Most people think in terms of purchasing power: how much can one’s cash buy?
In this week’s episode, CEO Keith Weiner & John Flaherty discuss an alternate perspective. Instead of spending your capital, what if you invested it to earn a return? What can that return buy?
Along the way you’ll learn:
- The concept of yield purchasing power & its impact on investing decisions
- How the Fed keeps us stuck in the purchasing power paradigm
- The perverse incentives existing at the household level
- How society is cannibalizing itself through speculation
- Video & articles on Yield Purchasing Power
- Yield Purchasing Power: $100M Today Matches $100K in 1979
John Flaherty: Hello and welcome to the Gold Exchange podcast. I’m John Flaherty, and I’m here with Keith Weiner, founder and CEO of Monetary Metals. Today, we’re going to talk about a concept called Yield Purchasing Power.
As many of you know, Keith received a PhD in economics and has spent a great deal of time developing his thoughts on this principle. He has written and spoken extensively on the subject, and links to that material can be found in the show notes for those who would like to explore it in more depth.
Keith, we talk a lot on this podcast about the adverse effects of a chronically falling interest rate. I’m excited to talk about this principle of yield purchasing power because to me it clearly illuminates the real-world effects of this issue. But before we jump into defining yield purchasing power, we ought to lay the groundwork by first talking about purchasing power. What is purchasing power?
Keith: Purchasing power, pretty simply is, if you have a dollar of capital, how much can you buy with it?
I emphasize “capital” because in the prevailing theory, all prices more or less adjust to reflect inflation, and if there’s inflation, then wages go up and prices go up. So an hour worth of wages, how much that can purchase, it’s a whole different discussion. And for the most part, people who are earning wages care about whether their wage buys more or less. The purchasing power is really looking at a dollar of capital and how much – I like to use groceries as an example – how much groceries can you buy for that dollar?
John: Gotcha. And now, so how what is yield purchasing power and how is that different than purchasing power?
Keith: Yes, it’s kind of interesting to compare the two. I gave a talk some years ago at a gold oriented conference and I gave my whole presentation on yield purchasing power. During that discussion, I kind of savaged the concept of purchasing power. And the speaker that followed me, his presentation was on purchasing power. I think I was a pretty palpable presence on his stage when he said, “Well, I know that Keith said…” And I didn’t do it deliberately, but it was kind of amusing because I think the one concept of yield purchasing power obsoletes or obviates the need for purchasing power.
Yield purchasing power is, what if instead of spending your capital, what if instead you invested your capital to earn a return? How much groceries can you buy on the return on your investment? Return being the yield, the interest rate, the dividend, the rent check, if it’s real estate, on your capital rather than simply liquidating the capital itself?
John: In your writings, you have a couple of examples that I’m fond of, the first one is the example of the farm. Can you can you walk us through that analogy?
Keith: Yeah, I use that analogy because I think it gives you a way to really understand in a tangible, concrete way, you know, the difference between the two. So suppose you inherit the family farm from your grandfather. Your grandfather passes away and leaves you the farm, and it’s a couple of hundred acres. And there’s two different approaches to what you can do. The purchasing power paradigm is, you put the farm up on the market because the farm will sell for, let’s just say millions of dollars, and then you count up how much groceries can I buy, how many years worth of groceries can I buy for the liquidation value of the farm? That is, I’m selling the farm and its ability to produce food, in order to trade the capital – the food producing asset – in exchange for food that I consume.
Now, I emphasize that way. I don’t think most people would quite think of it in those terms, but I emphasize it that way to make clear what you’re doing. You’re trading away the goose that lays the golden egg. One golden egg per day, let’s say. You’re trading it away for some eggs. And then once those eggs are consumed, you’re done.
The yield purchasing power approach is to look at the farm as a yielding asset, and then you’re going to spend a lot of time walking those two or three hundred acres and you say, “OK, we have some cows over here. Is this the best way…if we’re moving to the next pasture? It always gets a little more rain over there, a little more sun or whatever, and we get twice as much hay over there versus here, we’ll have twice as many cows. Let’s add a little more phosphorus and fertilizer mixed with wheat. And let’s do this and let’s do that and increase the yield of the farm and let’s operate the farm to maximize how much food it grows, rather than try to maximize how much fruit it liquidates for.”
John: Right. There’s another example that you gave the Larry versus Clarence example. I think you picked two retirees, one retiring in 1979 and one retiring, I don’t know, maybe a couple of years ago. Can you give us walk us through that example with just some simple numbers.
Keith: Yeah, I picked those names because I went back and looked up what was the most popular name in 1914. So if you were 65, retiring in 1979, you were born in 1914. I think the one that I wrote was several years ago, let’s call it 2015. So what was the most common name in 1950.
And so Clarence was a very popular name in 1914. Larry, or Lawrence, was a very popular name in 1950. So 1979, most people would say well the country was being ravaged by inflation. I’ve written many times that I was, I was a boy in 1979. I recall going to the grocery store with my parents every week noticing – and it’s not that kids are necessarily that perceptive of prices, it’s not the kind of thing I was focused on, certainly.
But I noticed every price of every item in the grocery store was up every week and up by enough that it caught my attention. So we’re being ravaged by inflation in 1979. Most people would say, well, retirees, we’re totally screwed versus in 2015 we had licked inflation, we had a new, what do they call it, a new economic paradigm. I had some term for it. It’s faded out of youth to make ready for the next propaganda term.
Anyway, in 1979 if you had $100,000 saved up, which I think is reasonable amount for somebody who is a successful, let’s say blue collar worker. So let’s say somebody retired as a shop foreman in a machine shop or something like that. Had $100,000 saved up in 1979. And it turns out that if you put that $100,000 in a three month CD and kept rolling it over and you know, certificate of deposit at a bank, then the amount of interest you earned, I think it was two thirds or 70 percent, something like that.
I’ll have to go back and reread my own article, it was two thirds or three quarters of the median income earned at that time. And that’s important because that’s the standard advice that retirement planners would give you. You need about two thirds or three quarters of your working income in retirement.
Presumably in retirement, you don’t have commuting expenses. You don’t have any other expenses related to work. The kids are out of the house, you’re not paying for college for kids anymore, the house is paid off, certainly in those days. I think today people perpetually roll mortgage debt.
And so your expenses are lower in retirement and therefore you need a bit less income. It turns out that the median person with a median savings could put their savings in a bank account and earn essentially the median lifestyle.
1979, in the midst of the ravages of inflation – and inflation have been raging for years. It’s not like it just started that year. And you can say, well, wait until a few years later happened and this would all go away. That’s what it was.
2015, if you calculate the same thing and say, OK, let’s say Larry has a million dollars in savings, which I think would be fairly typical of somebody retiring in 2015, it turns out that he’d barely be able to buy dinner for a family of four on the annual interest in the bank CD with his million dollars. He would actually need something like $120 million in that bank CD to earn enough interest to live the median lifestyle in 2015.
So clearly there’s an erosion, not necessarily of the purchasing power. If you look at consumer price index…consumer price index was rising at a diminishing rate after 1981 and by 2015, not rising much at all, if at all. And some prices are falling.
But the return you can get on your capital, had been absolutely crushed, and therefore you see a hyper-inflation. If you invert that, the inverse of return is the amount of capital needed in order to earn that yield, we see a hyper inflation going from one hundred thousand dollars, one hundred and twenty million dollars in that time period.
John: So clearly the world from Wall Street to Main Street over this period has been conditioned to think in terms of purchasing power, right? Like, you save these millions of dollars and then you liquidate it at the end rather than count on the interest to live on. What are what are the incentives that are driving the Fed and other government central planning efforts to keep us firmly in a purchasing power paradigm? Rather than a yield purchasing power paradigm?
Keith: Well, I’ve said before, and I think in a previous podcast episode, many mainstream economists, if not most of them, basically fall into two categories. There are those that develop the magic incantations, you know, the eye of Newt and Midsummer’s Eve, and the numerology by counting the letters of the first word on each line of a page and doing some sort of fancy look-up to figure out what the interest rate is supposed to be, or what the wage is supposed to be or whatever.
And then there are those that are the propagandists, the hacks that shill for the regime. Economists of that stripe are always giving us soothing noises. I guess the way a mother would give an infant who’s a little colicky and trying to tell us how good things are. And it just kind of boils down to, “But hey, look at how much better life is now because you have iPhones and Amazon and Sunday delivery and every movie, every TV show ever produced in the history of the world is available for free on Netflix. So, life has never been better. And besides, your house is up. Your 401k, your stocks are up. Nothing to see here. Move along, folks.”
The real purpose of the Fed – any central bank, they always jawbone about inflation and unemployment – but the real purpose is to enable the government to borrow more, at cheaper rates, so they can spend more. We certainly saw that under Trump with a $2.8 trillion CARES act piled on top of a $1.7 trillion dollar deficit.
And now Biden, basically doing the same thing. $1.9 trillion is what he wants to spend on so-called relief. And that’s just a down payment. He’s going to clearly do a lot more if he gets his way. They like to spend to buy votes. Spending is very popular. It adds to GDP, which is a whole other topic of the fallacies of that. And the falling interest rate allows them to spend ever more. So it’s ever more popular. So they have to come up with a whole lingo of selling it and why it’s good.
You know, people love it because it’s a bull market. Whatever assets you’ve invested in, whether it be real estate, whether it be GameStop shares, you know, everything is assured of going endlessly up and therefore, you’re getting more and more free purchasing power. And nobody asked the question if you’re getting to spend without producing, doesn’t necessarily mean something for somebody else. What’s what’s actually going on behind that? Nobody really thinks about that.
John: Right. So what are the incentives going on at the household level then?
Keith: I like to think of two things. I like to think of the question, is the rate of interest too low? Separately from, is it falling? So if it’s too low, then that means it’s mispriced. And if it’s mispriced….for instance, you walk in the supermarket one day and the price of sirloin steak is one cent per pound. But what does that do as an incentive?
Well, obviously it incentivizes you to eat a lot of steak. Assuming that they have a lot of steak in stock. And assuming it wasn’t about to be spoiled, assuming, it was perfectly good steak. Then you fill your grocery cart up with that for a penny a pound. You’d walk out with a hundred pounds of meat for a dollar. And, you know, depending on your views of diet, that’s either really good if you’re paleo or really bad if you’re of the view that saturated fat isn’t good for the heart.
Clearly, it’s an incentive to consume more. But what if instead of just simply a low price of meat, what if you had a falling price of meat? That is every day you went to the grocery store it’s a bit cheaper? Then the incentive there is, the incentive is changing. So everybody has their view of diet and everybody has their understanding of what’s healthy. And then every day you go, the incentive has changed. So one day there’s a certain incentive to how much meat you should buy and the next day they increase it and they increase it and they increase it and they increase it.
And that’s been going on for 40 years. Obviously not on the price of steak, but in the price of credit.
So, if you’re a household and you have a house, then they’re saying they’re saying two things at the same time. Two incentives are changing. One, the incentive to borrow to take out credit against your home equity. And the home equity is rising because it’s an endless bull market. So you have more and more equity locked away in your house.
And every day you go to the market, the cost of borrowing against that is going down. So even if you said “neither a borrower nor a lender be” and you said that in 1985, in 1990 it’s a little harder to hold that line. In 1995 even harder. And by 2015 your kids say, “Oh come on dad, you’re just an old fuddy-duddy. Why would, why would anybody not want to be a borrower? I mean look at how cheap it is now.”
So there’s at the same time that there’s an increasing incentive to borrow, there’s a decreasing incentive to save. I mean, what the heck is the point of putting money into a CD that’s paying zero point zero something percent interest. It’s never going to add up to anything.
John: While the principal is debased at the stated goal of two percent per annum, right?
Keith: You’re actually losing on that, and by the time you retire, your retirement savings will be enough to buy a hamburger. So it just seems rather pointless. But at the same time, the cost of borrowing is going down. And so people begin to treat their rising assets as a source of income, which is, essentially, they’re consuming their assets. That’s sort of the hallmark of our era. Everything’s about how do we consume our capital and then pretend that we’re getting rich while doing so.
John: So it seems that falling rates are forcing everyone to speculate their way to retirement at this point. But as you repeatedly point out, it’s impossible to think that generation after generation will be able to speculate their way to prosperity and retirement. So I just want to be clear. Are you opposed to speculation in all forms?
Keith: I’m not….I mean, there are a lot of things that happen in a free market that when the market becomes by varying degrees and in very different ways, unfree. And that’s what this is, right? I mean, the Fed imposes a monetary policy. That is, it supersedes your judgment about interest rates with the use of force. And the primary use of force is by declaring the government’s irredeemable credit paper to be money. And they have a variety of different ways they do that.
Legal tender is in way almost a lease at this point. And when that happens and things become unfree, then there’s certain things that used to occur in relatively small measure in a free market, but also in specific contexts that suddenly metastasize and grow out of proportion. I mean, you need a thyroid. Every human being needs thyroid. If you don’t need the thyroid, then you have to get thyroid hormone artificially or else I mean, you can’t live without thyroid.
But, if the thyroid becomes cancerous and begins to grow, somewhere between the size of a baseball and the size of basketball, it’s going to kill you. It’s going to choke the life out of you. And so what we have now is rampant speculation unleashed by the fact that the interest rate is unstable and the asset price is effectively the inverse of the interest rate. So with every halving of the interest rate, there’s effectively a doubling of asset prices. And that’s true even when interest rates get really, really miniscule.
So you go from one percent to half a percent. That can be very, very big changes in asset price markets. And so, speculation in an endless bull market fueled by endlessly falling interest rates, speculation is the process of conversion of one party’s wealth, or one party’s capital, into another party’s income. I like to use the example of the prodigal son and whether anybody is religious or not, has faith or not. The story is a timeless story because it shows obviously a foolish young man and what he was thinking at the time that he said, give me my inheritance, demands that of his father.
Obviously a very, sort of generous, but in a way a doting old man who agrees to something that he shouldn’t have. I mean, if I was a father, I would have said, “You can wait until I’m dead before you get your inheritance, right now it’s mine.” And that would have put the kid in this place, I would think. But in any case, he takes all of this capital, which is not only presumably, a lifetime of the father accumulating it, but presumably that’s the family legacy.
The father inherited something from his father who inherited something and who knows how many generations this has been accumulating in the family. And he goes and blows it. Right? He goes and parties for a year. And he comes back empty handed and obviously a little bit contrite, as I recall the story, not necessarily that much contrition there. You know, it’s a timeless story because everybody can imagine that idea of consuming would have taken five generations to accumulate. And I would think any normal person would have that horrible feeling in the pit of their stomach.
If you imagine yourself in the shoes of that young man holding your head in your hands and saying, you know, what have I done, father? What have I done? Just the guilt and the agony of that would just be unbearable. So nobody wants to…there’s always crazy people out there…but I don’t think the vast majority of people want to consume their capital, their family legacy. So you have to set up a complicated enough game that people can’t see through it.
So it’s kind of like three card monte or the shell game. That used to be a thing, I remember as a kid, as a young man in New York, you know, there were these hustlers on the street corner. And they would have a bunch of ringers with them so you couldn’t tell who was crowd and who was in on it. You know, whatever the gang that ran that corner and, they’d sucker the tourists and the fools who think that, you know, you put you put the pea under one of the shells and then shuffle them around in a way that looks like you can follow the pea.
Either they had a trick to mislead the eye or maybe just palm the pea, and there was no pea under any of the shells, but basically you’d lose your money every time. Because there was just enough complexity there to allow them to conceal the act in the complexity. It was just simply, OK I’m gonna put this pea down on the table and you point to it and then he palms the pea. Right? Nobody would fall for that. So there has to be just enough to bedazzle and beguile the victim.
And so if you have a bull market in real estate, a bull market in stocks, there’s just enough there to beguile people into consuming. Society consumes its capital in the aggregate. No one person is consuming his own. But what he does is he forks over his capital to buy an asset. And in the hopes, obviously, that the next person will fork over even more capital to buy if off of him at a profit. And that’s what happens as the asset runs all the way up.
Of course, people know that there’s losses when the asset eventually hits. The unsustainable top comes crashing down. Everyone knows losses are being taken then, but the capital is being lost on the way up.
People don’t really think in terms of “where am I getting this free purchasing power”, getting the purchasing power as a concept I’m getting for nothing, you know, free purchasing power or I’m participating in this market. And the market, I’m not sure quite fits the definition of Ponzi scheme, but it is Ponzi like in that, you know, the rewards paid to early investors come from the capital that’s invested by later investors.
So, am I against speculation as such? No? In a free market, there’s definitely times when, you know, if your city is growing, somebody recognizes that what’s right now, a piece of marginal farmland outside of the outskirts city is going to be inside the city at the current growth rate in 10 years. And buys it, there’s nothing wrong with that. But it’s when every asset is going up relentlessly and predictably because of the actions of the central bank that it becomes, you know, society is cannibalizing itself.
John: Right. So then what would you say….let me make sure I understand this. What would you say to someone who owns income producing assets? You know, the Kiyosaki doctrine, like rental real estate or equities that have traditionally produced a dividend.
Is that sort of the midway point or are there still some problems there?
Keith: Well, yeah, the problem is that the return that you get in the form of dividend or rent is going down. So let’s take a look at, you know, here in Arizona, real estate as a very concrete example. So the price of real estate here has gone absolutely bonkers since, since COVID, really. And I don’t recall reading anything about it in January, February a year ago.
But post-COVID, you know, at first, I mean, there was probably very little activity in real estate, end of March and into April, but at some point in May or June, it went absolutely mad. I can point to and say that’s because the interest rate crashed right at the beginning of 2020. You know, the interest rate. I’m trying to remember what it was. About 1.8% percent on a 10 year Treasury bond? Something like that.
And then by the end of March it was 0.5%. And mortgage rates are set as a spread to 10 year treasuries. So you get a collapse of the interest rate and that fuels a rise in home prices. And so people are buying these things, you know, as investments. I certainly don’t think there’s a greater number of people post-COVID who can afford to buy a house. And I’m sure it’s a smaller number of people because, you know, huge numbers of people lost their businesses, were personally ruined.
Most small businesses, obviously, if they go bankrupt and lose their business, but most small businesses, the owner signs a personal guarantee on the on the bank loan. So, you know, they’re now facing loss of all their assets, foreclosure on their house, all that kind of stuff in the wake of the COVID lockdown. So I don’t think, and obviously a lot of people are unemployed, I don’t think that house prices go up because there’s more people that can afford to buy a house.
Rather, it’s a smaller and smaller group of people who can buy more and more houses as investments. You know, right here in Scottsdale, you have the price to buy the house going up. Or to buy the condo going up significantly this year. But at the same time, rent is not going up. You know, rent is pretty steady. So what happens if you pay – and I don’t think house prices doubled, but just to make the math easy – if you pay twice as much to buy the same house, that has the same rental income on it, then the return you’re getting is half. And the net return is actually less than half, because out of the gross rent, you have to pay expenses to repair roofs and air conditioners and windows and all those things. And so the net return could be dropped by two thirds or something like that.
And so, yeah, you can buy real estate to get a return, but the return you’re getting on that real estate is diminished along with the interest rate, because the return on every kind of asset is ultimately a spread to the Treasury bond. You drive down the Treasury bond yield, you drive down the yield of every other asset.
John: Makes sense. So, Keith, where does gold fit into the yield purchasing power paradigm or a return to that paradigm?
Keith: This is a really important point and a great question. Obviously, a lot of people buy gold because they hope its price is going to go up.
So they want the purchasing power of their capital held in the form of gold to go up. That’s kind of like wishing your farm would go up so you can liquidate it and get more groceries. We’ve certainly read a lot of commentary about the gold price, but that’s not that economically interesting.
What’s economically interesting about gold is that…it’s not that the general price level is fixed under gold. That wouldn’t be possible. And even if it were possible, it wouldn’t be desirable. Nothing is fixed, everything’s always moving in a real market.
But what is stable in gold is the interest rate. With a stable interest rate, you have stable asset prices. There’s no reason for the same house that fetches the same rent to go up. There’s no reason for the same stock producing the same dollar of earnings – so it’s relatively predictable – to go up or to go down.
So with stable asset prices as a function of stable interest rates, it’s not that anybody passes a law that says make speculation illegal because it’s bad. I think those laws are universally terrible because what they’re doing is an act of what I call compensation. Compensation is when you do the wrong thing on purpose. Yeah, yeah, I know it’s wrong, but I’m doing it to fix something else that I cannot or will not fix the right way.
So my example of compensation is letting the air out of three tires because you have a flat. And you say, well, I’m compensating for the flat and at least the car’s riding level now. Yeah. Yeah, but.
So what the regulators tend to think today is, OK, we lower the interest rate and that creates all these incentives to do all these bad things, and will now compensate for that by imposing a giant regulatory regime like Dodd-Frank, for example.
That’s an attempt to…and then Janet Yellen as Fed chair, we’ll see what she says now as Treasury secretary, intends to talk a lot about macro prudential regulation. “Yeah, we’re going to force institutional investors to lever up because they can’t get the return that they need unleveraged. AND we’re going to enable them to lever up by making the cost of leverage ever cheaper. But that’s perverse and we don’t really want them to do that. So we’re going to impose macro prudential regulation to prevent them from doing the things that we force them to do and enable them to do.”
And then somehow the net result is going to be good. Like at least we’re driving on a car that’s that’s level because all four tires are deflated.
So it’s not that you make speculation illegal, it’s that in a free market, speculation is reduced back down to the size…the thyroid, when you don’t have cancer, it’s not a particularly large or massive organ in the body. It’s an important one. But it stays at its size because there isn’t a need or an opportunity for it to grow larger than that.
John: Right, so, Keith, finding a stable interest rate in gold seems to be the mission of Monetary Metals, am I right?
John: Well, if you’d like to learn more about that, please visit our website, monetary-metals.com. That’s all the time we have today.
Keith, as usual, we appreciate your thoughtful insights. You’re definitely in your element with this principle of yield purchasing power. Again, if you’d like to explore that in more depth, please see the show notes. Thank you again for joining us on The Gold Exchange.