Inflation Strategies

Inflation Strategies

It has been so long since I worried about galloping inflation--and I had so little in the way of assets the last time this was an issue--I find myself wondering how to cope with the near future. Obama and the Democrats have started a deficit spending frenzy that makes the last Republican controlled Congresses look responsible.

I mentioned almost three months ago that there are signs that the Fed is inflating the money supply to try and revive the economy--and the only reason that it isn't causing price inflation yet is that the velocity of money is quite low, as everyone has been socking money away into savings, instead of spending it.

At some point, the chickens are going to come home to roost on this, and when they do, we're going to see some serious inflation. Inflation benefits people who have fixed rate loans, especially long fixed rate loans, and no significant dollar denominated assets. For those who have lived in the same house for a number of years, doing a refinance at current fixed rates would be a good thing; I rather doubt that it would be worthwhile for us, since I suspect that 80% of current appraised value would be quite disappointing compared to our current loan.

On the investing side, variable rate or other forms of inflation protected bonds are probably a pretty decent deal, and I do own some of those. But what else makes sense? The great German hyperinflation of the 1920s was extreme, but in that case, people demanded to be paid twice a day, and then ran out and bought whatever tangible goods they could immediately buy with the noon paycheck, so that they could trade those goods for what they really needed at the end of the day.

That was an absurd hyperinflation, one that I don't think that even Obama's wrecking crew is stupid enough to engineer. The same principles apply, however, to other inflationary spirals.

Keep in mind that there are two different concerns here: inflation hedges, and true investments. An inflation hedge is something that you buy with the hope that you it won't dwindle in value because of the inflation. If you have $1,000 in the bank, and we get a galloping inflation of 25% a year, at the end of two years, even if you earned 10% interest per annum on your deposit, will still be worth 80% of what it was at the start of the inflation. (And that's assuming that your interest isn't taxed, because your job disappears during the inflationary chaos.)

The problem for inflation hedges is that:

1. The transaction costs of the tangible goods need to be small. If it you spend $100 to buy $1,000 worth of goods, you are 10% down right there.

2. The goods should not depreciate over time. So automobiles (unless you actually are going to use them, and need them in the interim) are not a particularly good choice.

3. It's important that whatever you buy as an inflation hedge doesn't have some sort of irrational valuation because of emotions. Yes, Ferraris and Corvettes are examples. So is gold. The market value of these items can be inflated beyond their rational value, and emotion can make the market value deflate suddenly, too. Buying lumps of osmium might be an example of a non-emotionally valued item. (Most people don't even know what osmium is--an essential component of ball point pens.) This website is quoting a spread of $360-$400 per ounce, which seems oddly cheap compared to gold, but this may be a sign of the irrational nature of gold buying.

4. It would be good for the commodity to be relatively easy to transport, if you had to hide it or carry it with you. (Advantage of osmium over ammunition.)

Investments, however, are a harder problem. What investments, historically, have kept ahead of inflation? I don't know.

UPDATE: A reader tells me that buying U.S. Senators is the best investment of all. Agreed, but they are a bit out of my price range. Perhaps if a few hundred of us kicked in $1000 each, and agreed to share control over his voting digit.