Central bankers, politicians, and some uninformed folks talk about how there is no inflation when in reality the contrary holds. If these individuals got off their butts and actually traveled around the world they would experience it themselves.
Inflation does exist-- I see it every day when I travel. From a 5% increase in French baguettes in Paris to a 7% increase in pad Thai in Bangkok. Much of these price increases are due to Mr. Bernanke and Mr. Draghi printing unlimited amounts of dollars and Euros out of thin air without gauging the impact of such deed in other countries. You see, when central banks in rich, developed countries conjure money out of thin air, third world countries such as Thailand must print money as well in order to maintain their exchange rates attractive. As a result of increasing the money supply to remain competitive, these developing countries suffer from a rise in costs of basic survival needs such as food (baguettes and pad Thai) and clothing, which forces more and more people into poverty. A truly unjust system, right?
Some countries such as Ethiopia have suffered from staggering inflation increases over 30 percent. However, most governments around the world are known to skew data to report favorable inflation numbers and make their citizens cling to an illusion they are better off than previous years.
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The charts above reflect how methodological shifts in government reporting have depressed reported inflation.
Some people pretend there is no inflation because Wal-Mart (NYSE:WMT) cut down Apple's (NASDAQ:AAPL) iPhone 4S price from $188 to $148, which is intellectually dishonest and delusional because the iPhone is not the economy nor is it a human survival necessity. Those making and believing in such bombastic claims have taken an inflation placebo pill, and thus, believe inflation will be non-existent in the next decade. This should be a major concern as the eurozone has started buying bonds, but especially if QE 3 comes to fruition shortly.
As the money supply increases, the dollar will continue to lose its value and those investors who are in denial about inflation will more likely lose their shirt. To put it into perspective, here in the United States $1.00 in 1971 had the same purchasing power as $5.24 did in 2008. In other words, $1.00 in 2008 purchased the same amount of goods that 18 cents bought in 1971. The diminishing purchasing power of the dollar throughout the years has been caused primarily because the government continues to increase the money supply. I am a strong believer that history will repeat itself in the next decade.
Last week, Draghi announced unlimited purchasing of bonds to lower the eurozone's borrowing costs. This week in the U.S. there is more concern that the Federal Reserve will continue printing money as the economic recovery weakens. The increase of money supply in Europe and in the U.S. will cause inflation to spread around the globe as other economies will inflate their currency to maintain a favorable exchange rate. Eventually, those higher prices will come back to us in the products we import from those countries.
Typically, to hedge against inflation, the markets tend to flock to gold and other metals, known as safe havens. Other positions that investors could take to hedge against inflation in their portfolios are real estate and Treasury Inflation-Protected Securities (TIPS.) As far as precious metals, gold has been a favorite of the market, having appreciated over 345% over the last decades. Although it is a non-incoming producing asset, it has maintained its value over the years. For example, in the days of Henry VII, an ounce of gold would buy you a nice suit. Today, an ounce of gold still buys you a nice suit. Then there is real estate, which is said to lose little value in periods of rising prices because it is a tangible asset that has an intrinsic value of its own.
Another option to hedge against inflation is through the Treasury Inflation-Protected Securities, which were introduced in the late 1990's and are issued in terms of 5, 10, and 30 years. TIPS are a form of government-backed bond that pay a return that is pegged to the increases in CPI. For example, let's assume these bonds are currently paying 3%. On a $1,000 bond you would earn $30 in interest this year. If at the end of the year the CPI indicates inflation rose at a 5% rate, then the principal value of your $1,000 bond is hiked to $1,050. The following year your interest payments would rise to $31.5 to reflect a 3% return on your $1,050 principal value. Be aware that in this case, if you do not structure your bond investment into a tax-sheltered vehicle the interest and inflation adjustments will be taxable. In other words, you would pay taxes on the interest earned and the $50 inflation-adjusted boost even though you did not actually receive the $50 in cash.
Inflation is a hidden tax that diminishes your purchasing power if your annual salary and/or investments do not keep up with inflation at a minimum. If you are in the placebo group, there's no need to adjust your portfolio, but if you do not believe the iPhone is the economy it is imperative to analyze your portfolio and make the necessary adjustments to hedge against inflation. Inflation is real and it is on its way here.