that you can only pay back if USD hyperinflation occurs.
If possible, you would want your income to be exempt from capital controls and US price controls. How would that happen? Generally, if you are in some sort of international business—import, export, tourism, foreign travel, selling or leasing to foreigners, work or business or investment that is in another country. During hyperinflation, U.S. residents would be prohibited by capital controls from possessing or using foreign currency. But the U.S. government will be even more eager than now to have foreigners do business with the U.S. and bring their money here. That means the U.S. government has to give licenses to some Americans in the activities I just listed to enable them to accept or handle foreign currency. Also, Americans who work abroad or have businesses abroad would earn foreign currency in those countries. Imports and exports are always exempt from domestic price controls
Can you do that within IRAs? No. You are not allowed to use the assets in your IRA. And you cannot barter them unless you withdraw them from the IRA which would trigger the tax liability that is always triggered by IRA withdrawals.
My research into IRAs seems to indicate that all withdrawals from them must be in the form of USD. That is, they can invest in hard assets, but they cannot give you the hard assets when you want to withdraw from the IRA. Rather, they must liquidate your hard assets for USD then give you USD. Ouch! That would be extremely costly during raging inflation.
Under IRA law, if you do any “prohibited transactions” or allow any “disqualified person” to make any “improper use” of the IRA assets, the IRA goes poof and it is as if you withdrew all the money in it at that moment. So you then have to treat the entire amount in the IRA as taxable income and pay tax on it at ordinary income rates.
What is an example of a prohibited transaction? A couple of guys [Peek and Fleck, 140 TC 12 (5/19/13)] bought a business using their IRA money, a bank loan, and borrowing against their homes. When they borrowed against their homes, they agreed to personal liability. Ooops! That was a prohibited transaction because personally guaranteeing the home mortgages was an indirect extension of credit to the IRA.
You may not loan to or borrow from your IRA. It goes poof if you do, even indirectly or constructively (legal technicalities).
A “disqualified person” is roughly you, your IRA fiduciary, certain relatives of yours, or entities that are controlled by you or one of those other people I just listed.
“Improper use” includes:
buying an IRA asset
leasing an IRA asset
selling an asset to the IRA
borrowing from the IRA
lending to the IRA
personal use of the IRA
camping in RV owned by IRA
vacationing in a property owned by the IRA
You almost avoid making an “excess contribution” to the IRA. For example, if you work on one of your IRA assets like a rental house, the fair market value of your labor is considered to be a contribution and if you already Maxed out your contribution limit for the year with cash, the additional contribution in the form of your labor breaks the law.
Okay, so you still want to keep your IRA money in your IRA. I am ruling out the so-called self-directed IRA where you trust Ned Nobody with all that money.
So if you have the IRA money in the care of a custodian or trustee like Vanguard or Schwab, what assets of the securities variety should you put it in? If you buy stock, it would need to be the stock of companies who do what I said above individuals should do:
• Own hard assets
• Own selected foreign currencies
• Owe U.S. dollars that they can pay back with normal income
• Have foreign income
• Have hard assets assets in foreign countries
Are there stocks that your Wall Street household name IRA custodian would be willing to buy where the financial statement would show precisely these sorts of assets, liabilities and income?
Yes, probably not perfectly but certainly many corporations are less vulnerable to USD hyperinflation than others just as readers of my book How to Protect your Life Savings from Hyperinflation & Depression, 2nd edition are generally less vulnerable than those who have not.
So the Reed Theory Investment Fund would own stocks of U.S. and foreign corporations that had the sort of hard assets, selected foreign currencies, fixed-rate USD-denominated liabilities, and selected foreign income I just described.
The Reed Theory Investment Fund could also hold a diversified portfolio of trustworthy commodity funds.
Would it hold any bonds? Uh, maybe five-year or shorter term, AAA-rated corporate and sovereign bonds denominated in my seven favorite foreign currencies: Australia, Canada, Denmark, New Zealand, Norway, Sweden, Switzerland. Absolutely no USD- or EUR-denominated or other shaky-currency bonds.
Would it hold any money-market deposit accounts or funds? Uh, I guess if such things exist that are denominated in the currencies of Australia, Canada, Denmark, New Zealand, Norway, Sweden, Switzerland.
Am I hoping some big-name Wall Street firm will license my name for an actual Reed Theory Investment Fund? No. Nicholas Taleb did that after writing the book Black Swan. I am not sure exactly what happened but I believe it did not perform well and went out of existence. I do not think I have that much name recognition. And I wonder if I would trust anyone with my name. Plus funds want to rank high in Morningstar. I would not have any interest in ranking high on yield. I am advocating insurance, not investment with regard to hyperinflation and depression. The only performance I would be interested in would be how my fund fared during hyperinflation or depression.
Howard Ruff used to be the Rush Limbaugh of the 1980s. Only he had not only radio but also TV, newsletters, etc. There was talk of his running for president. Until he started touting the FundAmerica pyramid sales scheme. Here is what Wikipedia says about his demise:
Ruff believed (as of his 1979-1981 writings) that the United States was headed for a hyperinflationary economic depression and that there was a danger that both government and private pension plans were about to collapse. His popularity fell off after the peak in the gold and silver speculative bubble in 1980.
I do not agree that “his popularity fell off.” It completely disappeared almost overnight, as did he. Like Dick Morris did after the 2012 election.
There is a saying on Wall Street that being early is the same as being wrong. Ruff may have been early, but I do not think he was wrong. Harry Figgie, Jr. and Ross Perot were also early on this. But I don’t think they were wrong. (Perot was wrong about another issue: NAFTA.) Perot was leading in the presidential polls in 1992 based almost entirely on his warnings of future financial trouble from too much deficit spending. And his running caused Bush I to lose to Clinton.
Also, my position is that hyperinflation and depression risk protection are like fire insurance. Fire might happen. So might hyperinflation. If either did it would be financially devastating to you. And there are low-cost, low-risk ways to protect yourself so protecting yourself is the prudent things to do. I am trying to give readers peace of mind, like an insurance salesman, not riches from gambling on monetary instability.
Being early in buying fire insurance—or hyperinflation—is NOT the same as being wrong. Indeed, doing anything other than being early when you buy insurance is financially suicidal. Being early with regard to insurance purchase is normal and prudent and the rule. Buying insurance before you need it and keeping it as long as you need it is normal and prudent because the cost is relatively low. When it comes to fire on hyperinflation insurance, it is better to have it and not need it than to need it and not have it.
Ruff was more into betting on bad times as a way of getting rich. His most famous book was How to Prosper During the Coming Bad Years.
Is there already a mutual fund that approximates my Reed Theory Hyperinflation Protection Investment Fund?
I doubt it. Maybe some readers who are more familiar with securities markets could tell us about some funds that might approximate the Reed theory. But what I really am trying to tell readers in this article is if you insist on keeping your assets in your IRA, try to move them to assets like those I described above. I will link below to some ads or articles on funds like commodity funds and foreign stock funds. Remember, and this is crucial, you are only looking for hedging USD inflation risk, not high yield. Many of these funds are pursuing high yield and those can get you killed financially.
I am not recommending any of these per se, just trying to stimulate your thinking. You have to do your on due diligence on them.
http://en.wikipedia.org/wiki/Commodity_index_fund
https://www.opers.org/investments/defined-contribution/non-us.shtml
https://personal.vanguard.com/us/funds/snapshot?FundId=0770&FundIntExt=INT
http://money.usnews.com/funds/mutual-funds/multicurrency/franklin-templeton-hard-currency-fund/icphx
http://www.merkfunds.com/fund/mhcf/
http://www.pimcoetfs.com/Funds/Pages/FORX.aspx
http://money.usnews.com/funds/mutual-funds/rankings/commodities-broad-basket
http://en.wikipedia.org/wiki/United_States_Commodity_Funds
Very briefly, investing in such funds exposes you to fund fees, possible fund mismanagement, exchange risk, counterparty risk.
I used to have Vanguard and USAA S&P 500 index funds. My wife still does. My Reed Theory Hyperinflation Protection fund would try to be like the S&P 500, as widely diversified as possible and not actively managed. If you must keep money in IRAs, this is the way to do it. Try to get diversified hard assets and foreign currencies outside of the jurisdiction of future U.S. capital controls and foreign currency income. Owe U.S. dollars. Don’t own them.
So, gimme your thoughts especially if you have above-average knowledge of the securities markets.
Reader Anthony Alfidi (Cell: (415) 317-9005
http://www.alfidicapital.com
http://www.facebook.com/alfidicapital
http://twitter.com/tonyalfidi ) has put some IRA stuff into a Canadian currency ETF (FXC ticker symbol) and an Australian ETF (FXA) and has identified a Swiss franc ETF (FXF). He could not find an NZD ETF. See his article about it at http://alfidicapitalblog.blogspot.com/2012/06/alpha-d-currency-diversification-for.html
One concern I have is getting the IRA somehow outside the jurisdiction of future capital controls. IRA law requires that the custodian/trustee be an American company with a location that is open during regular business hours in the U.S. I suspect that means all IRA custodians/trustees would be required by future U.S. capital controls to forcibly convert your foreign currency to USD immediately upon promulgation of the capital controls.
That is what the Everbank boilerplate fine print said. Everbank is a U.S. bank that will allow individuals to have foreign currency accounts—the only one. Plus they will be FDIC-insured and can be rolled over to such accounts from withing current IRAs. BUT, and it is a deal-killing but, they say if the U.S. government orders them to convert your foreign currency to USD they will do so whether you like it or not and at the conversion rate the U.S. government directs whether you like it or not. Count on that rate being less than market. Such conversions are essentially forcing you to sell your foreign currency to the U.S. government for less than its market value. If you think the U.S. government would not do that, read Executive Order 6102. That was about gold but capital controls generally treat gold as if it were a foreign currency. Also, there are already several executive orders in waiting that essentially authorize U.S. capital controls. See also Executive Orders 11051, 11490, and 11921.
Alfidi’s ETFs use JP Morgan. Sounds like they would come under U.S. jurisdiction and behave like Everbank says it will.
If you have to use a U.S. custodian/trustee, and capital controls force foreign currencies to be converted back into USD, that sounds like foreign currencies per se are out as IRA assets.
That leaves securities in the form of equities (stock) that disproportionately own hard assets and/or that own foreign currency that is located outside the U.S. Also, securities that have substantial foreign currency income. As far as I know, there is no precedent for the U.S. government forcing owners of stocks that go up in value to sell them to the U.S. government.
It also leaves commodity index funds. Again, I know of no precedent for the U.S. government ordering residents to forcibly sell their commodity index funds to the U.S. government for less than market value.
But I most say I see no liquidity in an IRA no matter what the asset because if you liquidate a hard asset stock or commodity fund, you must convert it to USD and pay tax on it when you take it out.
So it appears that whatever funds you have in your IRA are there for the duration of the hyperinflation. Putting your IRA funds into commodity index funds and/or the stocks of companies that own hard assets and that own and/or receive foreign currency that is located outside of the U.S. has a decent chance of preserving your IRA funds until the hyperinflation ends. If your IRA money is denominated in USD, however, you are guaranteed to lose it. About all you can do is try to yank it out as soon as the hyperinflation starts, which will trigger taxes, and invest the after-tax amount into hard assets at warp speed.
Another reader sent this:
I just read your article on trying to find alternatives investing in IRAs. You might want to look at prpfx, the permanent portfolio fund. They own gold, silver, Swiss francs, stocks with an emphasis on reits and natural resource stocks. They also own bonds in the fund. Harry brown came up with the strategy in the 70s
I believe. He wrote several books about investing. He was a big advocate of having some of your money overseas. He was a libertarian who ran for president. He died several years ago. There is a lot info online about him. His name is synonymous with the permanent portfolio.
I Googled this fund. A capsule graph and bare-bones facts box popped up. It appears to be up generally over its history although down in recent months. It has a .71% expense ratio. Funds like USAA and Vanguard have expense ratios in the .19 to .20% range. It is not front-end loaded.
Here is the mix of the Permanent portfolio according to a Wikipedia article about it called Fail-Safe Investing.
25% in U.S. stocks, to provide a strong return during times of prosperity. For this portion of the portfolio, Browne recommends a basic S&P 500 index fund such as VFINX or FSKMX.
25% in long-term U.S. Treasury bonds, which do well during prosperity and during deflation (but which do poorly during other economic cycles).
25% in cash in order to hedge against periods of “tight money” or recession. In this case, “cash” means a money-market fund. (Note that our current recession is abnormal because money actually isn’t tight — interest rates are very low.)
25% in precious metals (gold) in order to provide protection during periods of inflation. Browne recommends gold bullion coins.
That is far from the Reed Theory portfolio. Matter of fact I am mostly horrified by it.
The 25% U.S. stocks might not be too bad in a hyperinflation, but I would prefer that some effort be made to cull out corporations that are financially configured so they will be hurt badly by high inflation.
25% long-term U.S. treasury bonds!!? Do I even need to comment on that to my regular readers? Jesus H. Christ on a crutch!
25% Cash!!!!!? When hyperinflation is an imminent possibility!?
25% precious freaking metals!!? Precisely the ones I condemned in the strongest possible terms in articles like in http://www.johntreed.com/golddisadvantages2.html and http://www.johntreed.com/nomentionofgold.html and http://www.johntreed.com/U.S.-nickel-coin-actually-has-the-characteristics-falsely-ascribed-to-gold.html?
Do a search for the word “gold” within my web site by using the search box at the top of almost all of my web pages. Almost everything I say about gold applies to the other precious metals: silver, platinum, and palladium.
Also, Browne’s approach fails to take advantage of one-way indexed assets like U.S. pennies and nickels and high-loan-to-value-ratio, fixed-rate, non-recourse mortgages. One-way indexed means the asset can go up in value, but not down. Pennies and nickels can go up in value because they contain nickel and/or copper. They cannot go down in value because they has the words “one cent” or “five cents” engraved on them. There are other one-way, “heads you win tails the other guy loses” ways of configuringy our financial statement. Browne seems oblivious to them.
Two-way indexed assets, like a free-and-clear home, are less attractive but better than “heads I lose tails I win” assets like cash or precious metals or long-term U.S. bonds today when interest rates are so low they can only go up thereby reducing the value of the bonds.
I also see no foreign currencies in the portfolio. Mr. Browne, who is deceased, needed to read my book How to Protect your Life Savings from Hyperinflation & Depression, 2nd edition. His portfolio sounds like something concocted by a fourth grader to me.
To reader who scoff and such tiny assets I will point out that famed investor Kyle Bass just bought 20 million nickels in the last several years. See my article about nickels that is linked to above under the prcious freaking metals discussion
John T. Reed