Empires Collapse and Your Wealth Can, Too
Editor's note: Bad management is a subtle danger to your investment portfolio.
But an irresponsible CEO isn't the only way to erode shareholder value.
As Dr. David "Doc" Eifrig explains in today's Masters Series essay – adapted from the February issue of his Income Intelligence newsletter – another hidden danger is lurking out there for investors...
Empires Collapse and Your Wealth Can, Too
Crowned king of Macedonia at a young age, Alexander the Great looked unstoppable.
He controlled the most elite military power in the region, launching an invasion that swept through Asia Minor, Syria, Egypt, Mesopotamia, and Persia. He added each conquered land to his expanding kingdom... and plundered its treasury.
But as his empire stretched from Greece to the edges of what is now India, his soldiers refused to continue fighting. They were tired and longed to return home.
With little choice, Alexander headed back to the interior to start the businesses of organizing and governing.
He stopped for a time in the city of Babylon in the former Persian empire... toting a mountain of captured silver with him. Then, still in his 30s, he died suddenly.
This is where our focus today begins... Not with Alexander the Great's conquests, but with what happened to his empire after he died.
Rather than rejoicing in plundered riches, Babylon's market economy was crippled.
Babylonian scribes maintained a record of clay tablets, mostly for tracking astronomical data. But they also tallied the prices of barley, wool, dates, a type of mustard, cardamom, and sesame.
In the wake of Alexander's death, these commodity prices surged. Wool prices doubled. Barley prices rose more than 10 times over.
Alexander's riches of conquest didn't bring wealth to his kingdom. Instead, an influx of silver led to an increase in the money supply. More silver meant silver was cheaper. And the cost of everyday items rose in concert. This spiraling inflation lasted for at least a decade – halving the value of the currency at the time.
It's not the first case of inflation in the ancient world.
About 100 years prior, Dionysius I of Syracuse did it the old-fashioned way. He turned Syracuse into a powerful city through brutal military conquest. And like most military states, he racked up large debts.
To solve this problem, Dionysius called in all the one-drachma coins and restamped them to be worth two drachmas. His war debts became half as costly.
The downside was that the price of everything else doubled – leaving savers and those earning wages with a drastic decrease in their standard of living. (They, of course, didn't have an army to enforce a "coin restamping" of their own.)
Inflation has plagued savers and wage earners since the invention of currency and the market economy.
Any income investor, retiree, or business owner should know well the fear of rising prices... even if it's been quiet lately. The higher prices go, the less you can buy with your nest egg.
For the last 10 years, inflation has gone from a headline worry to an afterthought. After extreme inflation spikes in the 1970s and '80s, the beast of rising prices has been tamed. Official measures showed price increases of right at 2% a year (the so-called "target" inflation from the Federal Reserve). In fact, policymakers have spent a decade trying to boost inflation, not tamp it down.
Now, though, the ingredients are back for higher inflation. And understanding what it will do to your purchasing power and asset values is necessary for your investment success going forward.
The unfortunate truth is... almost no one fully understands inflation.
Everyday folks don't get it. Wall Street investors often botch the true drivers and end results of inflation. Economists admit they don't fully know how inflation happens and how to predict it. Even famed economist John Maynard Keynes struggled...
There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.
Our goal in Income Intelligence is to make our readers the rare few who can understand inflation. It's time to figure this out. Because we will see higher inflation over the next three to five years. And potentially much longer...
Defining and Measuring Inflation
The definition of inflation is simple. It's a general rise in the price level.
That means you don't want to consider relative price changes based on supply and demand. If OPEC cuts production and oil prices rise, that's not inflation. Similarly, if millennials gobble up more avocados and drive prices up, that's not inflation, either.
Every transaction is an exchange of a product or service for money. So you can flip the equation and think about inflation not as a rise in prices, but as a change in the value of money. When the value of money changes, other things will rise or fall in price.
That's the definition. Measuring inflation is much more complicated.
It's here that conspiracy theorists suggest that the inflation numbers are all cooked, or that it's a scam to... Well, I was never quite sure what the point of that scam would be.
The truth is less exciting... There is no one number that captures inflation.
It's too complicated. Different people lead different lives and buy different things. Our expenditures change across time, geographies, and demographics.
Here's a simple example: One of the hardest features in defining the cost of living is housing costs. Renters and homeowners will face different costs at different times. If you're trying to measure this, which do you put in your price index? How do you weigh each of them?
You can spend a career studying that question, and some people have. All the measures of inflation measure different things and need to be considered together to understand where prices are going.
The Modern Era of Low Inflation
It makes sense that things have gotten cheaper over the last 20 years. Supply-chain logistics have improved at the behest of Walmart (WMT) and then Amazon (AMZN), cutting costs drastically. Global trade has increased, allowing goods to be produced with lower labor costs. Ships transporting goods are growing in size, lowering per-unit shipping costs. Computers have cut the human overhead for production and processing orders and shortened the time between production and demand... making capital more efficient and less expensive.
In fact, if you go out to buy electronics, clothes, food, tools, or all sorts of goods, the prices in relation to your income have never been lower.
Consider a $500 television today and one you could buy for $500 in 1980. Then take note that, earnings-wise, that $500 in 1980 is worth about $1,500 today. That's a lot of money for a terrible television.
Of course, life doesn't feel much cheaper. In fact, for many people, it seems harder to get by than ever. That's because of two things...
First, wage growth for the middle class has been painfully slow over the long term. Since 1993, real gross domestic product (GDP) per capita has risen about 40%, but the median household income has grown only about 15%.
Second, there is an important group of necessities that have not trended lower in costs. In particular, education, health care, and housing have all increased drastically.
These aren't costs you can avoid...
- Since 1978, the CPI is up about 280%. But the CPI's measure of college tuition and fees is up 1,225%.
- In 1970, we spent about $356 per person per year on health care ($1,714 in inflation-adjusted terms). By 2013, that had risen to $9,255.
- And as far as housing goes, the median rent has risen about 33% since 1980 after adjusting for inflation.
The good thing is that we can mostly ignore these specific rising costs. They are important, but they don't threaten investors.
Rather, we're concerned with general inflation as a monetary phenomenon. Health care and college prices will keep rising, we're sure. But the cost of everything else rising is the true threat...
Don't Fear, Prepare
For those of you who remember the 1970s and 1980s, you don't have to fear inflation today. We won't see hyperinflation again... And the rates that we will see will be more in line with long-term expectations than the ultralow rates we've seen for the past 10 years.
But much like you don't need to live in fear of being run down by a bus, you should still look both ways before you cross the street.
Understanding inflation is important for investors to maintain their standards of living and keep their portfolios generating income and capital gains.
Few folks properly understand inflation. So taking just a little time to figure it out puts you well ahead of investors who skim headlines or focus on hyperinflation doomsday scenarios.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
Editor's note: Doc currently holds seven of the 10 best-performing open positions at Stansberry Research. So when he gets super-bullish on an idea, we make sure to listen. He just published a brand-new report detailing an investment whose shares could double over the next 12 months in today's inflationary environment... and yields around 6% today.
Plus, for an extremely limited time, you can get a LIFETIME membership to Doc's Income Intelligence newsletter for less than what it normally costs for a single year. Get the details here.