March 30, 2012

Santiago, Chile

One the more interesting investments I’ve made over the last few years was buying a sizeable chunk of a successful baby products company; our products sell around the world and in top retailers like Target, Babies R Us, Bed Bath and Beyond, etc.

The managing partner forwarded me a letter yesterday from one of our international manufacturing agents; the letter explained that, over the last two years, prices have risen substantially in the developing world where many of our products are manufactured.

China, for example, has seen wage increases of 44.6% since 2010. Vietnam- 39.1%. The polyethylene resin that we use has gone up in price 40.3%. Naturally, the rise in oil prices has also increased transportation costs substantially as well.

The letter pummeled us with this data about rising wages and input costs, and then followed it up with a polite assertion that they would be increasing their prices as a result.

It reminded me of the notices I get every year from my health insurance company– they usually start out with something like “Due to the continually rising cost of health insurance…” punctuated with a price increase on the order of about 20%.

And they say there’s no inflation.

This is a direct consequence of the rapid expansion of the money supply. When you print trillions of dollars, euros, renminbi, etc., there are consequences… namely, rising prices.

At first, it’s the developing world that suffers the most. Central bankers in countries where the entire economy is based on cheap manufacturing feverishly expand their own money supplies in an effort to keep pace with the dollar and euro. If they don’t, the fear is that their currencies will rise, killing the manufacturing industry.

Since these countries have tiny bond markets and lack reserve currency status, all the new money they print goes straight into the local economy. This pushes prices up.

At first, it’s usually raw materials, intermediate goods, and staple commodities. I remember being in Sri Lanka last year where the price of turnips had recently gone up nearly 40%, and people were demanding higher wages.

As wages in the developing world rise, it eats into the manufacturer’s profit margins. Eventually, the manufacturers capitulate and pass the inflation back to their customers in the developed world.

You can probably guess that, since we’re now paying more to have our products manufactured, we have to raise prices for our retailers and end users.

It takes a while for all of this money to make its way through the system… but rest assured, it does come home to roost. No doubt, inflation is very much with us.

Precious metals are still the best inflation hedge, bar none. But I’m also interested in other assets that can be more than just a store of value.

That’s one of the reasons I enjoy owning an 1,100 acre farm; productive agricultural land is a great hedge that grows in nominal value to keep pace with inflation… but I also get the added benefit of an organic food supply.

To give you an example, we recently harvest over 800,000 pounds of plums, which were then dried into prunes and sold to a local distributor at a handsome profit. The harvest yield was about 20% higher than last year… and even better, the unit price I received from the distributor was about 20% higher than last year.

Meanwhile, we have a thriving organic garden, an orchard of fruit and nut trees, egg-laying chickens, and a host of livestock.

If you’re not into agriculture, another interesting inflation hedge that also has functional merit beyond a store of value is… ammunition. Ammo has actually been a better investment than gold over the last few years, and over time, it holds its value in much the same way.

I wonder if that’s why the US Department of Homeland Security is openly purchasing up to 625 million rounds of ammunition– as an inflation hedge. Perhaps as a matter of coincidence, buying up to 450 million .40 caliber hollow point rounds and up to 175 million .233 caliber rounds is enough to double-tap every man, woman, and child in the country.

Similarly, I’m sure the NSA’s new $2 billion Utah Data Center is just an inflation-hedge real estate play as well. At more than one million square feet, the center is designed to collect, archive, and analyze ‘yottabytes’ worth of data– our Google searches, phone calls, email traffic, etc.

[Note- a terabye (TB) is about 1,000 gigabytes (GB). A yottabye is about 1 TRILLION terabytes. To put this in perspective, the entire iTunes store constitutes about 250,000 GB... so the Utah data center should be able to host the equivalent of about 5 - 10 BILLION iTunes stores.]

Ah, the land of the free.

To close this week out on some good news, I’m pleased to announce that my partners and I will be hosting our third annual Liberty and Entrepreneurship Camp this summer.

If you’re a relatively new subscriber, each summer we host a 4-day workshop for university-aged students in the picturesque Lithuanian countryside that focuses on Austrian economics, investing, entrepreneurship, international diversification, and actionable success skills.

I bring out some of my closest friends, all successful entrepreneurs and investors, to lecture and engage in small group instruction. Last year’s camp had an extraordinary group of 50-students from more than 35-countries around the world…. and to put it mildly, it changed many lives.

I’m interested in attracting the most motivated, energetic young people I can find… so if you’re between the ages of 18 and 25, you can read more about what we’re doing and how to apply at BlacksmithCamp.com.

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