"Since a powerful new inflationary trend is very likely to occur in the US, the prudent investor should probably take steps to not only guard against it, but to benefit from it. “But wait a second!” some readers will be saying, “What if a powerful deflationary trend occurs first?”
What is Inflation?
(Source: Wikipedia)
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.
The term "inflation" once referred to increases in the money supply (monetary inflation); however, economic debates about the relationship between money supply and price levels have led to its primary use today in describing price inflation. Inflation can also be described as a decline in the real value of money—a loss of purchasing power in the medium of exchange which is also the monetary unit of account.
When the general price level rises, each unit of currency buys fewer goods and services. A chief measure of price inflation is the inflation rate, which is the percentage change in a price index over time. and price levels have led to its primary use today in describing price inflation.
Economists generally agree that high rates of inflation are caused by an excessive growth of the money supply.
The consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.
Today, most economists favor a low steady rate of inflation.
Monetary inflation is the term used by some economists to differentiate direct inflation in the money supply from price inflation which they view as a result or necessary outcome of the former. Originally "inflation" was used to refer simply to monetary inflation, whereas in present usage it often refers to price inflation.
Effects of Inflation
(Source: Wikipedia)
An increase in the general level of prices implies a decrease in the purchasing power of the currency.
That is, when the general level of prices rises, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly, and as a consequence there are hidden costs to some and benefits to others from this decrease in purchasing power.
For example, lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while borrowers benefit. Individuals or institutions with cash will experience a decline in the purchasing power of their holdings.
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Debt Relief: Debtors who have debts with a fixed nominal rate of interest will see a reduction in the "real" interest rate as the inflation rate rises. The “real” interest on a loan is the nominal rate minus the inflation rate. (R=n-i) For example if you take a loan where the stated interest rate is 6% and the inflation rate is at 3%, the real interest rate that you are paying for the loan is 3%. It would also hold true that if you had a loan at a fixed interest rate of 6% and the inflation rate jumped to 20% you would have a real interest rate of -14%.
What you can do:
Source: Wikipedia
The Nobel prize winning economist James Tobin at one point had argued that a moderate level of inflation can increase investment in an economy leading to faster growth or at least higher steady state level of income. This is due to the fact that inflation lowers the return on monetary assets relative to real assets, such as physical capital. (cash) To avoid inflation, investors should switch from holding their assets as money (or a similar, susceptible to inflation, form) to investing in real capital projects.
(See "Strategies" for specific strategies)
- IMPORTANT NOTE FOR READERS:
The information in this website relates to the USA in terms of it increasing it's money supply. In countries such as Australia, they are in a completely different position economically to the US and the UK, and ARE NOT "printing money.".
However readers need to be aware that IF high inflation does strike the US, then Australia could very well also suffer from inflation due to the high importation of goods from overseas.
--------------------------------------------------------------------- THE DANGERS OF PRINTING MONEY
Is inflation going to Roar back?
The Fed's doing it. The Bank of England is doing it. With printing money back in fashion, will inflation roar back in these countries?
In 2009, according to the Federal Reserve Board, the money supply in the
Have car sales tripled?
Home purchases?
Consumer spending?
Corporate investment?
No.
So where is the money? If it isn't being spent, where is it? It is being parked, squirreled away. Consumers are using it to pay down their credit card balances, pay off their mortgages, reduce their student loans, make the payments on the car sitting in their driveway -- not the one in the dealer's lot.
Businesspeople are buying T bills, investing the money and saving it. They aren't spending, either.
But one day this recession will end in the USA, and things will begin to look up again.
Then, we can expect all of this money to come out of its parking space and get back on the highway of commerce.
All at once. The inevitable result will be inflation.
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"There are a number of on-going debates regarding deflation vs. inflation, one of which we should be more worried about.
Do you remember just a year ago, the world's biggest worry was the oil price, with oil aiming for $150 per barrel, many economists were worried that “hyper-inflation” was just around the corner.
But now that most commodity prices have been virtually cut in half and global economies are shrinking, inflation fears have been replaced by fears of deflation.
However, some are pointing out that inflation really isn’t rising prices, and deflation really isn’t shrinking prices - but that these are actually accelerating or decelerating money supply growth as as money growth increases, so to is the chance of inflation coming soon.."
(Stock trading to go, October 2008)
“Normally, I would never advocate inflation to cure our economic ills. These are not ordinary times. Given the size of the problems and the effect it is having, failing to take an inflationary path will lead to, at best, a deep recession and increase the possibility of a severe depression that will affect the entire country and thus, the world.
If I am correct about the need and intent of the government to inflate the economy, the investment implications are many. In an inflationary environment, Treasury bonds will suffer.
The largest beneficiary of increased inflation will be hard assets and related companies. Gold offers the purest exposure, but all commodities should do well. Equities that either supply commodity producers (i.e. -fertilizer companies such as POT) or currently possess abundant commodity reserves (i.e. - oil companies such as XTO) should see their shares perform well. Real estate should begin to bottom and then eventually outperform”
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Don't Be Fooled - Inflation is Coming
"As I wrote in the original edition of America’s Financial Apocalypse, “inflation is certainly going to be a very big problem.” I stand by this previous forecast first made in 2006. However, hyperinflation isn’t going to occur. While I may be wrong about some things in the future, I won’t be wrong about this. Quite simply, America would go to war before allowing hyperinflation to set in.
Mar 13, 2009
Mike_Stathis, Managing Principal of Apex Venture Advisors, Author: "America's Financial Apocalypse"
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Inflation will be a bigger issue than the recession. Inflation may well be the big story for the next century.”
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"One independent analyst who does an excellent job tracking the growth of the money supply is John Williams. (see extract of report under MORE on this website) Many decades ago, money supply measures such as M2 and M3 were regularly reported.
For some reason, the government stopped reporting M3, the broadest measure of the money supply, some years ago. Fortunately, the statistics and formulae needed to calculate M3 are easily available. Williams has taken up the slack and continues to calculate and publish M3.
The most fundamental monetary aggregate also calculated by Williams is called the adjusted monetary base, which measures very liquid forms of money such as bank notes and bank reserves. In his latest missive, Williams points out that the monetary base has recently exploded at a rate unprecedented in history -- up 38% year-over-year. Not even in the 1930s was so much money created so quickly. In fact, the only other time the monetary base grew anywhere near this quickly was during the build-up for World War II, when we needed a lot of cash to convert factories into making armaments.
Williams point is that all this cash is eventually going to work its way into the economy. The good news is that banks will have unprecedented amounts of money to lend, which will make them willing to lend more money at much lower rates.
So once the psychological impact of the current financial crisis wears off, we will be faced with an unprecedented rise in credit and monetary largess.
The next act in our economic drama could go one of two ways.
One possibility is that all this new money will never find its way into the economy, because it will be overwhelmed by psychological factors, such as fear, which will make people stop borrowing and spending and plunge the world into depression accompanied by deflation.
However, I doubt that will happen. It's just not as likely as the alternative.
Instead, the most likely scenario is one of inflation...
I expect a turnaround will occur in the near future in which the price of oil soars $2 for every $1 that it fell since last spring. Inflation may not hit record levels right away, but it will in time."
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"Today,
“AS THE MARKETS CONTINUE BUCKING WILDLY, and the fed slashing rates with more cuts to come, we can expect more volatility with our currency. The
Thus, the vital question for every investor is how to hedge, or protect, your wealth against inflation. Some urge to hedge this risk with real estate. So should we really hedge with real estate?
To answer this, we need to consider two closely linked topics. First, what is an inflation hedge? Second, what makes a good inflation hedge? The first answer is simple. An inflation hedge is an asset that loses little value in periods of rising prices. Thus, it holds its value and purchasing power during inflation. This also applies to hyperinflation. An investor expecting inflation will buy this asset to hedge against inflation.
Real estate qualifies here, as does other hard assets such as Gold.
The answer to the second question requires understanding of the two basic types of assets: real assets and financial assets. Real assets have intrinsic value. They have value of their own. People value them for their direct or indirect usefulness. Examples include books, TVs, cars, wheat, gold, real estate, land, etc.
Financial assets, on the other hand, are a claim on the income or wealth of a firm, family or the government. Their typical form is a certificate or a receipt. Examples include paper money, stocks, bonds, mortgages and exchange traded funds. All money market and capital market instruments serve as examples.
In general, real assets hedge better than paper assets. By definition, real assets have a value of their own. Inflation does not erode their value. Thus, any real asset can be an inflation hedge. It follows that real estate is also a hedge.
Good hedges have a few key properties. We mention here only four. One key property of a hedge is that it holds its value. It should lose little value over time. Cars and eggs lose value over time. Land, silver and wine do not.
Another key property is marketability. This means that it is easy to sell. Other people will easily take it for payment. Hence, it is good for barter. Chairs and clothes do not sell. Corn and gold do.
A third key property is divisibility. This means that the asset splits into smaller parts without a loss of value. Houses, cars and cows are not divisible. Rice, wine, gas and gold are.
The last key property is financing. It is vital. Experts prefer to fully ignore it. Investors buy assets with either cash or credit. Cash-based hedges are perfect.
But few have the kind of cash to needed to get them through serious hyper inflation.
The verdict is clear. Real estate can a agood hedge. Providing it is the right type of property, and you adopt some careful strategies.
Gold is a hedge. Gold aces all the tests of a good hedge.
HYPER INFLATION: If we suffer a bout of “hyperinflation”, then Real estate bought with cash, free and clear of any debt, is nevertheless a hedge. It will protect the value of your money. It is not as good a hedge as gold, but it will do the job.
INFLATION: Should we just suffer inflation, albeit perhaps high inflation, then it is important to know that money loses its value through inflation, including the money people have lent you.
Simplistically, consider this: If you had bought an property for $10,000 forty years ago, and borrowed $10,000 to do so, and only ever paid the interest on the loan, at the end of the forty years you would still owe the $10,000.
The property would be worth say $400,000.
At an average interest rate of even 8% over the whole time, then your total interest bill would have been $32,000.
Total investment $42,000, for a property now worth $400,000. Hopefully, that simple example shows you how inflation increases assets, and DECREASES the value of the dollars you owe.
Ideally of course, you selected an income producing property, where the rental covered the whole interest bill, so fact you never paid any interest at all.
Inflation rewards borrowers who acquire appreciating assets using depreciating dollars, but disadvantages savers as the value of their money goes down over time.
In inflationary times cash could be the worst thing to hold.
"global lobal inflation could spiral out of control as foreign central banks try to maintain the dollar's value relative to their own currencies and the coffers of sovereign wealth funds bulge with surplus dollars”.
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