We will be discussing John Exter’s pyramid and its role in assessing market investment value and risk. However, though I like Exter’s pyramid from a macro economic perspective, it is not necessarily designed to help individual investors plan their portfolios around market liquidity and risks in the system.
It does, however, give us a really really good place to start discussing just how to do that. We just need to make some modifications to the existing pyramid to make it more investor friendly in today’s markets. I will be examining Exter’s pyramid in this month’s digest, and based upon my investment experience and research, will provide you with a version that allows you to safely store and grow your wealth over time regardless of what is going on in the economy.
John Exter was an advisor to Paul Volcker in his time at the Fed. His theory on the liquidity of market investments, and how much risk they carry, have often been cited by market observers who wanted to show where money flows to during economic crises.
Volcker presided as the Chairman of the Board of Fed Governors from 1979 to 1987. His policies are largely connected with saving the US economic system from the recession of the late 1970s and early 80s. US inflation in 1980 was 14.8 percent, a far cry from the low interest rate policies that have existed for the majority of many investors lives today.
Volcker raised the Federal Funds rate, which averaged 11.% in 1979, to 20% in June 1981. The high interest rates slowed down the rampant speculation in real estate and other areas of finance, which had led to an enormous speculative debt boom, strong rise in consumer price inflation, and high unemployment. While the rise in interest rates affected farmers, machinists, and other blue collar workers, the impact of the Fed interest rate policy was to cool the speculative areas of the economy off enough to stabilize it.
What most people don’t know is that Volcker has called upon his friend John, a former New York Fed colleague, to help him work his way through the economic crisis the country was experiencing. Volcker’s fight had peaked with the 20% Fed funds rate, but price inflation was initially still strong. John advised Volcker when to ease his monetary policy to stabilize the economy. And his advice worked.
John himself retired after setting up two foreign central banks, serving as governor of one of them, and ending up in charge of gold and silver operations at the Federal Reserve Bank of New York.
John also advised Volcker and the rest of the Fed Board members that gold was the basis of a sound monetary system. He warned that Keynesian economists failed to understand money and debt. John Exter predicted that the US would suffer a deflationary depression, and the Fed would be unable to prevent it with their monetary tools.
It was from this realization that Exter developed his pyramid, with true money on the bottom and all derivative financial products on top. In his original pyramid, he included junk bonds, illiquid debtors, commercial paper, bankers acceptances, developing economies’ debts, CD’s, federal government debt, corporate and municipal bond debt and finally paper currencies.
Modern versions of his pyramid include commodities, private business, and real estate while leaving out some the specific financial instruments mentioned in his first version that are no longer seen as primary market instruments.
In reality, the adjustment in Exter’s model away from the early years of banking instruments to the new derivative-based paper system indicates that overall risk and lack of true liquidity in the current fiat money system has reached levels none of the other Fed governors predicted it would, with the exception of John himself.
The version above depicts a recent accounting of how much of these various Ponzi financial instruments exist in the world. The way John Exter advised reading his pyramid was that both the amount of the instrument, as well as it’s overall risk, increased as you moved up from the base of the gold and silver money.
This is where we separate from Exter’s pyramid and begin to form our own version for the purposes of determining which investments are best to hold in the hyper-risked state our banking and currency system now lives.
I’ll explain why I decided to do this, and why it is VERY important that we use this modified Exter pyramid to map out safe, private investments to hold during the coming economic collapse. Because, dear reader, you will have a very hard time surviving economically during the currency and financial reset coming to the Western nations without having this map to plan with.
My primary complaint with Exter’s pyramid is that it approaches financial investments from a central planner’s perspective. However, it fails to advise individual investors how to approach saving and growing their individual estate.
Secondly, the pyramid was simply designed for high level economics discussion, but fails to sufficiently break down each investment class into appropriate categories. For example, the pyramid lumps all real estate together at the same level of liquidity and risk. As a long time real estate investor of almost 20 years, I can tell you this is a woefully inadequate analysis of the real estate market.
Lumping all real estate together with the same risk levels is completely misleading. It may cause us to miss special values in real estate that can be as powerful an investment as, say, gold and silver. One video to watch for coming up in the Investor Education Center series of videos is a discussion of property rights where I discuss why owning land is so important to economic freedom.
The Founding Fathers of this great country equated land ownership to freedom. They reasoned that not owning land made one the slave or servant of someone else. They were right, but you won’t see that fact reflected in Exter’s pyramid. And that is why it needs modification it to better suit those who understand that economic freedom comes with individual ownership and limitations on government interference.
Exter’s model is great for the central economic planner that looks at the economy from the top down, addressing with policy only the largest classes of financial vehicles. As investors, we are much more suited to look at investments and risk from the bottom up. Our portfolios are built over time using our sweat and labor. Our portfolios often resemble a hodgepodge of different investments accumulated over time. Therefore, our view of risk is much different than that of a government bureaucrat.
Second, we don’t take on the aggregate risk of every investment in the economy with each of our individual decisions. Though, we should at least be aware of what the broad risks are when purchasing something. While the central planner is focused on stabilizing markets to maintain government receipts, the individual investor searches for unappreciated values and solid growth prospects to help build wealth over time.
So what I will do here is rebuild Exter’s pyramid from the ground up as an investors would see the market. I will not ignore the view of the central planner; indeed we will compare the two models later in the discussion.
In Exter’s financial model, gold and silver form the base and actually sit outside the pyramid. Meaning, they retain value regardless of what happens elsewhere in the economy. The base layer does not change in the new model.
The first change in the new model is to place people immediately above gold and silver. The collection of skills and talent, along with their labor, make up the value of people. It is safe to say that gold and silver will not get mined, houses will not be built, and derivative contracts will not be written without the labor and expertise of humans. Therefore, I argue that each person forms the second base level of their individual financial system. Note how individual property rights, not government economic control, is emphasized here.
As an example, if one increases their skills in an area which are demanded, then it is likely the person can earn more through their labor for having developed those skills. Those earnings can be used to purchase all of the other assets in the pyramid. So why are people not at the base? Because risk increases as we move up the base, and mined gold and silver reflect past human skills and labor already spent after all risks have been realized.
In other words, there is no risk that gold and silver will lose the value of the already imputed labor spent to mine and mint them. Humans, on the other hand, contain more forward risk. Perhaps it is one’s health or longevity that is the risk. Or perhaps it is declining skills that are not replaced, reducing the time value of one’s labor. So gold and silver stay at the bottom of the new pyramid.
The next level up the pyramid becomes non-residential land, which includes farm-able and ranch-able land that can produce food, minerals, and commodities. This land does not have buildings, or other infrastructure improvements, on it which have been financed with debt.
From the Great Depression to the recovery, the only investment that fared better than gold was undeveloped farm and ranch land. That is because farm and ranch land are limited in supply and often decrease for every property development that springs up over time. Good farm and ranch land is an increasingly scarce resource on a world in which population increases march on through time.
This change may generate a lot of argument, because Exter had commodities placed very high on his pyramid. That is largely because commodities derivative price contracts are heavily influenced by speculative investment. For example, many of the commonly traded commodities on COMEX are traded for price speculation, where the contracts are not settled in the actual commodity, but instead in cash.
The profit between cash purchase and settlement costs are earnings for speculators that never intended to take delivery of a barrel of oil, a shipment of sugar, or a single pig. Further, speculators can often control a lot of a commodity for only a fraction of the retail sales price. This allows trading tremendous amounts of a paper commodity contract for very little real money. This leverage is very attractive for investors looking for a lot of yield on short term commodity contract trades. Given all of the cash sloshing around in the system, speculators have been provided by central banks with billions of dollars to spend buying up commodities contracts for speculative purposes.
And there isn’t enough physical product to satisfy those contracts even if they did decide to settle in the commodity instead of cash. The fact that they rarely do is what keeps overall prices lower than what they may have been. This tends to dampen the market value of many commodities and promotes rampant over-use of the world’s precious resources beyond what a truly free market price would encourage.
Commodities are primarily risky if one is buying an indexed commodity fund at the top of a commodity price market cycle. However, real commodities are also growing increasingly scarce. It is a known fact that oil, natural gas, uranium, copper, and many other commodities are becoming harder to find and in much smaller quantities.
Therefore, scarcity factors ensure that the base price of commodities will rise over time despite monthly speculative activities of the paper traders. If we just look at global growth rates over time, then commodity market observers should expect significant price increases over time. Further, China and India’s emerging middle classes are sure to demand more and more commodities to obtain their desire lifestyles. The sheer size of these emerging markets ensures there can be no long term price devaluation of important, every day commodities that are mined every day.
The exceptions to this rule will be commodities that are not longer useful, e.g. replacements are developed. Generally, as industrialization increases, new uses are found for most commodities. But there exists a risk that a particular product will be demanded less. So it is good to focus broadly on commodities markets and to closely follow analysts predictions for their future demand. Just be sure not to invest with the crowd when prices are at cycle highs and due for temporary price corrections.
Next up I would add private businesses. This means any business you have setup to generate income. Wouldn’t business income DECREASE during a recession? The trick is to be in a business that will produce in both good times and bad. For example, food is a staple that is always in demand. The key is to focus on food items that are affordable to many. High end gourmet or specialized food product demand may fall precipitously when more people are unemployed.
We are late in the current economic cycle, meaning the economy is weakening. So if you are considering starting a new business, it would help to focus on business that people demand when times are bad. This could be security-related services to protect goods and other businesses. It could also be selling vice items such as cigarettes and liquor, the use of which tends to increase when times are bad.
Other ideas are inexpensive entertainment such as music and movies. Difficult economies bring with them demand for distractions to keep people’s minds off their misery. Lastly, employment related services, such as developing new skills and marketing employment opportunities, would be at a premium as long as you can match the needed skills and the people that have them. Do not focus on luxury products or non-necessities because your sales are likely to plummet when a recession hits.
This one is a bit confusing at first, and the value depends largely on timing. For example, the US dollar will be under extremely heavy pressure during the next deep recession. Many countries are dumping their dollar reserves while also negotiating trade agreements in alternative currencies. Less demand equals less value.
That being said, dollars will be in heavy demand within the US at the onset of the recession Incomes will have fallen and more people will be unemployed. Any paper money is better than none. And, most merchants will readily accept these dollars for goods until it is apparent the dollar is no longer the strongest currency in the world. When this happens, you will want to switch over to your gold and silver reserves as money.
Also, other currencies such as the Canadian dollar, Euro, Yuan, and Pound could increase in value during the next recession relative to the dollar. Depending on how these other economies do, these currencies may buy more dollars that can be used to buy goods and services. In some cases, black markets may develop for people to exchange their other currencies, particularly those of neighboring countries where money can flow across borders, directly for goods and services.
It may not hurt to hold a small portion of other currencies in the event of a collapse. Just make sure you have identified places to exchange them for dollars or directly for needed goods. And don’t buy too much – failure to being able to exchange these currencies is just as bad as not having them when they are needed.
Any type of debt instrument will be severely devalued in the next big recession. The current system is absolutely flooded with debt that cannot be paid back. Literally, debt exists in many magnitudes the size of available physical cash or bank deposit (electronic computer, but not real) money. The government would have to print excessive amounts of money to pay off this debt, which will devalue the currency to the point the strategy falls apart. Whatever debt is left over will likely be worthless to investors because it will never be paid back.
Do not fall for the idea some financial types use to claim municipal or local bonds are safe and will not be affected. Many local cities and states are completely financially insolvent. And unlike the national government, they cannot print more currency to cover their financial obligations. Many of these bonds will go bust long before US Treasury debt does.
This section will surely shock readers more than any other. This is because the mainstream financial media has brainwashed investors on the value of stocks for far too long. Any stock that does not pay a dividend is part of a Ponzi Scheme. Tan Liu and I cover the four factors making stocks a Ponzi in our interview, so be sure to listen to it.
In short, stocks have no direct monetary connection to the company that issues them. The company does not have to redeem them, and it is up to the next investor to buy it for you. The common term for this in financial lingo is ‘greater fool theory’. It means that as long as you can find a bigger idiot, you can offload you near worthless stock paper to them. If you can’t, then you know what it is like to hold stocks during a deep financial recession such as seen in 2000 and 2008 when stock values plummeted off their highs. As was emphasized in our interview with Tan, the stock ‘value’ was a pure paper derivative in and of itself, and inferred no real value to the holder unless it could be sold at a market high.
There is only one plausible argument against our argument – companies have real value and stock holders have claim to it. However, bond holders almost always get first pickings during a company failure, which is the only time stock holders will be able to make a claim against company assets. By that time, most of the company value has been looted by senior management and wealthy stock holders who sold their shares at or near the top as it became obvious the company was reaching insolvency.
From timing perspective, stock can be the absolute worst investment to hold during an economic crash. Values are down, and the only real chance an investor has in getting real cash is waiting for companies to fail, or maybe, get taken over by a bigger one. In reality, recessions cause stock holders to take cents on the dollar. This is not unlike the game of musical chairs, where someone is left out each time the music stops. Think of music as the next recession we are about to face in the not too distant future. Recessions happen all the time, on average every 4-10 years. A time of this writing, we are in year 10 of the current boom, the second longest on record, meaning our chances of seeing a recession are increasing every day forward. This is not a recipe for long term wealth building success.
Being invested overseas may not save you during the next collapse. The banking, credit, and company sectors are all hopelessly intertwined with one another. The next collapse will be like a row of dominoes falling down across a giant map of the earth. No corner will be spared. The medium term exception might be China’s market – even though their economy is collapsing, their companies have very modest debt ratios. Meaning, they are likely to pay the bills and at least keep the lights on, even if they are producing less. But make no mistake – all stock markets will take a serious hit once the next collapse occurs. China just may recover faster than many of the others due to the frugal financial positions of many of their companies. The government has used its monetary power to see that their industry will survive.
I grouped these together because the risk is so high that it won’t matter. These will never be paid back. The unfunded liabilities of the US government, which include entitlement programs such as welfare programs and Medicaid, will become completely insolvent. This is why taking care of your own financial and healthy well-being are so crucial while you have time. Government will not be able to pay for those promises they made without funding them ahead of time. In fact, all government reserves will be emptied in an attempt to keep the economy from completely collapsing. These efforts will fail, of course.
Derivatives are paper leverage, and in many cases are worth nothing today. For example, how many times can mortgage security paper be leveraged on an over-heated housing market due for a MAJOR price correction, and still have any value? Even if most major asset prices don’t collapse during the next recession, which they will, derivatives are mostly made up of paper and ink (or just electrons on a computer database). The initial first few investor claims on those derivatives will bankrupt them, causing the vast majority of the remaining ‘value’ to simply disappear where they came from – into nowhere!
The primary purpose of re-engineering the pyramid is to blend the size of the financial vehicle with the risks of owning them during a major economic crash. The chart should be used primarily for individual investors and their families who seek to preserve and safely grow wealth, regardless of the state of the economic environment. This chart is your cheat sheet also should the economy completely collapse – each layer, starting at bottom, will be your primary means of surviving the collapse. In short, having too much money in any of the higher layers vastly increases your risk of loss and moving into financial insolvency. At that point, your only choice would be to rely on what is left of government handouts for food, security, and shelter.
The differences in the pyramids are immediately obvious. In Exter’s pyramid, physical paper money is listed right above gold and silver. The reason is because we live in a fiat paper system based upon debt. And all central bankers consider the currency to be legitimate accounts of exchange and stores of wealth, though history has disproved this notion thoroughly. Paper money has its uses for limited periods of time, and so it appears midways up the pyramid. Sometimes we are forced to use it by government, but over the long haul it always returns to its intrinsic value of zero.
The second major difference are non-monetary commodities. These have a lot of longer term value, and make good strategic investments especially when you can hold them in physical form. Beware holding funds based on commodities because it may be exposed to paper derivatives that don’t tie directly to their physical counterparts.
Next, I moved private businesses out into its own layer. Individual businesses can generate long-term wealth for their owners. But, it depends on what your business is, and when. Timing is the biggest risk, so it resides just below paper money on the wealth generation pyramid.
Again, one of the biggest shocks to many of my readers will be putting stocks near the top, or most risky position, on the pyramid. As stated, non-dividend stocks have many of the same features as Ponzi schemes. Even stocks with dividends don’t pay back for an average of about 20-25 years, so you have to be really comfortable holding them for any length of time. Given that business cycle corrections happen every 4-10 years, you are basically guaranteeing two major investment losses over that 20-25 year period that dividend stocks need to be paid fully back. In addition, dividends don’t account for the time value of money, meaning the longer you hold that stock, the less of a real return you get on your dividends in the future. Inflation almost always dissolves stock gains, which is why gold has outperformed stocks since 2000. Gold prices rise long term by the amount of monetary inflation in the system. That is why it resides at the bottom of the chart.
Lastly, and perhaps most importantly, is the inclusion of the individual on our Gold Silver Pros Wealth Generation Pyramid. Most financial analysts and pundits will never tell you that you have the keys to your own financial success in your own hands. That is because they need you to believe they are the experts; and by using them you will be provided higher returns and more safety. This is a ruse – no third party will ever take as much care of your wealth as you will. This is a primary reason I am not a stock picker or finance professional – it goes against my morals. At the end of the day, education is the key to your success. That is what I aim to provide you, not the hottest stock tip that will evaporate in 3 weeks time. And despite whatever past issues you have had in securing and growing your money, you can always invest in yourself to get better. You can also increase the value of your labor, and make more money doing this than any financial advisor will do for you in your lifetime! Lastly, YOU are what you will have to depend on when financial collapse happens – the banks, brokerages, and advisors will be looking out for themselves first. This is the way it has always been.
There are a few other changes you will notice between John Exter’s pyramid and mine. Feel free to compare and contrast, and send me a note by email with any questions or comments you may have. I look forward to answering them!