Jonathan Christopher

Inflation Hedging: How to Protect Your Portfolio

First thing to understand is that we have been in an inflationary environment since the end of WWII. The current dollar is only worth about 2 cents compared to a dollar at the end of the war.

What we are seeing now is an increase in the rate of inflation to levels not seen in several decades. What will work for individuals is the same standards for investment that have work for me for the past thirty years.

Summarized the rules are simple, and in no particular order.

!. Own assets that have a value separate from the dollar. Examples are: Farm land, Gold, silver, oil, copper, uranium, and other real property.
2. Don't overpay. If you buy a building, be sure that you purchase it at a price at or below the cost to put up a similar building in the same area. Be sure that the building, if rented out would have a positive cash flow.
If you buy a gold mine (shares) be sure that the price you pay is less than the cost to build a similar mine, and that the gold in the mind is fairly valued. Be sure the company is comfortable cash-flow positive.
3. Borrow as much FIXED RATE debt as you can support during the worst likely future. As the value of the dollar goes down, so does the value of the debt you owe, leaving you with greater net value (equity)

4. Do not assume that government pensions will hold value. The impulse to change the method of inflation adjustment by government will be irresistible. Don't be surprised if the government eliminates things like food, housing, fuel, energy, and medical costs from the Consumer price index as "too volatile" ie: their prices are going up higher than the government wants to admit. That will result in your Social Security, Military Pension, and State pensions going down in real purchasing power.
5. Strongly consider transferring assets or moving to countries whose cost of living (measured in dollars) is much lower than the United States, and whose economies are dependent on a large variety commodity based products.
6. Do not buy bonds, except as a short-term investment, unless the bonds are fully inflation protected.
7. I am not a "Gold Bug" - so this last suggestion is at the far-end of the un-likely. Consider that the US government may again make the owning of Gold coins and similar portable sources of wealth illegal. While this is of low probability, consider this as the endpoint before a re-issuing of the currency. It would provide the US government a way to collect additional reserves by forcing people to accept soon to be worthless paper for Krugerands, silver dollars, gold ingots, platinum bars, etc. Placing assets overseas will reduce this risk, and may be one element of your program af asset re-deployment.

NOTE: If the situation really gets bad, the government could resort to a tactic used by other countries, such as Japan. People with incomes based on production from companies or with pensions guaranteed by the government could be forced to accept "equal value" of government treasuries, providing equivalent income. In the event of dollar re-valuation, these incomes would essentially disappear, impoverishing those groups that had accepted the Treasuries.
The Chinese are very aware of this possibility. As a result they are trading long term Treasuries for shorter term Treasuries, and then trading Treasuries with other governments for real assets (commodities, commodity production contracts, land, etc.)

Evidence That Big Inflation Is Coming

While I agree with the Hamilton conclusions of upcoming major inflation, there are several things I disagree with:
1. Deflation, in common usage refers to decreasing price levels. There is no mechanism implied in the term. It could be due to decreasing demand or decreasing cash available, or perhaps some legislative action. The result is OVERALL dropping in price levels. We may or may not have classically defined "Deflation" at present, but we are awfully close.
2. Money defined as cash in circulation is too narrow a measure. While it is clear that the Federal Reserve has created an awfully large amount of cash, part of that cash has been counteracted b a large decline in "Velocity" or how quickly that money changes hands. Due to declining economic activity, money is not changing hands as quickly, that is reducing the effective amount of money in circulation, partially or even completely counteracting the increase created by the Federal Reserve.

What this implies, of course, is that as economic activity picks up, there will be a double whammy effect on prices, Quite beyond the intent of the Federal Reserve, the amount of money in circulation will increase as economic activity increases, simply due to the effect of velocity.

It is likely that the Federal Reserve, in an attempt to eliminate the excess funds, will begin issuing huge amounts of treasuries, and will be required to pay very high interest rates to bring the money in.

This action will crush the value of corporates and other bonds, and raising interest rates on mortgages to levels not seen since the eighties. That will by itself drop house prices again.