How Money Is Created

 Money is ubiquitous and fungible. It also plays an important, if not dominant, role in practically everybody's life. A minuscule number of individuals (economic nerds), however, truly understand how money is created in our financial system. The process by which the money supply of a country is increased or decreased is important in understanding how an economy functions. Before proceeding with the details, I should mention I am specifically addressing money creation in the United States. Most other countries with a central bank operate in a similar fashion, but this blog will only pertain to the United States.

The majority of the money supply that the public uses for conducting transactions is created by the commercial banking system. This is done by commercial banks exercising their lending function. Bank loans expand the quantity of bank deposits. Our system of banking is called fractional reserve banking because banks only keep a fraction of deposits as reserves, and they loan out the rest. A bank creates new money merely by issuing a loan. The amount it creates is limited by the reserve ratio or "fraction" it is required to maintain to cover its cash-flow needs and comply with standards mandated by its regulators. With a general industry reserve ratio of 10%, then each $100 it lends includes $90 that never existed before. A commercial bank, therefore, can create a sizable amount of money merely by making loans. Conversely, money is destroyed when bank loans are paid off by borrowers or charged off by the lender.

In the world of dollar creation and destruction, the "Wizard behind the curtain" is America's central bank, the Federal Reserve Bank. There are multiple levers the Federal Reserve can pull to influence the nation's money supply. One way a commercial bank can expand reserves and make even more loans is to borrow funds from the Fed. This process is called going to the "discount window." When a bank goes to the discount window, the bank is expected to pledge collateral. The collateral can be government bonds, but it commonly consists of commercial loans. The Fed then grants credit to the bank in an amount equal to the debt instruments. This allows the bank to convert its old loans into new reserves. Every dollar of those new reserves then can be used as the basis for lending nine more dollars in new money.

The Federal Reserve Bank is the banks' bank. That is, banks hold deposits at the Fed much like you or I might hold deposits in a checking account at our local bank. From its inception in 1913 until October 2008, the Federal Reserve never paid a penny of interest to its various depositors (commercial banks). That all changed a month after the collapse of Lehman Brothers during the throes of the Great Financial Crisis. On October 6, 2008, the Federal Reserve began paying interest on depository institutions reserve balances (both required and excess). The program is known as the Interest on Reserve Balances (IORB). This tool allows the Fed to implement monetary policy by influencing short-term interest rates. The higher the interest rate the Federal Reserve offers to pay its member banks on their reserve balances, the less likely it is for the banks to lend money to private borrowers. Banks are generally unwilling to lend to private parties at a rate lower than what they can earn risk-free on reserves at the Fed. If the Federal Reserve wants banks to lend more of their deposits, thereby creating more money, all they need to do is lower the IORB. And that's exactly what they did during COVID. In January 2020, the interest rate on reserves was 1.55%. By mid-March 2020, the Federal Reserve had dropped the rate to 0.1%.  

The Fed can also manipulate the amount of reserve deposits in the financial system by purchasing or selling bonds (primarily Treasury securities) in the market. This is referred to as open market operations. When the Federal Reserve buys bonds from banks they digitally create new money out of thin air and exchange this new money for the bonds that are then included on the Fed's balance sheet. An increase in bank reserves theoretically increases bank lending and in turn increases liquidity and the money supply. This open market purchase strategy is known as Quantitative Easing (QE) when it is pursued on an aggressive basis for an extended period. QE during the financial crisis (2008-2009) added about $3 trillion to the Fed's balance sheet. The COVID crisis triggered the addition of another $5 trillion to the Fed's balance sheet. From January 2020 to January 2022, the M2 money supply increased from $15.4 trillion to $21.6 trillion. That's a 40% increase in the money supply - unprecedented in recent U.S. history.

There are risks associated with an insufficient money supply, but it happens so rarely in history it is not worthy of discussion. The historical problem, however, which we happen to be currently experiencing, is excessive money supply with more most assuredly coming down the pike. Excessive money supply growth, when outpacing economic output, triggers inflation, erodes purchasing power, and causes currency devaluation. To quote Milton Friedman: "Inflation is always and everywhere a monetary phenomenon." When too much money chases too few goods, prices invariably rise. High money growth often precedes inflation by roughly a year. This was seen in the 1970s when inflation hit double digits and hung around for a few years at dangerous levels. It was also evidenced in 2021-2022 when inflation went from 2% to 9%. This was triggered by the massive (40%) increase in the money supply in response to the COVID pandemic. Consumers painfully discover their cash buys fewer goods and services. Excess money and liquidity can also flow into stocks, real estate, and other assets, creating asset price bubbles. Sound familiar? 

Although it will never be acknowledged by the leaders of either of our major political parties, it is my opinion that the government will continue to run the economy hot and intentionally target an inflation rate of 3% - 5%. Inflation works as a "soft default" on current debt since the real value of the debt is repriced. The total real liability of the current federal debt decreases by 19% with an inflation rate of 5%. Inflation acts as a mechanism that reduces the consequential debt-to-GDP ratio. It also effectively transfers wealth from holders of government debt (creditors) to the U.S. government (debtor). Inflation is an insidious, hidden tax that decreases the purchasing power of the populace. Using inflation to reduce debt is a blunt, dangerous tool that ultimately can serve as a catalyst for a fiscal crisis and significant social upheaval.

Reversion To The Mean

 A powerful phenomenon exists that is often ignored or overlooked during both bull and bear markets. This is possibly the case because many investors prefer a sappy narrative to an analysis based on mathematics and historical data points. In a financial context, "Reversion to the Mean" describes the tendency of a stock or stock index price to return to its average or "mean" value after deviating from it. This behavior is based on the premise that extreme price movements are often temporary and unsustainable in the long run. The basic principle is that what goes up must come down, and what goes down must go up. While the daily movements of the stock market may be chaotic and unpredictable, long-term stock market returns tend to follow a somewhat predictable upward trend. Deviations from this trend can last for extended periods, even decades. Mean reversion is not a consistently viable strategy for short-term trading. On the other hand, it is useful in identifying individual security valuation and overall market valuation relative to historical trends. 

The concept of mean reversion was first observed in the field of biology by Sir Francis Galton, a cousin of Charles Darwin. In his book, "Hereditary Genius" (1869), Galton set out to prove that human ability passes through the generations. He found some confirmation that the descendants and relatives of distinguished people were likely to contain great achievers among them. The effect, however, diminished over time. Only 36% of the sons of eminent men and only 9% of their grandsons were eminent. Galton also discovered that the same principle holds true for height. The children of abnormally tall people tend to be smaller than their parents, and vice versa. Without regression to the mean, the world would comprise of geniuses and dimwits, and giants and midgets, with nothing in between.

Examples of reversion to the mean abound. Major League baseball players who hit well in their rookie season are likely to do worse in their second season. The acclaimed "sophomore slump" is more than a myth. Likewise, regression to the mean is an explanation for the Sports Illustrated cover jinx - periods of exceptional performance resulting in a cover feature are likely to be followed by periods of more mediocre performance, giving the impression that appearing on the cover causes an athlete's decline. The hottest place in the country today is more likely to be cooler tomorrow than hotter. Another example, returning to the financial realm, would be the best performing mutual fund over the last three years is more likely to see relative performance decline than improvement over the next three years. The "Dogs of the Dow" investment strategy incorporates reversion to the mean to a certain extent. This strategy selects the 10 stocks in the DJIA at the beginning of the calendar year with the highest dividend yield. The theory holds that those companies are near the bottom of their respective business cycles and would thus exhibit a lower share price than if they were near the peak of their business cycles. The 10 companies near the bottom of the business cycle should have their share price appreciate more quickly compared to the other 20 companies in the Dow Jones Industrial Average.

Mean reversion investment strategies often incorporate specific technical indicators in the process of trading equities. These indicators help identify overbought or oversold conditions. The most prominent tool in this area would be the Relative Strength Index (RSI). The RSI is an oscillator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock. It fluctuates between 0 and 100. A high RSI (typically above 70) suggests the asset is overbought, while a low RSI (typically below 30) indicates oversold conditions. Traders adopting a mean reversion approach might buy when the RSI is low, anticipating a price rebound, or sell when the RSI is high, expecting a price correction. Another technical indicator used on a frequent basis would be Bollinger Bands. Bollinger Bands consist of a moving average and two standard deviations plotted above and below the moving average. These bands widen during periods of high volatility and contract during periods of low volatility. A stock price moving outside of the Bollinger Bands can signal an overextended move, suggesting a potential mean reversion opportunity.

In discussing Bollinger Bands in the previous paragraph, the term "standard deviation" was mentioned. In the world of statistics, standard deviations measure how far from the normal trend line data points have strayed. Two standard deviations cover 95% of all events and three standard deviations cover 99.7% of all events. The S&P 500 Index is currently 2.3 standard deviations above its historical trend line. The last time it pushed above two standard deviations was when it hit 2.2 standard deviations just prior to the Internet Bubble bursting in 2000. As a reminder, the NASDAQ lost 80% of its value during that particular drawdown. So, be careful, market participants.

For a long time, a popular strategy in the investment world was to simply buy solid companies and tuck them away forever. That's what was considered prudent investing. Investors didn't understand that bad companies are often too cheap and good companies often too expensive. The assumption was that companies would maintain a constant return on their retained earnings. The ROE is never constant, however. It's always changing. There is a systemic tendency for high returns to fall and low returns to rise, in both cases regressing toward the typical corporate return. Capital moves towards profits, whether it be in certain sectors or specific corporations within the sector. This leads to complacency among the "winners" and attracts new competition. It becomes more difficult for the wildly profitable entities to maintain their margins. Lower margins lead to lower stock prices.

Multiple studies confirm that the rate of mean reversion was not identical for every company. There are  two primary factors that can either accelerate or decelerate the pace of regression. Debt, especially a high level of leverage, speeds up the regression rate. The profits of a highly leveraged company are going to drop much faster when things turn bad compared to a company with little or no debt. The firms that display the qualities of a monopoly can slow mean reversion to a glacial pace. These companies are the price-setters in their industry with a dominant market position. Refer to multiple members of the Magnificent Seven (Meta, Google, Nvidia) for prime examples. So far, they appear immune to mean reversion. Their day will come. It's hard to defy the Laws of Physics. It's also hard to defy the Laws of Math and Statistics.

K-Shaped Economy

 One of the biggest economic buzzwords the past few years has been "K-Shaped Economy." Take a second to picture a K. The one line shooting up and to the right represents Americans who are financially doing great. They're mostly people who are heavily invested in the stock market, and that market continues to break records. And the line shooting down? That's pretty much everyone else. Essentially, the rich are getting richer, the poor are getting poorer, and the middle class is shrinking. The number of Americans considered to be middle class shrank from 61% in 1971 to 51% in 2023 according to a 2024 Pew Research report. While United States income inequality has trended higher for the better part of a half-century, the split between the haves and have-nots has become even more pronounced since the Covid-19 pandemic. Of even greater concern is the widespread prediction that the divide will continue to widen in the ensuing years. Following, I will look at the primary factors contributing to the growth in income inequality. After writing about the causes, I will go over some of the possible ramifications to the economy and society in general if the income/wealth chasm is not successfully addressed. Lastly, I will list a handful of possible solutions to close the gap.

The main culprit for the expansion and acceleration of income/wealth inequality is, of course, our federal government. The central planners in Washington D.C. have flooded the economy with government spending of all sorts and inflated the money supply via artificially low interest rates and QE for the last quarter of a century. These abhorrent fiscal and monetary policies have been especially egregious since the Covid-19 pandemic. The majority of Americans, especially working class Americans, have not recovered from the inflation surge precipitated by the government response to covid. While inflation has since moderated from its highs in 2022, the 25%-30% cumulative price increases since 2020 have been devastating to most household budgets. One-hundred dollars in 2019 has the same buying power as $127 today. Rising prices have largely eaten up wage gains, leaving low and middle income Americans struggling to make ends meet. A softening labor market along with fears that Artificial Intelligence adoption will displace large swaths of workers further sours many Americans outlook on their future financial prospects.

The "haves", on the other hand, are prospering and optimistic about the future. While lower-income households are increasingly relying on debt to make purchases, higher-income households are maintaining or increasing their spending levels. The top 10% of income generators are responsible for 50% of consumption on a national basis. This group is essentially "carrying" the economy and keeping it out of recession. Cumulatively, this richest 10% of American households also owns 70% of the nation's wealth. Over the past five years or so, a soaring stock market along with rising real estate values have generated more than $50 trillion in new wealth. Nearly three-quarters of the growth in consumer spending this past year can be attributed to what economists call the wealth effect: as people's net worth rises, they spend a fraction of their increased wealth. Asset owners, holders of stocks, bonds, and real estate, have made out like bandits the past few years. The same can't be said for Americans who own little or not assets.

The artificially low interest rates perpetuated by The Fed have directly fueled the staggering increase in asset values. Rates were depressed for over a decade (2008-2022). Multiple rounds of Quantitative Easing (QE) have also contributed to asset inflation. More and more monies chasing a finite number of assets has pushed stock markets and real estate prices into the stratosphere. That's great for homeowners, people with stock portfolios, and the wealthiest 10% who hold most of the country's wealth. The same can't be said for the seniors with modest savings accounts who rely on social security benefits and the young adults looking to form a family and to have children. There is a reason why about one in three U.S. young adults (ages 18-34) live with their parents. I can fully understand why members of the Millennium generation and Generation Z are miffed with the Baby Boomers.

History shows that excessive income concentration can weaken economic growth by lowering overall demand. Those with fewer resources depend on borrowing and accumulate debt until it's no longer possible. When these imbalances become unsustainable, the economy typically shifts from boom to bust. There is also no question that grossly unequal distribution of income and wealth can facilitate political polarization and tear at the social fabric of a nation. I don't see a second American Civil War or something like what happened in Russia in 1917, but capitalism will continue to be under threat as old coots head to either the nursing home or the cemetery and younger voters cast their preferences at the ballot box. A case in point would be the recent election of Zohran Mamdani in New York City. It would not surprise me to see additional politicians getting elected across the country who share Mamdani's socialist views.

Flattening the K-Shaped economy may be crucial for the nation's long-term economic and political health. A key question is whether technology (Artificial Intelligence) will help flatten the K-Shaped trend or do just the opposite. The cynic in me believes AI will exacerbate the problem. Although the government tends to make problems worse when it attempts to solve them, look for the government to introduce measures in an attempt to flatten the "K." This will primarily be done by revising the tax code with the goal of reducing wealth and income disparities. Fixing our antiquated, wasteful, and corrupt education system at all levels would hopefully facilitate a narrowing of the divide and offer disadvantaged students the possibility of dramatically improving their financial situation. In reality, the only surefire way to fix the problem is for deficits to be reduced, end The Fed's interventions, return to sound money, and let interest rates be determined in the markets. Don't hold your breath.

I offer the ultimate solution to the problem. However, most of my peers, if not all of my peers, are not going to like this quick and brutal solution. We could use a good, old-fashioned recession. One where overvalued real estate loses 30% of its value and the supremely overvalued stock market loses 50% of its value. I don't anticipate this happening. At the first signs of trouble, Congress will recklessly expand the annual deficit from 6% of GDP to 12% of GDP, while The Federal Reserve Bank cranks up the printing presses and floods the financial system with even more excessive liquidity. In other words, the proverbial can will get kicked down the road. Again.

 

Get Ready for Stablecoins

 For those not familiar with this financial instrument, a stablecoin is a type of cryptocurrency that aims to maintain a stable value relative to a specific type of asset. For the most part, the specified asset is either fiat-backed (U.S. dollar) or commodity-backed. The structure of fiat-backed stablecoins closely resembles that of money-market funds. The issuer defends the peg of the stablecoin by holding fiat-denominated short-term assets, such as Treasury bills, commercial paper, repurchase agreements, and bank deposits. Commodity-backed stablecoins, for example, those backed by gold, are relatively rare at this point in time. A stablecoin should not be confused with a central bank digital currency (CBDC). While both are electronic digital payments using the blockchain, CBDC is issued by central banks, meaning they are a direct claim on the central bank, while stablecoin is issued by a private entity. Basically, stablecoin is a digital representation of fiat money, moving not through the arteries of traditional payment rails, but through the digital circuitry of the blockchain.

The future of stablecoins points to significant growth. As of July 2025, the stablecoin market was approximately a $270 billion market. With the passing of the Genius Act on July 18,2025, many financial movers/shakers are projecting a $3.7 trillion market by 2030. The Genius Act is a game-changer. This recent legislation provides a sturdy regulatory platform on which stablecoin ecosystems can be built. Under its provisions, stablecoin issued within the United States must maintain a full 1:1 backing of outstanding coins with high-quality reserve assets; they must publish monthly disclosures of reserve composition and undergo independent audits for larger issuers. Compared to the current bank-centric era, transfer of funds under the stablecoin system will be faster and cheaper. Domestic wire transfers can now take hours, and even be processed the following business day if the wire is initiated after 3:00p.m. Fees for domestic wires typically range between $25-$50, depending upon the commercial bank involved. International wires are processed via the SWIFT system and have to navigate a network of banks and middlemen. Fees for international wires exceed domestic wire transfer fees. Stablecoins can travel at the speed of light to anywhere in the world, for just a few cents in fees.

As the name implies, stablecoins will address the major reason why Bitcoin and other cryptocurrencies have not been adopted on a large scale in the payment system - volatility. Stablecoins are not instruments of speculation, but of settlement. Even the only cryptocurrency that makes any sense to own, Bitcoin, has weathered extreme volatility since its inception in 2009. There have been four major drawdowns of over 75% before rallying to new highs. Many investors will still favor Bitcoin as a "store of value" and as an asset to trade for speculative purposes. For payment and settlement purposes, however, Bitcoin holders will turn to stablecoins. They are comfortable and familiar with blockchain technology. Owning the stablecoins themselves won't make anyone rich, though. Each one is designed to be worth exactly $1.00, and it will remain valued at $1.00 even a decade down the pike.

As mentioned earlier, stablecoins will not be issued by Uncle Sam. They will be issued by commercial financial institutions and other private entities that have the resources to sufficiently collateralize the coins they issue. Amazon, Walmart, and other household names are already rumored to be exploring stablecoin integration. Stablecoins will be used extensively for cross-border payments, especially for cross-border remittance to less developed countries. Cross-border payments are traditionally associated with high transaction costs, prolonged processing times, and limited access for unbanked populations. Since stablecoins can be sent using a smartphone, they will supersede the banking system and facilitate faster, cheaper transactions for individuals with zero or limited access to financial institutions. Stablecoins will continue to be popular in countries dealing with hyperinflation. Due to the monetary policies implemented by these countries, average citizens experience non-stop debasement of their local currencies. The U.S. dollar has some problems, but it remains the cleanest shirt in a drawer full of dirty shirts. Thus, it remains in high demand across the world. Foreign countries and foreign banks fear the potential widespread adoption of U.S. dollar stablecoins. I would say their concerns are justified. American banks have mixed feelings about stablecoins. They see the potential for a mass exodus of deposits, which in turn could shrink banks' lending capacity. Simultaneously, they view stablecoins as a part of the future financial landscape and are developing strategies to incorporate stablecoins and monetize them in their business models.

Many people, including myself, are moderately surprised that our federal government has adopted an attitude that is favorable to cryptocurrencies, particularly stablecoins. Five years ago, I would have put the odds of the regulations incorporated in the Genius Act becoming law at something like one in one hundred. That said, when you step back, look at the big picture, and take into account the evolving macroeconomics environment, it makes perfect sense. Scott Bessent, U.S. Secretary of the Treasury, knows that crunch time is rapidly approaching for the dollar and Treasury securities. Foreign central banks have been either selling U.S. Treasuries on the secondary market or letting them roll off at maturity while hoarding more gold to supplement their reserve holdings. These actions were accelerated when the West sanctioned Russia after the 2022 invasion of Ukraine. Trump's ill-advised tariffs imposed in 2025 have also retarded the purchase of U.S. Treasuries. Then you throw in utterly reckless fiscal and monetary policies courtesy of Congress and The Fed, respectively. All of this is a recipe for disaster. Who is going to buy our debt, and at what price? Secretary Bessent's solution - besides financial repression and yield curve control - expect an exponential growth in stablecoins. There is no question that stablecoin issuers will be actively buying U.S. Treasuries to back their coins. This activity could plug the demand hole. However, unless there are serious entitlement reforms at the fiscal level, this will simply kick the can further down the road and delay the inevitable crisis.

Contrarian Investing

 In simple terms, contrarian investing is about doing the opposite of what most people are doing in the stock market. A contrarian investor strives to identify and then capitalize on market inefficiencies driven by emotional "herd mentality." It is an investment strategy of going against the crowd, against the mob. If everyone is buying a stock and its price is going up quickly, a contrarian might avoid it or even sell it. On the other hand, if a stock is being sold by everyone and the price is falling, a contrarian might consider buying it. The concept is based on the premise that markets frequently overreact to good news and bad news. When prices go up too fast, they might be overvalued. And when prices fall sharply, they might be undervalued. Contrarians attempt to take advantage of these situations. Contrarian investors believe that by staying calm and thinking differently, they can find opportunities where others see trouble. It's about being patient, doing your own research, and not getting carried away by emotions.

There are numerous traits associated with a contrarian investor. First and foremost, contrarian investors are independent thinkers. They have the confidence to form their own opinions based on their analysis of fundamental factors and market trends. They have the ability to tune out the noise of the financial media and ignore short-term fluctuations in market prices. Contrarian investors have the courage to go against the crowd and take positions that may be unpopular. They have an abundance of patience and discipline, as well as possessing a long-term perspective on investing. Contrarian investors have the resilience and emotional control to stay committed to their investment thesis, even in the face of adversity. They are lifelong learners who continuously seek to improve their investment skills and adapt to changing market conditions. Additionally, they are open-minded and willing to learn from both their successes and failures. Last, but not least, contrarian investors ultimately focus on value. They are not contrarian for the sake of being contrarian, but rather because they believe that the market is not always efficient in accurately pricing. Contrarian investors seek to identify undervalued opportunities that offer the potential for attractive returns over the long haul.

A major challenge for contrarian investors is accurately identifying undervalued opportunities. This can involve extensive research and a deep understanding of fundamental analysis. Furthermore, simply - you could be wrong. Just because everyone else is selling doesn't mean they're wrong. Sometimes, a stock falls because the company is genuinely in trouble. There are a few general guidelines to consider when determining whether or not a stock qualifies as a contrarian play. The first requirement would be the "down-by-half rule." A stock must be down at least 50% from its highest closing price during the past 12 months. Another prerequisite would be a price/earnings (P/E) ratio of less than 12. Normally, "beaten up" stocks that are undervalued are selling at low multiples. The contrarian investor is also looking for a company with a price/free cash flow (P/FCF) of less than 10. This metric is extremely important. It never ceases to amaze me how often free cash flow is ignored. Another buy signal would be significant stock purchases by insiders. When it comes to knowing when to sell a contrarian play, it is quite simple: Sell once the stock rises 50% from its purchase price, or after three years, whichever comes first.

Numerous studies support the premise that "down and out" stocks frequently rebound and turn the table on peers that were considered "winners" in a given year. Using 36-month performance spans, two prominent researchers, professors DeBondt and Thaler, created portfolios of "loser" stocks (those that had performed worse than the market), and "winner" stocks (those that had beaten the market). Their findings: You're better served buying losers than winners. An investor who put together a portfolio of loser stocks and held it for three years would beat an investor who assembled a portfolio of so-called winner stocks by 25%. The emphasis on a three-year holding period echoes the approach of Ben Graham, the universally acknowledged mentor of Warren Buffett. And, Mr. Buffett arguably just happens to be the second greatest investor of all time. He religiously subscribed to value and contrarian investing principles.

There are a couple of factors that can undermine the traditional contrarian strategy. The 800-pound gorilla in the room is "large, mindless robot investing." This is a term attributed to Mike Green that describes the enormous, automatic flow of capital via 401(K) account contributions into passive investment vehicles like index funds and exchange-traded funds (ETFs). Passive flows now account for more than half of the funds flowing into the stock market. Unlike active fund managers who make discretionary decisions based on stock valuations and other factors, passive funds have a non-discretionary mandate to simply track an index. When an active manager might sell an overvalued stock, a passive manager will buy more as its market share grows. This insensitivity is a recipe for disaster. Another distortion is created by the ever-increasing propensity of corporations to allocate significant portions of their profits to buying back large amounts of their own stock. No longer are buybacks restricted to just when a company's stock is deemed undervalued. Now this type of financial engineering is utilized even if the stock is fairly valued or overvalued. This is another example of insensitivity to price.

Although I don't consider myself a full-throttled contrarian investor, I do share some tendencies common to that approach. This is not surprising since by nature I question many common assumptions after discarding my rose-colored glasses several decades ago. In my mind, it is preferable to be skeptical instead of naive and gullible. I feel knowledge, understanding, and the truth supersedes conformity, even in cases where the contrarian position is unpopular with the majority. We are living in an era when so much of what we have been told to be true is in fact false. I would rather be wrong with my viewpoint and change accordingly, than to blindly accept something as the gospel.

Poor Man's Gold

 I am old enough to remember when the Hunt brothers (Nelson and William) attempted to corner the global silver market in the 1970s, which subsequently imploded in March 1980. Using significant leverage, these two sons of Lamar Hunt amassed a huge silver portfolio, buying physical silver and futures contracts. Their buying activities contributed to a massive increase in silver's price, rising from $6.00 an ounce in 1978 to a record high of $49.45 per ounce in January 1980. It was a crazy time, especially on the economic front with inflation hitting double digits in the late 1970s. I had started working at The First National Bank of Ottawa in 1978 when the price of silver began its relentless climb. People started to sort through their loose change and coin jars to pick out pre-1965 U.S. coins. Coins minted in 1964 or before were primarily (90%) made of silver, and the melt value was significantly higher than face value. Bank customers were finding safe places to store their sterling silver. Everybody was talking about silver and how it was set to blow by $50 per ounce. Needless to say, the silver bubble burst with values eventually retreating to the $5-$6 range. It made another run at $50 in 2011, peaking at $48.70/oz. before sliding back to the $10-$20 range.

Fast forward to the 4th Quarter of 2025. We find ourselves in the midst of the third major silver bull market in the past half-century. The precious metal has finally breached the $50 per ounce plateau. Silver is up 70% in the past 6 months and 22% in the past month. Extreme optimism, make that euphoria, has seized the silver market in 2025. Many market participants, especially those selling their book, are predicting silver reaching $100/oz. or even much higher. Before expressing an opinion on those predictions, let's take a look at some fundamental conditions that can influence the price of silver.

Silver has widespread industrial uses, primarily because it is the world's best electrical conductor. It shows up in almost every electronic device. If something has an on-off switch, there's probably some silver inside. Every electrical connection in a modern car is activated with silver-coated contacts. Electric vehicles contain more silver than internal combustion autos. Despite the Trump Administration's disdain for solar energy, this source of energy will continue to expand. Solar cells, also known as photovoltaic cells, convert sunlight into electricity. Silver powder is turned into a paste that's loaded on silicon wafers on a solar panel. The bearings in jet engines and helicopter engines require silver because they operate for long periods at high temperatures. Silver also serves a purpose in medicine. It helps fight germs, serving as a longtime go-to antibiotic. Silver is an important component in the water purification process. It prevents bacteria and algae from building up in the filters of purifiers. I'm not sure if it qualifies for "industrial" use, but sterling silver jewelry and tableware have historically been in demand by consumers in most cultures. By definition, sterling silver is 92.5% silver and 7.5% copper. Another non-industrial utilization of silver would be as a component in an investor's portfolio of assets. That will be addressed shortly after addressing the ongoing silver squeeze in terms of supply and demand.

Global silver demand is surging while supply provided by mining operations has either been stagnant or declining over the past decade. It is estimated that silver has been in a 10%-20% annual supply deficit over that time period. This consistent market deficit has drawn down above-ground reserves. The primary reason that mine supply remains constrained is due to the fact that silver is often a by-product of the mining of other metals such as lead, zinc, copper, and gold. Over 80% of mined silver is a secondary output of other mining activities. There are very few true silver mining plays, with the number of "primary" silver mines dwindling. There are only a dozen or so mines in the world where silver is mined as the primary metal. The current high price for silver may well trigger the development of new mines. However, that process takes years, if not a decade, due to the massive red tape and regulatory hurdles. Another drag on silver supply could be the fact that its price is somewhat inelastic. An increase in price may not lead to higher supply. This is primarily because, as mentioned, silver is a by-product of base metal mining. Economic slowdown could dampen demand for base metals - therefore, we may not see an increase in the mining supply of silver.

For those who readily embrace conspiracy theories, there is one out there involving silver. According to this particular theory, the big banks (looking at you J.P. Morgan) have been consistently repressing the price of silver. The behemoth banks do this by relentlessly shorting silver futures contracts on the Comex exchange and the LBMA (London Bullion Market Association) exchange. For commodity futures, such as silver, buyers rarely stand for physical delivery. The overwhelming majority of contracts are closed out before expiration by taking an offsetting position. A tiny percentage, typically 2% or less, results in physical delivery. In the past few months, a significantly higher percentage of futures buyers have been "taking delivery" of physical silver. The LBMA's physical silver supplies have decreased by 30%-40%. Many informed participants in this market believe there is a real danger of this exchange defaulting on delivering physical silver to futures contract traders and needing to pay cash instead. This would inevitably trigger panic buying.

All of which leads us to the proverbial $64,000 question - where does the price of silver go from here? In a nutshell, I don't know. I will, however, tender a couple of possibilities and opine in my humble opinion which one is more likely to come to fruition. One possibility, a distinct one in my estimation, is that silver is being fueled by a speculative bubble and will fall (to the $30-$40 range) back to earth in due time. The other possibility, also a distinct one in my estimation, is that this is different, and we're in the early innings of a long-term silver bull market that will push the silver price to $100 per ounce or beyond before the books are closed on this decade. Those favoring this outcome, which includes the author of this blog, have an argument that should not be summarily dismissed. In the last few years, I have arrived at the conclusion that an investment portfolio should include some exposure to precious metals, including physical possession of gold and/or silver. Silver has been prized for centuries as a storehouse of wealth and as a medium of exchange like gold. Because of its lower value than gold, silver is more available to a greater number of people. Thus, the term "poor man's gold."

The value of silver is inextricably linked to gold. Without fail, a gold bull market eventually incites a silver bull market. We have witnessed that process work out over the past couple of years. The gold-to-silver ratio is a comparison of the price of gold against the price of silver. It is also effectively a measure of the number of silver ounces that would be required to buy a single ounce of gold. Generally speaking, the ratio has existed between 40:1 and 80:1 for most of its history. After creeping above 100:1 earlier in 2025, the ratio at this time sits at 74:1. Silver may have some more room to go higher. Although it lags in starting, silver almost always outperforms gold during a gold bull market. I remain optimistic about the direction of silver trending upward. There is a scenario that would certainly temper my expectations. This scenario would entail a reversal of foreign central banks buying gold, a dissipation of geopolitical unrest, and Congress enacting entitlement reform to reduce the obscene level of annual federal outlays. Of course, the Easter Bunny and Santa Claus also may magically materialize in the next few years.

 

Most Investors Don't Understand Risk

In terms of your investments, risk can be defined as any uncertainty that has the potential to negatively affect your financial welfare. Risk offers the possibility of complete loss of capital. It is my contention that the majority of investors consistently misunderstand the concept of risk when making investment decisions. Many investors mistakenly view risk as market volatility - the day-to-day or year-to-year swings in asset prices. However, long-term investors should care more about the risk of losing purchasing power over time due to inflation or a permanent loss of capital. Volatility is the chance of sudden and unpredictable movement. Volatility can actually be an opportunity for an investor to buy more shares at a lower price during a downturn. Some fairly recent examples of negative volatility would be: 1.) Dot.com bubble of 2000 when the stock market dropped 40% over 3 years; 2.) Great Financial Crisis (2008-2009) when the market dropped 37% in one year; 3.) Black Monday (10/19/87) when the market dropped 21% in one day; 4.) Covid-19 fast and furious recession (2020) when the market dropped 30% in 3 months. Shrewd investors were able to take advantage of these market swoons and profited greatly when the stock market recovered and resumed its right and upward trek.

Not properly understanding the underlying risk of an investment can lead to some unfortunate outcomes. In addition, allowing human emotions to determine asset allocation is a recipe for disaster. Many investors, whether due to social influence or the fear of missing out (FOMO), will buy or sell assets based on what others are doing. This "herd" mentality often leads people to participate in market bubbles and sell during crashes. We have all heard the adage, "buy low and sell high," but the reality is that many investors do just the opposite. If you buy a stock when the market is hot and prices are high, you will have greater losses if the price drops for any reason compared with an investor who bought at a lower price. There are a couple of human nature biases that can nudge investors into potential risk traps. One is referred to as recency bias - the tendency to assume that recent trends will continue indefinitely. The other bias is known as loss aversion bias. The pain of losing money is psychologically more powerful (by a power of two) than the pleasure of gaining it. Aversion bias can cause investors  to make irrational decisions, such as holding on to a losing investment too long or selling a winning investment too soon.

The fundamental error that many investors make with their risk assessment process is that they limit it to determining a binary outcome and do not include the element of probability in the equation. Risk is reduced to either yes/no, win/lose, 0/1, good/bad. In other words, all-or-nothing thinking void of nuance and without a middle ground. Instead of avoiding risk, an investor, or his advisor, should strive to manage risk. Smart risk-taking involves making investments where the potential upside far outweighs the possible downside. There is nothing wrong with risking modest amounts of capital for the chance of significant gains, without betting the farm. Think of it as risk with a safety net.

Investors who hold too much of their portfolio in cash or ultra-conservative investments are vulnerable to a guaranteed, long-term loss of purchasing power due to inflation. This will especially be the case if inflation creeps higher over the next decade. The argument can be made that the government intends to run the economy hot with higher inflation and financial repression being utilized to mitigate the federal debt level problem. Investors should thus avoid long-term bonds like the plague. The rate of return on Bank CDs and U.S Treasury securities will end up less than the rate of inflation. In other words, the poor saps who invest in fixed-income instruments will lose significant purchasing power over time.

In general, higher risk is associated with the potential for higher returns, and lower risk with lower returns. However, higher risk does not always translate to higher returns. The returns for certain investments are high for a reason. It is important for the investor to spend some time and energy on a risk/reward analysis. But before identifying specific investments, an investor needs to determine the amount of his assets, outside of blue-chip equities and stock indexes, he is willing to put "at risk." Following are suggested risk allocation levels for different investor profiles: 1.) Conservative - 1% to 5%; 2.) Balanced - 5% to 10%, 3.) Aggressive - 10% to 20%. Real-world examples of some alternative investments with inherent risk would be precious metals, stock options, speculative stocks, and cryptocurrencies, in particular, Bitcoin. It should be noted there is one overriding rule when pursuing assets of this nature: Never risk more than you're willing to completely lose.

Selecting assets perceived to be riskier than normal but resulting in outsized returns is both a challenging art and requires some brain work. On a personal basis, I remain a work in progress, ever-striving for a higher lifetime batting average. This may not be an apt analogy, but in many respects, the decision-making process is similar to the bets made by a professional blackjack player who has the skills necessary to hold a slight edge on the house. Like the blackjack player, an investor can take small, calculated risks when the math works in his favor. If successful, this can drive portfolio growth without threatening financial security. In theory, losses are capped and gains are uncapped. By allocating only a small percentage of capital to higher-risk opportunities, even multiple losses won't significantly impact overall wealth. The key is to suffer modest losses on some risky bets, but more than make up for the losses by capitalizing on a few big wins when the probability of success is favorable. An investor's risk allocation percentage is dynamic over a lifetime and never static. As wealth grows, the dollar amounts grow but the percentage allocated to risk assets should align with risk comfort and life stage.

As I wrap things up and tie a bow to this blog, I would be remiss if I didn't mention a few other ways to mitigate investment risk. My basic premise thus far is that there is more risk being overly conservative instead of accepting and managing selective risk when conditions justify such and opportunities present themselves. In that light, investors should not lose sight of sticking to the basic principles of broad asset allocation and diversification. A common mistake is when investors over commit to one asset class or individual security and fail to rebalance when there is exceptional appreciation. There is nothing wrong with realizing some gains when a holding far exceeds expectations and is disproportionately represented in your portfolio. Trimming back to the original allocation percentage makes sense in such a situation. Also, although there is some added cost to your investment, there are times hedging provides protection to downside risk. It would also be wise in general to avoid leverage to fund investments. Lastly, instead of fearing risk, embrace smart and timely risk and manage it closely.