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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