I Wish I Knew What Was Going To Be On The Other Side


An Update on Our Performance
The Great Inflation/Deflation Debate
Is Inflation Causing a Rippling Effect?
Getting Real on Inflation...
Paper Money Siren Song
Fiat Money Time-bomb?
Portfolio Performance Analysis
The Idaho Back Country

Over the next 20 years, you are going to see significant changes in how we function as a nation.  With our back up against the wall, it won't be business as usual for the foreseeable future.  I am not sure how it will end, but I am fairly certain that the reset button will be hit.  I just wish I knew what was going to be on the other side. 

Why am I so certain?  Because we simply owe more money than we can afford to pay back, and not paying back your debt or paying back the amount you owe in dollars that have been devalued tends to make people mad at you. 

Our current publicized deficit is around $11.4 trillion.  The true deficit, or the deficit that accounts for all the United States' financial obligations, is around $60 trillion.  These other financial obligations consist of off-balance sheet liabilities-Social Security, Medicare, TARP money and a few other trillion dollar debts.  So, in reality the publicized $11.4 trillion national debt is not even close to the real amount of money owed by you and me.

How can this be?  The Fair Accounting Standards Board (FASB) considers Social Security and Medicare off-balance sheet obligations because the government can change its mind on how they are paid.  Your government has the flexibility to change the retirement age, lower payment amounts, reduce your medical coverage, and numerous other activities to reduce its financial debts.  Because of this flexibility, the FASB considers these obligations off-balance sheet items.  How many politicians do you know that would vote for a bill to reduce these obligations?  I don't know any either.

Historically, there is an incredibly accurate predictor for resetting societal norms.  The ancients called this predictive cycle a saeculum, which is the length of a long human life-80 to 100 year time span.  According to the authors of the book The Fourth Turning and the founders of the respected think tank Life Course Associates, this repetitive cycle has happened consistently, dating as far back as  Roman times.

If you work the math, you'll discover that the last three cycles in the United States have been the Great Depression/World War II, the Civil War and the Revolutionary War.  Each event is separated by the length of a long human life.  War is a normal part of the cycle but it doesn't always happen in the resetting process.  If you are curious about this methodology, I strongly encourage you to get the book and give it a read.  The book was published in 1997 and amazingly the authors predicted current events.  Thanks to my good friend Joe Barrato for sending me a copy. 

Most economists are currently predicting that the economy is in danger of either soaring inflation or spiraling deflation.  Since most economists are terribly wrong with their forecasts, I am always looking to take the other side of their trade.  In this case, I think they might both be correct and that our economy is at risk of Stagflation.  This unique situation would be caused by our enormous national deficit, falling dollar, increasing commodity prices (which are generally tied to the U.S. dollar), and high unemployment.

In this ProfitScore IQ, we are going to discuss the hard facts of soaring inflation.  If I had a choice, I would prefer hyper inflation to spiraling deflation.  And now, to add insult to injury, we may be faced with suffering through both at the same time.    

"The United States debt, foreign and domestic, was the price of liberty."
Author - Alexander Hamilton

An Update on Our Performance

June was case and point for the importance of portfolio diversification.  Our fixed income models made significant profits, while our equity models were hammered across the board.  It was a very odd month for equity trading because our trading accuracy was north of 60%, but our losses were larger than our gains-causing larger than normal losses for our 100% long/short equity allocation.  Given our consistently positive performance lately, I guess I should be thankful for a loss so our readers wouldn't think we were trying to emulate Bernie Madoff.

Below are recent performance returns on the four portfolios we currently offer:

Past 12







Income Builder  (IB)




The Guardian  (GRD)




Harmony Plus  (HMY)




The Expedition  (EXP)




S&P 500  (SP500)




Important Performance Disclosure



ProfitScore provides separately-managed accounts for individuals, advisors and institutions.  If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

  1. Complete our Private Client Group request form by clicking here http://profitscore.com/clientgroup.aspx and submitting your contact information. (This is the most preferred method.)
  2. Call us directly at (800) 731-5690.
  3. Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

The Great Inflation/Deflation Debate
You can't afford to get this one wrong!

Anyone who has tuned into the financial news recently has been assaulted with contradictory reports.  First, that deflation is the biggest risk, then later that inflation is what we really need to worry about. Why is this so important?

Simple, in a deflationary environment, cash is king. Asset values such as stocks, commodities (including gold and silver), as well as the cost of food, fuel and other everyday necessities fall. Deflation is the result of a drop in demand for goods as the economy slows, unemployment rises and people have less and less money to spend. Money supply, the money in circulation in our financial system, declines.

Stagflation occurs when costs climb but salaries and incomes either remain stagnant or fall. The last time our nation experienced Stagflation was during the 1970s.  Squeezed between the cost of necessities and a fall in available cash, consumers spend less. Strikes increase as discontented workers rebel against falling real incomes. Price controls by government exacerbate the situation, causing long lines for food, fuel and other necessities, as the cost to purchase these goods falls below the cost to produce them.

Inflation occurs when an increasing number of dollars chase a limited supply of assets. Consumers rush to trade cash for goods as the price of these goods climbs. Stocks and commodities rise initially as investors increasingly seek refuge as the value of their dollar falls. But this trend is usually short-lived. Rising inflation forces responsible central banks to raise interest rates in an attempt to control the inflation monster-eventually leading to deflation.

Hyperinflation occurs when inflation is left unchecked because central banks are reluctant or unable to raise interest rates or reduce money supply-usually the result of populist government intervention. Instead the government tries to fix the problem by doing more of what got it into trouble in the first place. It prints more and more money until the inflation rate skyrockets. Hyperinflation has occurred periodically throughout history where a fiat paper currency has granted political leaders the freedom to print money as the mood arises.

This next news story is a textbook example of hyperinflation at its destructive worst.

Zimbabwe Abandons Its Currency
BBC News, January 29, 2009
BBC southern Africa correspondent Peter Biles says the Zimbabwean dollar has become a laughing stock. A Z$100 trillion note [equivalent to $30USD] was recently introduced. Our people are now using multiple currencies alongside the Zimbabwean dollar according to Acting Finance Minister.  The country is in the grip of world-record hyperinflation which has left the Zimbabwean dollar virtually worthless - 231,000,000% in July 2008, the most recent figure released. Teachers, doctors and civil servants have gone on strike complaining that their salaries - which equal trillions of Zimbabwean dollars - are not even enough to catch the bus to work each day...

Is Inflation Causing a Rippling Effect?

Before the Zimbabwe dollar finally became worthless and had to be taken out of circulation in early 2009, inflation soared to nearly 500-billion percent, according to the International Monetary Fund. It was triggered by a scarcity of foreign currency that caused shortages in just about everything from food to fuel. In April 2009, the Zimbabwe dollar was officially declared dead and completely worthless.  Zimbabweans were forced to transact in gold.

Could this situation occur here? The possibility is remote, according to the guardians of our financial system-experts such as Federal Reserve Chairman, Ben Bernanke, a host of Federal Reserve Board members, Treasury Secretary, Tim Geithner, as well as a battalion of economists, bankers and professional money managers. In fact, they have warned us that deflation is the greater threat.

But not everyone agrees.

Here are samples of the contradictory media reports to which we've been exposed to lately.

Fed's Yellen Says Rates May Stay Near Zero for Years
Bloomberg News, July 1, 2009
Federal Reserve Bank of San Francisco President Janet Yellen said the prospect that policy makers will leave the benchmark U.S. interest rate near zero for the next several years is "not outside the realm of possibility. We have a very serious recession, we have a 9.4 percent unemployment rate," and inflation possibly falling further below the Fed's preferred level, she told reporters [June 30] after a speech in San Francisco.

As for inflation, the "predominant risk" is that it will "be too low, not too high, over the next several years," Yellen said. Inflation excluding food and energy may fall to about 1 percent over the next year and remain below 2 percent, with an unlikely possibility of turning into deflation if the economy fails to recover soon, she said.

U.S. Inflation to Approach Zimbabwe Level, Faber Says
Bloomberg News, May 27, 2009
The U.S. economy will enter "hyperinflation" approaching the levels in Zimbabwe because the Federal Reserve will be reluctant to raise interest rates, investor Marc Faber said. Prices may increase at rates "close to" Zimbabwe's gains, Faber said in an interview with Bloomberg Television in Hong Kong. Zimbabwe's inflation rate reached 231 million percent in July, the last annual rate published by the statistics office.

"I am 100 percent sure that the U.S. will go into hyperinflation," Faber said. "The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.

Federal Reserve Bank of Philadelphia President Charles Plosser said on May 21, inflation may rise to 2.5 percent in 2011. That exceeds the central bank officials' long-run preferred range of 1.7 percent to 2 percent and contrasts with the concerns of some officials and economists that the economic slump may provoke a broad decline in prices.

"There are some concerns of a risk from inflation from all the liquidity injected into the banking system but it's not an immediate threat right now given all the excess capacity in the U.S. economy," said David Cohen, head of Asian economic forecasting at Action Economics in Singapore. "I have a little more confidence that the Fed has an exit strategy for draining all the liquidity at the appropriate time."

Rising National Debt Raises Prospects of Eventual Inflation
USA Today, June 28, 2009
Inflation is as dead as the Wicked Witch of the West in a waterfall. The consumer price index has actually fallen 1.3% in the past 12 months. So why is everyone so worried about soaring prices?

In a word: debt. The government owes the world $11.4 trillion - $37,000 for every person in the U.S. In the next fiscal year, the government will add $1.8 trillion to the deficit.

The government could simply print more dollars to pay off our debts with cheap currency - a tempting but inflationary solution. Politicians wouldn't have to ask citizens to pay for the government's services, and citizens wouldn't have to think about the actual cost of what they demand - until, of course, the currency collapses, interest rates soar and the economy craters.

If you're worried about inflation rearing its ugly head soon, relax. Inflation just isn't going to happen in this economy.  "A lot of the worries about immediate inflation are examples of financial illiteracy," says David Wyss, chief economist for Standard & Poor's. "You won't get inflation until the economy gets back, and that's at least five years out.""

So who should we believe?

Getting Real on Inflation...

As the last article points out, the consumer price index has been dropping. In May, the official consumer price index (CPI) registered its worst decline since 1950. But, just how accurate is this modern-day CPI as an inflation meter? As Figure 1 shows, CPI has been substantially altered over the past 25 years.

Here is a comparison of the old and new consumer price indexes - the first (in red) is the alternate CPI calculated pre-1982, before it was first changed during the Reagan administration. The most recent alternate CPI showed an inflation rate of 6.15% in May.

This statistic is in sharp contrast to the official CPI (blue line in Figure 1) published by the Bureau of Labor Statistics (BLS), which showed a 1.28% decline in May. That is a difference of 7.43 percentage points! Is it any wonder that the public is confused?

Figure 1 - Official CPI vs. the SGS alternate CPI (calculated pre-1982) before the modifications by various government statisticians, provided by John Williams of http://www.shadowstats.com/ . In May, the official CPI showed a 1.28% drop vs. May 2008. This compares to a SGS CPI of 6.15%, as it was calculated using the statistical methods pre-1982.   SGS Link http://www.shadowstats.com/charts_republish#cpi

In the May report the BLS official CPI number was 213.86. The alternate CPI was 636.48. Take the official CPI 213.86 and add 197.62% and you get the alternate of 636.48-nearly triple the official CPI. As the chart also shows, the rate at which the two estimates are diverging is rapidly increasing as evidenced by the parabolic shape of the curve. It shows that government statisticians are increasingly "fudging" the CPI number to make inflation look more benign than it really is.  

Figure 2 below provides another perspective on the difference between the two CPIs and shows how the two estimates of CPI have diverged since the calculation was first changed in 1982. The scale at the left side shows the percentage difference between the official nominal CPI and the traditional calculation - a figure we'll call the CPI "fudge" factor.

Here is a point to ponder. Other than the price of a home and the cost of gas since July 2008 (which was a short-term spike), how much has the everyday cost of living dropped in the past year?  Or, does an increase of 6% over the past year seem more realistic?

Paper Money Siren Song

The USA Today article above brings up an interesting point. With U.S. government debt levels climbing at such an alarming rate, wouldn't the government be tempted to simply print its way out of the problem? And just how big is this bill? Perhaps more importantly, just how fast is it growing?

According to Williams of ShadowStats.com, U.S. government debt is at least three times greater than government debt in the rest of the world. As of December 2007, total U.S. government debt and obligations totaled more than $60 trillion and has grown significantly since then (Figure 3).

Figure 2 - Chart showing how much greater real CPI is than reported CPI. In May the Bureau of Labor Statistics reported an inflation rate of 213.86, which was 1.28% lower than the previous May. Real CPI, as calculated before the changes after 1982, was 636.48 nearly 3 times the reported CPI-plus 200% "fudge" factor.

Figure 3 - Chart comparing U.S. government obligations and GDP with the rest of the world. The U.S. government had total obligations (debt) amounting to more than three times that of government in the rest of the world.       Source - http://www.shadowstats.com/

If the government is printing dollars to help ease the debt problem, wouldn't this show up in the Fed's official money supply figures? What is the Federal Reserve's money supply data telling us?  (For descriptions of the different money supply statistics published by the Federal Reserve, please see Money Supply Definitions at the end of the article.)

Figure 4 - Chart showing M1, M2 and M3 money supply based on data from the Federal Reserve. Data for M3, after the Federal Reserve stopped publishing it in 2006, is provided by ShadowStats.com http://www.shadowstats.com/charts_republish#m3

M1 (blue line in Figure 4), which its currency held outside of bank and government vaults and includes travelers checks and other checkable deposits, rose more than 15% over the past year. M2, which is a larger measure of money supply and includes M1 plus savings deposits and shares in retail money market mutual funds, grew at a slow rate of just under 10% per year. 

However, the growth rate of M3, which is a broader money supply measure and includes M2 plus large-denomination deposits, repurchase agreements, Eurodollar deposits, as well as institutional money market mutual funds, fell from above a growth rate of 16% in 2008 to around 7% in 2009.

There is no clear evidence of government printing presses working overtime so far.

However, one money supply metric - Adjusted Monetary Base (AMB) - has shown rapid growth in the last year. Defined as the sum of currency in circulation (outside Federal Reserve Banks and the U.S. Treasury, deposits of depository financial institutions at Federal Reserve Banks, and an adjustment for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories), the annual AMB growth rate skyrocketed to more than 100% in January 2009, according to Federal Reserve data (see green line in Figure 5). Between June 2008 and June 2009, the AMB soared from $862 billion to $1.7 trillion.

However by definition, AMB does not include deposits in Federal Reserve Banks or the U.S. Treasury or deposits of financial institutions at Federal Reserve Banks, so it does not include the massive increase in Federal Reserve assets from approximately $800 billion last year to nearly $2 trillion this year. Which money supply measure includes those figures?

Figure 5 - Chart from the St Louis Federal Reserve showing changes in the adjusted monetary base. Why is this important? When Ben Bernanke talks about dropping money from helicopters to ease deflation risk, this is where it shows up.  (For more money supply definitions see http://research.stlouisfed.org/publications/mt/notes.pdf )

If the government did start printing money in ever larger amounts to pay off its debts, where would this show up in the statistics? And if this data were available, could it be minimized and therefore misleading due to the same sort of statistical manipulation that occurs with the CPI and other government-produced statistics? How can you protect yourself from the inflation wave that many believe is approaching?

Fiat Money Time-bomb?

Next month, we continue exploring the inflation/deflation question as we delve into the role fiat paper money has played. Fiat paper money is a currency that is not backed by a non-renewable precious commodity, such as gold, silver or platinum. Since 1971, when Richard Nixon took the U.S. off the gold standard, the U.S. dollar has met this definition-it is backed by nothing more than the faith and trust in the government to increase money supply in a responsible manner. Is this a realistic expectation?

Unfortunately, this duty has not stopped both Republican and Democratic administrations from spending beyond the ability of the nation to pay its bills. The result is growing budget deficits, a massive debt and an increasing reliance on foreigners to act as our nation's lenders of last resort.

In his last year in power, Bush was responsible for a budget deficit north of $455 billion. But that is nothing compared to what his predecessor accomplished in his first 100 days of his term. So far the projected budget deficit for fiscal 2009 tops $1.85 trillion or almost four times the 2008 deficit.

As a result, the U.S. has accumulated Federal government debt in excess of $11.4 trillion, which amounts to more than $37,300 for every man, woman and child in the country. This debt is projected to grow to more than $23 trillion by 2019. To keep paying the bills this year, the U.S. government will have to sell a total of $3.25 trillion of debt by September 30. Just the interest alone on the $11.4 trillion in debt at 3.5% (current interest rate on 10-year Treasury bond) amounts to an addition $400 billion per year!

But what is more troubling is the rate at which the federal government and Federal Reserve is spending money to address the current credit crisis.  Thus far, more than $12.8 trillion (and according to one estimate, more than $14 trillion) has been committed by these two parties in the past two years. 

As investor Jim Rogers commented in June, "This policy has never worked. The Americans tried it in the 90s. The policies which have worked let people who make mistakes collapse, let people who are competent take over the assets from the incompetent and start over. Now what's happening is the government is taking the assets from the competent, giving the assets to the incompetent and saying now you compete with the competent. This is not going to work, it's madness."

Is he right?  Either way, can we ever hope to repay this huge bill? What happens if we can't? Could the government simply print its way out of this mess? No matter what happens, there are serious economic and financial implications to consider.

Please stay tuned for the answers in our next ProfitScore IQ.


Hyperinflation in three parts with Ron Paul, Peter Schiff, Jim Rogers, Tom Woods, Marc Faber that is definitely worth watching. 
1. http://www.youtube.com/watch?v=Yd0b5XIhCkM
2. http://www.youtube.com/watch?v=1O7jRfCqwSc
3. http://www.youtube.com/watch?v=vvc2GDgkAkQ

Economist Dr. Chris Martenson explains the games government statisticians play http://www.chrismartenson.com/crashcourse/chapter-16-fuzzy-numbers

McCulley Says a New Stimulus Plan Must Show Restraint

U.S. Debt Clock

Fiat Paper Currency: The History and Evolution of Our Money by Ralph Foster

Portfolio Performance Analysis

Risk & Reward

Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below.  Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength. 

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

Is this market a replay of 2003?  The last 12 days have bears screaming, "Uncle!"  The Nasdaq 100 index has now closed higher 12 days in a row.  In a quick glance through my data, I could only find a handful of dates that experienced this kind of upward bias.  Markets are certainly overextended, but as they have shown many times before, they can remain overextended longer than most trading accounts can withstand to bet against them.  Right now the market is doing a good job of inflicting pain to those with short positions.

Something is up with government bonds.  While equity volatility continues to decline as prices increase, volatility in government bonds has been extraordinary over the past 12 days.  I have always felt that bond traders were better economists or forecasters of the economy than equity traders, so anytime I see something strange, it makes me pay close attention.  For the first half of the year, the government lost the battle against interest rates, as traders in these liquid instruments push them lower forcing interest rates higher. 

So far in July, rates continue to increase.  However, over the past 10 days, trading has been excessively volatile.  It once again appears that the Fed may be trying to inject demand back into the government bond equation as they attempt to manipulate the long end of the yield curve.  At this point, I am not sure what this all means, but I can almost guarantee that this volatility will soon push back over into the equity markets.   

Below is a performance summary for the indices we track and benchmark our portfolios to:    

Cumulative Return


Average Annual Return




1 yr


3 yr

5 yr

10 yr
















CSFB Multi-St. *







Barclay F-of-F *







S&P 500







Barclay HY







Barclay Agg.







* Note:

Estimated monthly performance

Index Advantage:

The S&P 500 index was mostly flat in June gaining 20 basis points for the month, while our long/short allocation incurred larger than normal losses.  Our trading accuracy has dropped off somewhat over the last 6 weeks and our average trade loss has also increased.  In summary, we appear to be at the wrong place at the wrong time, causing us to incur larger than normal losses.  And when we were right, we received only small rewards.         

For the month, this pillar gained -6.55%. 

Strategic Balance:

Our seven-month winning streak for our most consistent allocation incurred a small loss for the month.  Total investment exposure for the month was very low, so our losses happened over the course of a few days.  So far our exposure for the month of July has been lower than any time over the past 12 months.  These traders only take high probability trades, and thus far these trades haven't materialized. 

For the month, this pillar earned -1.35%.      

Dynamic Income:

Our fixed income traders have clearly been the shining star among our various allocations for the last four months.  The contrast between 2009 and 2008 has been 180 degrees, showing the importance of trading different asset classes to diversify your return stream.  May's performance took us positive for YTD 2009 and June's performance takes us positive for the last 12 months.  As mentioned above, the Fed appears to be applying pressure to the long end of the yield curve, so it is making our job more difficult to trade government bonds.  I am closely watching this important allocation and will adjust allocations accordingly.

For the month, this pillar earned 2.67%.

Our portfolios are built using varying distributions to the strategic allocations discussed above.  To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below: 

If You Are a Client, Don't Be Confused.
Actual management and performance fees are incurred monthly but are deducted from client accounts in the first month of every quarter (January, April, July, and October).  For performance reporting purposes, we deduct fees monthly as they incur and not quarterly, as they are reflected in client statements.  It all washes out in the end, but this may cause your account performance to deviate from our published performance reports on a month-to-month basis.  To be conservative, we also deduct the maximum fees we charge from our performance reports and your actual overall fees paid may be less than our maximum. 

The Idaho Back Country

On Friday, the family and I will pack up the "rig"-that means truck in Idaho speak-and drive to our favorite camping spot in Bear Valley, Idaho.  I had originally discovered this area archery hunting for elk in the mid-90s and have returned there every year since to camp with the family.  Bear Valley unfortunately became ground zero for the Idaho wolf reintroduction project, so we rarely see elk like we used to because of their predation, but the fishing is still good. 

We normally camp right on Bear Valley Creek, which is large enough to hold lots of fish and even big enough to float a small raft.  Bear Valley Creek is actually the size of a small western river, so this year we are going to float a five mile stretch of the river and play.  My wife is a fantastic cook and she has been brushing up on her Dutch oven recipes for the trip.  I can't wait to taste what she has on the menu.  Food cooked in a Dutch oven always seems to taste better.  Sarah, my oldest, always makes sure we have everything required to prepare perfect S'mores. 

I got a scouting report from a friend that recently camped in Bear Valley and they warned me that mosquitoes and horse flies were worse than normal.  There are lots of good repellants to keep the mosquitoes at bay, but those horse flies are flesh eating machines.  I guess I should be thankful there aren't any black flies.   

Our activity list so far is shooting BB guns and sling shots, catching and preparing fresh trout, floating the river, catching crawfish and tadpoles, bike riding, and scaring the girls when they least expect it.  I can't wait to see Boise in my rear view mirror.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

  • Complete our Private Client Group request form by clicking here  and submitting your contact information. (This is the most preferred method.)
  • Call us directly at (800) 731-5690.
  • Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.


Posted 07-27-2009 9:22 AM by John M. McClure


Stuart wrote re: I Wish I Knew What Was Going To Be On The Other Side
on 08-06-2009 3:26 PM

very thoughtful.