Inflation: Your Four Best Defenses For Preserving Your Wealth

I kicked off this series on inflation with a warning about why all of us should fear inflation and why the US government needs it to take root in our economy. But I’m not the only one who thinks so.

Forbes posted an excellent article on the coming cash tsunami that is destined to strike as the United States Treasury printing presses work overtime to cover the multi-trillion dollar budget deficit resulting from President Obama’s massive and unprecedented government spending plan.

Once that tidal wave of cash starts infiltrating the economy it will be hard to contain. With so much cash floating around looking for a place to go the dollar will quickly begin to slide in value and stock and commodity prices will begin their inevitable ascent.

Remember, probably the most devastating effect of hyperinflation is the annihilation of wealth built up over long periods of time in saving and investment accounts. Nest eggs that were carefully built up over time can be made practically worthless in short order.

A frightening example of this was detailed in the second post of my inflation series where we discussed 18 specific things you probably didn’t know about inflation and its uglier cousin, hyperinflation. Readers of that post will remember the story of a German man who had, starting in 1903, faithfully contributed every month to a 20-year life insurance policy. Unfortunately, the policy matured in 1923 during a period of severe hyperinflation and when he cashed it out he was only able to buy a single loaf of bread with the proceeds.

Fortunately, savers and fiscally responsible individuals who have built up significant savings and investment accounts can defend against the pernicious effects of inflation and, especially, hyperinflation. In no particular order, here are four of the best defenses:

1. Precious Metals

As a rule, precious metal prices don’t track inflation, per se. Rather, they tend to move opposite the value of the dollar. During times of high inflation, the value of a fiat currency like the dollar falls as the price of precious metals such as gold and silver rises. The primary advantage of precious metals is that they provide a stable store of value; unlike dollars which can be created out of thin air, gold and silver require real effort to produce — and that ensures their scarcity. That’s why people flock to gold and silver as they lose confidence in the value of their fiat currency.

Those interested in buying gold can choose to buy gold coins, such as the American Eagle, South African Krugerrand or Canadian Maple Leaf. Although I don’t recommend it, other options include gold bullion exchange traded funds, such as the SPDR Gold Shares ETF (GLD) where, in theory, each share equals one-tenth of an ounce of gold, minus the fund’s expenses.

2. Real Estate

In an inflationary environment, investment instruments with fixed yields such as a fixed-rate annuity or a bank CD should be avoided like the plague because the fixed-interest payments will buy less each passing month.

The good news though is that what’s bad for savers is nirvana for debtors! This is especially true for those with fixed-rate 30- or 40-year mortgages, who will discover that their notes only get better with age as inflation takes hold and prices rise.

But, Len, how can that be?

Well, it’s because in an inflationary environment home prices and your salary can be expected to rise significantly (although your buying power won’t). What won’t rise, however, is your fixed-rate mortgage payment. So as time goes on, not only does the percentage of your paycheck that goes toward that mortgage payment decrease significantly, but you also end up repaying the loan with cheaper dollars.

3. Treasury Inflation-Protected Securities (TIPS)

If you believe, like I do, that inflation is inevitable and likely to break out within the next couple of years, then you might want to consider Treasury Inflation-Protected Securities, otherwise known as TIPS. TIPS won’t make you rich, but they are designed specifically to protect investors against inflation. TIPS are designed such that both the interest and the principal payments are indexed against the Consumer Price Index. As a result, the quoted yield is a “real” return after the effects of inflation.

Be careful though because, if inflation doesn’t rear its ugly head, you may be better off buying normal T-bills.

For more information on TIPS, check out this article at the Motley Fool.

4. Your Own Earning Power

When inflation is on the rise, those on fixed incomes like senior citizens and other retirees are adversely affected because their buying power declines sharply as their dollar-denominated savings and retirement accounts rapidly lose value.

Having a job of any kind helps slow the effects of inflation’s penchant for eroding purchasing power. Although unemployment tends to rise substantially during periods of high inflation, those who do manage to stay employed can usually minimize the loss of their purchasing power during these periods because employers are pressured to increase wages in order to allow their workers to keep up with rising consumer prices.

Indeed, none other than Warren Buffett, at his 2009 shareholders meeting for Berkshire Hathaway, recommended that “the best protection against inflation is your own earning power. If you are the best at what you do, you will get your share of the national pie no matter what inflation does.”

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    Hi Len,

    This is a golden oldie and thanks for bringing it to the forefront once again. You hit on the four key points that everyone needs to take a very hard look at going forward as the economic sins of the past catch up with us.

    We would like to offer comments on all four points in reverse order.

    Point number 4: Your Own Earning Power

    This is a vitally important consideration going forward. It is much more important today than during the late 70s. Many retirees, in the late 70s, mistakenly believed they had enough to retire on and had to go back to work in the 80s. The problem was, however, their earning power had softened somewhat. Many were high income earners in their prime, but some of those high incomes were based more on tenure than merit. Once they returned to the work world they were shocked that they would be competing for jobs at much lower salaries or wages than before. Most, however, were appreciative they could find any work at all in an interest rate environment of 15-18%. This was tough on business, but inflation and even hyperinflation had threatened to take the dollar to a total collapse when gold peaked near $850 in 1980.

    The raising of interest rates, even though Fed Chairman Volcker was given most of the accolades, was really a market phenomenon. Fed Chairmen have direct control over short-term rates, but the real driver of long-term rates is the currency markets. Then, just like now, the dollar was becoming increasingly suspect and fewer and fewer central banks were willing to pony up and buy our debt. Interest rates rose fast and furious. Locking in 30 year treasuries, at these high rates, would have made one look like a market genius, in retrospect. At the exact time interest rates peaked, many thought the dollar was toast.

    We are confident that rapidly declining demand for U.S. debt will again lead to even higher interest rates than witnessed in the early 80s. The burning question is, however, will Johnny-come-lately high interest rates successfully mitigate the loss in the dollar con-fidence game?

    The dollar is, essentially, the common stock of U.S.A. Inc. and looks terribly injured at the moment. Its safe haven status is markedly declining as witnessed most recently by the Dubai and Greece financial implosions. The dollar bounced a little only to be sold by Asian holders of U.S. debt. Smart move on their part. Selling the dollar into the bounces is good strategy when holding too many dollars. None of them want to start a run on the dollar until they have appropriately positioned themselves to advantage.

    Some key comparative considerations are in order. In the late 70s and early 80s we still had a robust manufacturing sector and wages and salaries were more accurately aligned and increasing with the true inflation rate. Both of those conditions are now absent. The Consumer Price Index had considerably more integrity then than now. For a detailed look at how the Consumer Price Index has been manipulated to keep wages, pensions, and social security COLAs artificially low, see work by economist John Williams of Additionally, the dollar’s status as the reserve currency of the world was much less pronounced in the 70s and 80s than it is today. Central banksters are notorious for their ability to increase the money supply, but their Achilles heel is their lack of absolute control over demand. When foreigners decide to head for the dollar exits, in mass, there will be a tsunami tidal wave of cash hitting our shores that will make Helicopter Ben and his predecessor Easy Al, if he is still alive to witness the illegitimate monster he fathered, shake in fear.

    The common stock of U.S.A. Inc. is not just invoking the wrath of its own citizens, but it is also invoking the wrath of the entire world as they witness the devastating effects of our loose monetary policy as it races around the world destroying everything in its path. A very burning and critical question going forward is whether 25-30% interest rates will be enough to save the dollar this time around? And, what do 25-30% interest rates portend for the recovery of real estate when there is already such a tremendous baby boomer overhang in residential and commercial real estate? It means much lower prices for real estate, much higher down payments, and a critical dependency upon a thriving job market. It is not likely the job market will be thriving in a 25-30% interest rate environment which means real estate will continue its downward spiral for years to come until all the excess is sopped up.

    Yes, we agree that many will have to off-set the coming inflationary destruction and loss of purchasing power with continued employment in an era of ever increasing unemployment and underemployment.

    Point 3: Treasury Inflated-Protected Securities

    The fiction associated with TIPS is the Consumer Price Index calculations. The scoundrels in charge of the index juggle the components around repeatedly to favor low inflation numbers. This has represented a huge rip-off to those on fixed incomes along with wage earners who’ve also experienced a severe loss of purchasing power. This rip-off has been intentional and bi-partisan.

    Point 2: Real Estate

    We discussed real estate in point 4. The baby boomer overhang in real estate will be with us for years. The same may be true for stocks. Baby boomers will be looking to liquidate real estate and stocks to keep up with inflationary pressures, but who will they sell to in a jobless recovery? The newly rich in China are their only hope. 30 years ago the term “jobless recovery” didn’t even exist. It, too, is an Orwellian fiction like the Consumer Price Index. How can there be a jobless recovery in a consumer driven market? Where do these idiots come from? Another inhibitor to real estate is taxes. Practically every state in the union is struggling with declining tax receipts due to the decline in economic activity. They will go after the soft targets which are fixed and immobile. Many homes were seized during the Great Depression over back taxes. How many homes will the tax collectors seize this time around before they realize the on-going maintenance cost of these properties exceed their intrinsic value?

    Point 1: Gold

    Gold is morphing from its more recent role, as a commodity, to its more historical role as a safe haven currency in a financial world gone mad. Gold is wagging, via price, its wise and ancient fingers at central banksters around the world and saying, “I know what you gals are up to as I’ve witnessed, throughout the history of the world, skimpy skirt after skimpy skirt who thought they could out seduce all the other gals with their lipstick, perfume, batting eye-lashes and suggestive whispers. It’s the oldest story in the world and a close cousin to the oldest profession in the world. You’ve prostituted yourselves for so long that your former suitors (johns) are now leaving you. Yes, you may continue lathering on the lipstick and perfume; and you may continue whispering sweet nothings into the ears of drunken and wayward sailors and, in low light conditions, may be able to convince a desperate young sailor or two to part with his hard earned substance, but deep down inside you know your days are numbered. You are feeling your age and can see the wrinkles, sagging skin, and your own spiritual depravity every time you look in the mirror. Recently, the talk of the town is that the IMF will take all you down-on-your-luck-and-past-your-prime gals in and give you a place to stay as if the answer to financial whoredom is in the building of a larger whorehouse. Well, I’m not buying the malarkey. You can put fresh lipstick on a pig and fresh paint on the outhouse, but that type of beauty is only skin deep and the horrible stench never fails to betray your real essence and character.”


    We see a real arbitrage opportunity between gold and real estate. We see continued real estate deflation against a backdrop of rising commodity prices. Farmland could be the logical exception because of the associated commodity value. An interesting play might be to consider trading a portion of one’s gold for some real estate and 30 year treasuries in the vicinity of the inflationary top in commodities. If the dollar were to go bust, gold would logically be a good insurance policy against hyperinflation. If deflation ruled the day, 30 treasuries drawing 25-30% interest would give tremendous purchasing power.

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      Thanks for the fantastic comments, Steven and Debra! I agree, the CPI is a joke. I also am with you regarding the continued depression (or at least treading of water) in the real estate market due to the selling pressures that will be brought about by the quickly-aging baby boomers. Meanwhile, t.he dollar is imploding thanks to years of loose monetary policies at the Fed.

      I agree 25-30% returns on 30-year treasuries is enticing. Then again, if hyperinflation collapses the buck I don’t put it past our government to seize that opportunity to introduce the Amero and, presumably, wipe those 30 year treasuries off the books.

      Oh, and after your portrayal above, I have to tell you I’ll never look at fiat currencies the same way again. LOL

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