Hyperinflation Over-Hyped

There is a lot of skepticism about the plans of the Federal Government and the FED to defrost the credit markets through its many stimulus plans. One of the biggest fears for some investors is that pumping too much money in the system would lead to hyperinflation and a complete devaluation of the US dollar against hard assets such as gold, oil, land and others, which would eventually lead to everyone living in caves hunting for food. There are even several ETF tracking Gold (GLD), (IAU) and Crude Oil (USO), (OIL).

I disagree with those fears. First of all I do expect average inflation of 3% annually for the next 3-4 decades to continue. The best way to hedge against that is to buy common stocks, which are not just pieces of paper, but rights to ownership of real businesses which would be able to pass any price increases on to their consumers. At the same time these businesses would share a portion of their profits with shareholders, by paying out dividends. Over the past 80 years dividend growth in the Dow Jones Industrials Index has more than compensated for the eroding forces of inflation. Dividend Growth for the 1920-2005 period was 4.9%, which was almost 2% higher than the 3% average inflation rate. The best ETF to track Dow Jones Index is Dow Jones Diamonds (DIA).

Over the past few decades the wealth of US households has been primarily comprised of Real Estate, stocks and fixed income. The real estate has been the primary residence of families; stock ownership was through owning mutual funds or owning stocks directly, while the fixed income portion consisted of deposits, bonds and cash on hand. As the value of stocks and real estate rose steadily, consumers felt richer and spent more, which in turn stimulated the economy. The past 2 years however have brought low stock prices, and declining real estate values.

According to some estimates, the total amount of stock market losses is estimated at 8 trillion dollars. No wonder many investors simply throw away their quarterly brokerage statements these days – their passive investments have plunged significantly in value.
On the other hand, the housing bubble has eroded a total of 6 trillion in homeowners equity in the US.

To summarize:

Money lost in the stock market: $8 trillion dollars according to World Exchanges

Money lost in real Estate: 6 trillion dollars according to Safe Haven

Total: $14 trillion dollars

Government Bailouts: 8.5 billion according to this article

Source: Government bailout hits $8.5 trillion

At the end of 2008, Americans' net worth fell $11.2 trillion, or 18 percent from 2007, to $51.5 trillion according to the Federal Reserve; which makes people less secure about their net worth situation. Investors have most of their wealth invested in real estate and stocks. When stock and real estate markets are booming, people feel wealthier, and tend to spend more. If homeowners wanted to redecorate their house or take a cruise around the world, they could easily sell their appreciated stocks or take a HELOC against their home equity. If they lost billions of their networth however, on aggregate they would be less likely to spend it all since they would have less assets to post as collateral in order to get the credit to live the nice life.

Thus in order to make people feel wealthier again, the government is spending several trillion in bailouts in order to lessen the negative wealth effects on the economy. As fewer consumers take out loans in order to spend on anything from decorating your house to going to that cruise to the Bahamas, and the ripple effects of this is felt throughout the economy there is less money to be loaned. Someone has to step in to provide a buffer against further declines in spending, and the government’s recent plans are a decisive action to prevent the worst from happening.

Thus I disagree that the government bailout would lead to hyperinflation, such as the one we saw in Germany in the 1920s, Zimbabwe or in Eastern Europe in the early 1990s. If the private sector’s participation in the economy decreases, and the government’s participation increases and offsets the decline in the private sector, the net effect for the economy is zero. Another difference between US and the other hyperinflation situations is that the US dollar is a currency that virtually all countries in the world accept in their foreign trading. Not only that but the US dollar is the primary reserve currency for many large foreign central banks such as the Chinese, Russian and Japanese banks. These banks hold their US dollar reserves in US Treasury Securities. They don’t have another alternative for their reserves. If they sold all their dollars their currencies would be much more unstable and the countries would suffer a huge drop of confidence in their economies. Furthermore during economic crises most foreign individuals tend to purchase dollars. For example during the Asian financial crisis (1997-1998), Russians, Indonesians and others were converting their savings mostly into US dollars, not gold or silver.

Thus I believe that the best way to protect your wealth is to purchase shares in consumer staples companies, whose products we use on a daily basis. I am a fan of Procter and Gamble (PG), Clorox (CLX), Colgate Palmolive (CL) and Johnson & Johnson (JNJ), which have not only been able to pass inflationary pressures onto consumers but are relatively recession immune as well. For a larger list of the best dividend stocks for the long run, check out this post.

Procter & Gamble makes detergents, soaps, toiletries, foods, paper, & industrial products. Brands include: Always, Head & Shoulders, Olay, Pantene, Wella, Actonel, Dawn, Downy, Tide, Bounty, Charmin, Pampers, Folgers, Iams, Pringles, Gillette, MACH3, Braun and Duracell. The Cincinnati, OH company has increased dividends for 52 consecutive years and currently yields 3.30%. Check out my analysis of P&G.

Johnson & Johnson is the owner of some well knows brands such as SPLENDA, TYLENOL, SUDAFED, ZYRTEC, MOTRIN IB, and PEPCID AC. The New Brunswick, NJ company engages in the research and development, manufacture, and sale of various products in the health care field worldwide. If you are concerned about the US dollar depreciating, look no further – 49% of JNJ’s 2008 sales came from abroad. Johnson and Johnson has increased dividends for 46 consecutive years and currently yields 3.60%. Check out my analysis of JNJ.

Colgate Palmolive manufactures and markets consumer products worldwide. It operates in two segments, Oral, Personal, and Home Care; and Pet Nutrition. The New York, NY based company has rewarded stockholders with a rising dividend income stream for 46 consecutive years. This dividend champion currently yields 2.90%. I am considering initiating a position in CL on dips below $53.

Clorox manufactures and markets a range of consumer products such as Clorox, Formula 409, Glad, K C Masterpiece, Ever Clean. The Oakland, CA company has a 31 year uninterrupted streak of dividend increases. The stock currently yields 3.40. Check out my analysis of Clorox.

Disclosure: Author long PG, JNJ and CLX.

Comments

[dybydx]

actually i am expecting inflation to go above 5% in a few years from now.

i can not forsee how the us econ can out grow its debt. even GAO believes double digit growth is needed for that to happen. short of that growth, the us gov can either drastically slash spending and cause a recession, or print money.

the latter sounds more plausible.

with respect to protection against inflation, the standard procedure is to buy hard assets like gold and real estate. purchasing stock is can work, but most rational individuals will not place more than 50% of their assets in volatile instruments like common shares.

2009 Apr 22 12:24 PM

[twitee]

With mounting unemployment, increase in foreclosures, predicted another 30% drop in real estate values, lack of liquidity and lower corporate profits the consumption will decrease (which is 70% of US economy). The consumer staples may do better than most, but their growth rate will decline and in a short term (2-3 years) will not be profitable...The most secure place to preserve or grow your money is in GOLD...Gold is winner in both hyperinflation or depression

2009 Apr 22 12:35 PM

[conceptwizard]

I agree that deflation is the black cloud right now. This is further supported by the fact that the Bank of Canada lowered rates .25% today down to .25% and committed to leave it there for 14 MONTHS! Never before has this happened in that country. This clearly indicates that inflation is not in their vocabulary right now and puts clarity on where the rates will be for the near future.

This does not however remove the risk of high inflation when the ship turns around and heads for China.

2009 Apr 22 01:01 PM

[Jasper M]

I find the author's argument re hyperinflation sound - current total $ creation does not even cover wealth destroyed to date, much less what is coming.
I also lean toward his view re currency - for all the jawboning, there seems as yet no viable alternative for the world's lenders.
But I must dispute the notion that government spending in these circumstances is inherently beneficial. Spending that is not subject to market discipline is likely to be malinvested (as we have been shown), and extreme spending is likely to produce extreme malinvestment. The consequences of recent credit inflation are like something Straight Out of an Austrian School Econ textbook; we would do well to notice them in real time.
Also, I find twitee's notion that gold is a winner in depressions unsupported. That said, if it drops a bit more, I will buy.

2009 Apr 22 01:06 PM

[Socialism cannot compete!]

Author is clueless about what is yet to come economically and what is happening politically. No, we won't return to living in caves. But those hard assets will be where it's all at. There is unrest to come; total economic collapse, and political turmoil, both national and international. Read the signs of the times: unprecedented debt, and instead of paying it off, we ADD to it en masse; persisting unemployment; out-of-control government leaning hard Marxist and totalitarian; and in particular, an narcissistic leftist "president" who is *clueless* about foreign policy, unless his goal is to align with dictators, terrorists, and rogues! There IS NO POSITIVE SPIN THAT CAN BE PUT ON ALL THIS!! Get the rose-colored glasses off. Protect yourself and your family. Hard assets will never go to zero; there is a SOLID chance equities will, within two years.

Good luck to all, and may God have mercy on America.

2009 Apr 22 01:08 PM

[@TexasER]

I believe high inflation is on the horizon. And that hyperinflation is best looked at in terms of a probability which is always non-zero. (Today, it is more "non-zero" than usual).

The anti-inflation faction is CORRECT that the increase in M2/3 does not offset the decline in asset values. And right now, that is not a problem.

But this isn't about what is going to happen next week, it's about the next 12-36 months. Within a few months I believe the current optimism will fade and another round of even more massive government "programs" will be required.

That's what I'm afraid of -- not the simple nickle and dime accounting tricks we have seen so far.

2009 Apr 22 04:56 PM

[drflounder]

I certainly hope you're right about inflation, but the truth is that no one can tell for certain what is going to happen. I believe a well balanced portfolio should contain at least some commodities as a hedge against inflation.

I recently bought into gold and oil, and I'm about to buy into silver and copper. My portfolio is however still mostly in stocks.

2009 Apr 23 10:16 AM

[Airelon Trading]

I enjoyed the above article.

Dividend DRIP investing is a great way to take advantage of any stagflation we might * might * see. Because as stock prices stay depressed? The shares will be reinvested at lower prices, improving the cost basis in such companies as JNJ and PG. You're basically receiving more shares, for free, at better prices * if * stock prices continue to fall.

If they don't fall, then you make out on the cost basis of the stock itself, and the dividends.

The problem is that Inflationists (Particularly hyperinflationists, since we all know that sooner or later, some inflation will return) just cannot understand that the market doesn't care what they WANT to happen. Reality is a different matter.

Their economic education usually consists of watching YouTube videos and then trying to find data that supports their bias. Rather than simply accepting what the market is saying. They simply CANNOT understand that deleveraging and supposed "liquidity injections" are not an increase in the money supply. They are conversions for asset control. It's one giant margin call, with the taxpayers, paying for the deleverage. The money supply charts are all skewed and wrong, since they do not reflect that REALITY.

And therefore, just as Milton Friedman screamed and hemmed and hawed and was completely epileptic about hyperinflation in 1982 and 1983? They continue to scream that the sky is falling. And just like Friedman? Reality will prove them to be very, very incorrect.

2009 Apr 23 10:35 AM

[andypandy]

Maybe it's me, but I don't understand how there is even a debate as to whether there will be increased inflation if not hyper inflation in the mid to long term. The bottom line is that the number of dollars are increasing; the US fed is buying treasury bonds. How is it that the more money we print the less risk there is of inflation? In the very short term I understand that the credit contraction is actually decreasing the amount of available money (deflation) available for credit, loans, and bank deposits. Once this contraction clears banks will go back to lending and granting credit pursuant with the fractional reserve requirements (although I have read very convincing arguments that the credit contraction itself is the cause of the hyperinflation). Eventually the M1 multiplier will return to 1.6 (the multiplier during the peak of the market).

The US is running a huge deficit and a huge budget. I seriously doubt we will ever have less than a 1 trillion dollar deficit for the foreseeable future. We have over $50 trillion of future liabilities for social security, medicare, medicaid. Does anyone really think the government will reduce payouts of these programs, or increase age requirements? I don't, and even if they do, any government action will not be enough to bring the liabilities / entitlements to a manageable level. There are four solutions: reduce benefits, increase taxes (meaning 90% tax rates, which i highly doubt anyone would stand for), print money, or a combination of the three... I feel almost dumb stating the obvious, The US will just print the money (or just increase the numbers in the bank accounts however you want to look at it) to meet these entitlements. Any other action is political suicide (I don't care how the media spins it people will go crazy when their benefits are reduced).

Further, foreign creditors (especially China) have both been buying large amounts of other assets like gold and decreasing their purchases of treasury bonds. What happens to those dollar reserves when they are spent, instead of frozen back into the bond market - they come straight back to the US - giving us the classic "too many dollars chasing too few goods" scenario.

2009 May 02 05:10 PM