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01/29/2008 - 12:49am
Dave Ramsey, Bad at Macro-Economics
However, from listening to his radio show for so long, I can't help but feel that he doesn't have a good grasp of macro-economics. Macro-economics is the study of economics on a large scale, like for a state or an entire country, as opposed to much smaller economics like that of a single business or family. Macro-economics is not just "economics but bigger", it has a different behavior to it.
Let me start off with a disclaimer that for what Dave Ramsey does and his purpose, he doesn't *need* an understanding of macro-economics to do his job, so this is not an attack on his ability to accomplish his goals. This is simply an observation, and to keep people ever vigilant; in this case, just because someone understands money does not mean they understand every aspect of it.
Economics on a small scale, say for you family or your own business, or even your town, all pretty much works the same way. If you spend more than you make, you acquire debt which must be repaid, usually at a rate of interest. If you spend less than you make, you have a surplus which can be saved, usually while accruing interest.
These principles hold true for governments as well, but there are things that are different. But first, it's time for another disclaimer. This entry is *not* meant to stimulate opinionated conversation of a political fashion. The events mentioned here are for explanatory and mathematical purposes, not to stir up controversy about the events.
Governments can borrow money that they are obligated to pay back, they can accumulate it through taxing, but they can also do something that individuals and businesses can't. They can create it out of nothing. Let's use the United States as an example. The total wealth of our country is somewhere around 60 trillion dollars (I don't recall where I got that figure, but its accuracy isn't important, just that it's a number for us to work with), much of which is in the form of real estate and other hard assets, but some of which is in circulating cash. When the government prints more cash (or does the equivalent by creating it electronically), more wealth isn't created, but instead the existing wealth is divided into smaller pieces.
Of the 60 trillion in total wealth, let's say that 10 trillion is in cash in circulation. And let's represent this in a pie chart, where each dollar represents a sliver of the pie. If another 100 billion were to be added to circulation by government creation, the total cash in circulation would be 10.1 trillion, but the pie would be the same size. That means that the sliver represented by $1 has shrunken slightly to make room for the new dollars. A dollar is now worth 1% less. In other words, we just experienced 1% inflation, because the prices of goods and services will soon adjust upward to take into account the increased money in circulation.
There are certain things that tend to not change in value, but they always seem to go up in price. Many of these things are commodities, like oil and gold. A gallon of gas isn't worth any more to most people than it was 10 years ago, but for some reason the price has tripled. Sometimes it's difficult to separate monetary inflation (price increases due to inflating the currency) and real inflation (an increased price due to an increase in demand or decrease in supply). A good way to measure this is to compare it against something that has remained relatively stable for a long time. Gold, for instance, is worth approximately the same amount it was 4,000 years ago. It's value doesn't change much. Sure, from day-to-day it's price is volatile, but over a period of weeks or months it stays pretty flat in value.
Gold and gas have both tripled in the past 10 years. So did the value of gold and gas increase three fold, or did the dollar decrease significantly? The latter is true, because of the political environment; namely, deficit spending. When the government borrows and taxes to its limits, it begins inflating the currency to make up for the short falls. The larger the deficit, the higher the rate of inflation.
This sort of issue is not something that really needs to be dealt with on the personal finances level, so it's unique to macro-economics. Dave Ramsey is right about one thing when it comes to gold, though. He says that it increase in price at the same rate of inflation. This isn't coincidence. It's not because the value of gold is increasing, it's because the value of the currency is decreasing. If inflation is 4%, and there are other investments that are consistently bringing returns of greater than 4%, then Dave's advice to avoid gold is good advice. But what about when inflation hits 10%, or 15%, or even 20%? An investment in gold at 20% is going to look a lot more attractive than Dave's advice to invest in mutual funds at 12%.
He says that he doesn't invest in anything that doesn't have at least a five-year, preferably 10-year, track record of good gains, and this is sound advice. However, he doesn't seem to apply this to gold. When he talks about gold, he talks about how it's performed over the past 70 years or so. The increase in returns from investing in gold is not random chance, and the future for gold is not necessarily best determined by its past performance as many other stock investments are. Gold's price increases because of inflation, which is due to deficit spending. The higher the deficit spending, the higher the rate of return on gold. In a political environment where the government's deficit spending has no end in sight, the returns on gold will continue to increase. If you want a good indicator for the future of gold pricing, keep an eye on the federal government's budgets. Once you see a balanced budget, that will be the time to divest yourself from gold, because that will be when inflation drops down near zero.
Posted by: Jacob
Very insightful! Also a Dave Ramsey fan, but haven't understood his position on gold. I have to disagree with him on that subject.
Posted by: Jacob
Also, do you know what the current monetary inflation rate is right now? Is it actually 10, 15 or 20% yet? Where can I go to always look at the current monetary inflation rate?
Posted by: Nick Coons
There is no where to go to find that.. the Federal Reserve has purposely discontinued publishing that, and you can imagine why. The only way to "guess" at it is to study actual inflation across many industries, and then try to account for legitimate supply/demand price fluctuations. The other way to guess at it is to watch the price of a commodity like gold, who's price changes primarily as a function of the money supply and rarely because of supply and demand. My gold investment has gained approximately 26% in the past five months, which means the dollar isn't looking too good.
Posted by: fielding j. hurst
i love dave and tend to agree with him on gold, but you do seem to have isolated a conflict when he talking about track records.
Posted by: margot
how is the budget deficit paid?? is it taxes?
Posted by: Nick Coons
As it is now, the deficit just gets piled on to the national debt, which is approaching $10 trillion (that's about $33,000 for every man, woman, and child in the country). The only way to pay it off is by raising taxes, but I believe the monetary system will collapse before that happens.
Posted by: Nick Coons
Let me clarify. The only way to pay it off is with taxpayer money (theoretically, we could sell off federal assets to cover it, or most of it), which would either mean raising taxes, cutting spending, or both.
Posted by: George
Dave Ramsey has said that "gold is stupid". I ask, who is the stupid one? Look at what has happened to gold in the last 8 years! Ramsey claims to be a Christian yet he calls God's money stupid. Gold has protected you wealth people. It is one of the most conservative investements one could ever make. Gold is money, Federal Reserve Notes are not. How can I make such a claim. Money can be defined as a sytem of exchange and a store of value. Federal Reserve Notes are used for echange but are an awful store of value. Federal Reserve notes are nothing but debt instruments. Gold has been an excellent store of value for centuries. For example, at one time in the 20's one ounce of gold bought you a nice suit, that same one ounce of gold can still buy you a nice suit. Try doing that with a twenty dollar bill. One pre 1964 quarter will still buy one gallon of gas people. The rule applies for silver as well. Gold is money and Dave Ramsey is dead wrong. The stock market in terms of gold has lost value. It has been crushed!!! Gold is not "stupid", Dave Ramsey is.
Posted by: Josh
I think that you've pegged the issue: Dave Ramsey is great at what he does (advise individuals, families, and businesses in finances) but this in no way goes to show that he is an expert in all financial matters. This is a quote from Ramsey's book The Total Money Makeover (pg 55):
“The truth is that gold is a lousy investment with a long track record of mediocrity. The average rates of return tracked as far back as Napoleon are around 2 percent gain per year. In recent history, gold has a fifty-year track record of around 4.4 percent, about the same as inflation and just above savings accounts…"
This is a fundamental misunderstanding in the purpose of investing in gold; gold doesn't make you money, it allows you to keep what you have. If you fulfill the most conservative investment plan and simply open a savings account and collect interest you will lose (real) money hand over fist. Most other investments based on the US dollar are the same way right now and will continue in that way in the foreseeable future. Don't believe me? Do some research into what your dollar is worth now as versus 10, 20, or 50 years ago.
Your US Dollar is worth about 4 cents today compared to its value in 1971 when it was taken off of the gold standard... looks like gold would have been a pretty good investment.
Posted by: David Bunker
Dave Ramsey's highly individualized fiscal regimen is more than problematic on a macro level. It encourages whole segments of Christian enclaves to allow their values and ethics to be formed by a theological sacramentalzing of capitalism. He stirs up sentiments that are increasingly anti-govermental (i.e. he speaks of Obama and leaders with a high degree of arrogance and flippancy regarding highly complex issues), antiwelfare,( he places responsiblities for all financial problems on the isolated person nuclear family) anti-urban,(the assumption that cities need less help from the government rather than more) which ultimately reflects a great indifference to and ignorance of racial justice) which all points to how disengaged from the troubles of the world this guy is. This is not a biblical understanding of economics but a highly selfish and personalized sense of economic freedom. I.E. I will help you when I get my life together. In the meantime...sorry! He should see if his teaching works in the inner city or in parts of the country where entire towns have been wiped out by corporate greed. Obviously I take a much harsher read on the financial advice of the regressive Dave Ramsey.
Posted by: Rob
Firstly, I would disagree that gas has tripled primarily because of inflation; decreasing supply seems to be the culprit. Secondly, if gold increases in price with inflation then it doesn't matter if it's 10%, 15%, or 20% if our dollar decreases by the same percentage. It levels out, right?
Posted by: Nick Coons
"Firstly, I would disagree that gas has tripled primarily because of inflation; decreasing supply seems to be the culprit."
If that's the case, then what is the reason for the recent major price drops? Has the supply of gasoline gone back up? Probably not.
"Secondly, if gold increases in price with inflation then it doesn't matter if it's 10%, 15%, or 20% if our dollar decreases by the same percentage. It levels out, right?"
That's right. And when inflation surpasses the rate of return on other safe (or fairly safe) investments, "leveling out" is preferable to "losing."
Posted by: Rob
"If that's the case, then what is the reason for the recent major price drops? Has the supply of gasoline gone back up? Probably not."
-No, supply has not "gone back up". But prices dropped because demand (of the ever-decreasing oil supply) dropped something like 4% last year. (see: http://www.redorbit.com/news/science/277857/gas_demand_drops_in_september/index.html) Demand obviously influences price along with diminishing supply. Notice, I did not argue that inflation did not play any role I just said that it did not play the primary role--perhaps I was incorrect in listing supply as the primary influence, when clearly, both supply and demand are highly influential. Also, I'm saying all of this without an adequate understanding of the role OPEC.
"That's right. And when inflation surpasses the rate of return on other safe (or fairly safe) investments, "leveling out" is preferable to "losing.""
True, but preferable to leveling out would be a high-yield mutual fund--as Ramsey advocates.
Posted by: Nick Coons
Of course there are many factors that influence the price of oil/gasoline. But it is influenced by the relative inflation of the dollar more than many products because it is less domestic than other products (that is, we import huge amounts of it, whereas many other products and/or services are domestically provided, so their pricing will be less affected by relative inflation; relative inflation being the inflation of the dollar versus inflation of other currencies).
The price of gasoline has dropped over 50% in the past few months, so this probably has more factors than the 4% drop in the demand. Note that while up to about a year ago the dollar was inflating at a relatively high rate. At the moment, it's inflating at a relatively low rate (that is, other countries are inflating their currencies faster than we are at the present), so this can also partially account for the drop in prices.
"True, but preferable to leveling out would be a high-yield mutual fund--as Ramsey advocates."
I agree. However, note that my qualifier in the original article was comparing a high-yield mutual fund (which I believe Ramsey often quotes at around 12%) is no longer "high-yield" in the face of 20% inflation. If the price of gold is increasing at 20%, and one invests in gold, it means the number of dollars they have will increase 20% annually, but the buying power will remain the same. By extension, an investment in a 12% mutual fund will yield 12% more dollars, but 8% less actual buying power (i.e. a loss).
But if inflation is 20%, and a high-yield mutual fund is 25%, then by all means invest in the mutual fund.
Posted by: Konrad Mast
You can get (close) to the real rate of inflation. John Williams is an economic consultant who has spent most of his career providing the real (as close as we can get) CPI (inflation), Unemployment, and GDP numbers. He has worked with the BLS to determine how they change their models every year.
Last year inflation got as high as 9% in December. Right now it's down to about 6%. Still pretty high.
John's website is http://www.shadowstats.com/.
FYI, I make no money off this, I'm merely a subscriber. Even if you don't want to subscribe, you can still go there and view the basic charts (find out what inflation rate is).
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