Baby Boomers, Currency Devaluations, and Capital Flows

There is no doubt in my mind we will eventually have a currency crisis in America. While all swaths of America will be affected, select groups will bear a greater burden. In my opinion, the burden will fall most heavily on Baby Boomers. The result of currency devaluations can be boiled down prosaically: savers get screwed. Remember, it is the Baby Boomers who have the largest accumulation of savings- either in the form of savings accounts, bonds, or home equity- and therefore, the most to lose from a devaluation.

The flow of capital and behavioral adjustments in the Baby Boomer demographic will coincide with larger capital flow megatrends. Humans are fundamentally driven by self-preservation; they eventually get the long-term trends right. The only question is when. Will capital gradually flow out of the dollar as a devaluation becomes increasingly evident, or will be see a sudden revaluation? My guess is both.

The money flowing into gold is the “smart money.” This is the type of money that steps in front of trends instead of being trampled by them. I am positive that Baby Boomers will eventually buy gold en masse to protect themselves from the stupidity of politicians. When they do, watch out- gold is going to fly.

The most common argument against gold as an investment is that it does not generate cash-flow. Frankly, this has got to be one of the most short-sighted arguments I can think of. It would benefit retiring Baby Boomers to forget the sanctity of cash flows for a second and think in terms of absolute returns.  

Generally investing for cash flows is wise. But the factors that dictate investing decisions go far beyond simple cash flow analysis. Certain assets at certain times exist outside the purview of cash flow analysis.

In a rising inflationary environment, bonds will suffer, since they are fundamentally claims on dollars. Sure bonds provide “safe” and reliable cash flows, but in an inflationary environment, the net present value of bond investments is negative.

The current panic-driven capital flows into bonds is a precursor to a substantial rise in gold, and to an extent, stocks. As yields continue to fall, “no-yield” investments like gold become attractive. The bond market is comparatively a huge market, so cash outflows from bonds into gold will result in remarkable rocket launches in gold.

So let’s put cash flows in perspective. You may be receiving 10% dividends, but if the dollar drops 25% against global currencies, you lost money. The number one risk facing us right now is currency risk. Eventually people will take off their blinders and react accordingly. Until then. the right thing to do is to buy gold.

Real Estate and Home Equity

Baby Boomers inordinately benefitted form the rise in real estate. I would imagine they are leading cheerleaders of real estate since they don’t know what a sustained downturn in real estate looks like. Most Baby Boomers will learn about historical real estate cycles the hard way. For a generation that used their home equity as a form of savings, this is troubling.

Homes are negative carry assets, which is disastrous when prices don’t move. Price and time are everything in housing. It appears housing is set to experience another downward move. The savings embedded in home prices is about to evaporate. Baby Boomers will likely have to trade down and search for alternative investments for their freed up cash.

Predicting the likely asset allocation of retirees is an interesting thought experiment. The standard line is that retirees should get out of stocks and into bonds. This makes sense if you have a stable currency, a bull market in bonds, and a bear market in stocks. Otherwise, it makes no sense.

If I had to hazard I guess, I would say that Baby Boomers, or more conservative cash flow investors in general, will find their way out of bonds and into high yielding large cap stocks. This is one of the factors that I believe will drive the seemingly paradoxical rise in stocks as the economy crawls at a snail’s pace. Be very careful not to conflate the performance of stocks with general economic conditions; they are independent entities.

As inflation becomes a problem, dividend distributions can rise nominally along with earnings. This will draw people back into equities. However, since returns on equity remain unchanged in an inflationary environment, investors won’t actually benefit in real terms. Nonetheless, stocks will beat the alternative of bonds.

Current account deficits in America put dollars in the hands of foreigners. This forces them to make decisions about the proper allocation of capital. The rise in the dollar, driven in part by the unwinding of the carry trade, would drive investments into the U.S. if the trend were sustainable. Unfortunately it is not and foreigners will have to rethink their investment strategies.

It’s hard for me to imagine foreigners investing in any American asset besides stocks. Because of paltry yields, the margin of safety for U.S. bond investors is non-existent. U.S. real estate is a losing bet when the dollar is devaluing against global currencies. Because of currency appreciation, I believe it will be far more profitable for foreigners to sit on their own currencies in conservative bond investments. Since everyone alive today has only experienced dollar hegemony, capital flows out of the U.S. will not happen overnight.

The years ahead will bring volatility to markets. A currency devaluation will set off a wave of events that will have investors searching for answers. During relative times of calm, it is wise to weigh various outcomes and prepare accordingly. The price of insurance in the form of gold is set to rise in leaps and bounds. However, most people can’t pull the trigger at current prices. Be honest, how many people do you know buying physical gold at above $1200 dollars? I fail to see how this is some kind of public-driven gold frenzy.

Right now capital is scared. If you can foresee with a fair degree of accuracy where money will flow, you can make some serious profits. The above is a brief synopsis of how I generally see capital flows moving.  However, events can change quickly. The only trend that appears inevitable at this point is a flood of capital into gold.