Sunday, August 19, 2012

Cash Conundrum

You're devastating in the dark
You could be tearing me apart
But you still feel the same
Lost like tears in the rain
--Ric Ocasek

"How much cash should I hold?" This is among the difficult decisions facing investors (broadly defined to mean any individual with residual income after consumption) at our present juncture.

The 'easy' part of the answer is to set aside at least enough cash to handle 6-12 months of living expenses. Once this 'emergency fund' is taken care of, use further cash residuals to pay down debt--first credit cards, then car loans, and perhaps even extra on monthly mortgage payments if applicable.

If you are fortunate enough to have checked off these items and still have spare cash to work with, then you might consider adding more to retirement accounts although, personally, beyond making sure one contributes enough pretax income to meet an employer's match, I'm chilly to channeling lots of present day capital into tax deferred retirement instruments (rationale here).

Beyond the IRA route, investors with left over income face two general choices: a) invest in 'taxable' asset classes like equities, bonds, real estate, commodities, collectables, etc, or b) build additional cash (or cash near-equivalents such as CDs or T-bills).

Few financial professionals advise the cash route. They argue for asset classes like stocks and bonds because of belief that these asset classes will outperform cash over time--due to either compelling valuation or because inflation gnaws at the value of cash. The first argument, that stocks and bonds possess compelling valuations here, finds little sympathy with me. From where I sit, stock and bond values are closer to (or at) historic highs.

I am sympathetic to the inflation argument, however. It is easy to build the case that, on top of the $trillions already created out of thin air, governments worldwide have little choice but to try to print their way out of massive debt. Huge increases in the supply of paper currencies will destroy the value of paper money relative to the value of things. Think Weimar, or Argentina, or Brazil. Hard assets in particular, such as gold, seem advisable under these circumstances.

The counter argument is that there is not that much 'free' cash, i.e., true savings, on hand. The world is highly leveraged, meaning that most money that has been 'printed' is linked to a liability somewhere. If people become risk averse and no longer want to live with their debts, then the 'cash' on hand will evaporate as people use it to close out debt projects or address margin calls.

Indeed, a good argument can be made that we have been inflating for decades, and that people have been intelligently shedding cash in favor of debt that gets paid back with currency less valuable than when the debt was taken on. Stated differently, a debt super-cycle IS an inflation super-cycle.

If that super-cycle is coming to an end, then, by definition, it should be replaced by a deflationary phase.

The problem is this. If one accepts the thesis that we've been inflating for years and debt has reached extremes that make it difficult to add more debt, then one still has to explain how deflation occurs when governments around the world still control the monetary printing press. Won't governments just keep printing to keep the system from collapsing into the deflationary abyss?

The answer to that question is the ultimate answer to the question of how much cash to keep on hand. There is a compelling case for a veritable paper blizzard ahead. But the contrarian in me suggests that cash in its true 'saved' form is already scarce and thus should be valuable in the future.

position in SPX, gold

1 comment:

dgeorge12358 said...

The dollar is backed by the Treasury bond, and the Treasury bond is paid in dollars.  It is circular, self-referential, and it is a ponzi scheme.
~Keith Weiner, Gold Standard Institute