Sunday, January 27, 2013

The Dark Inflation Rise

The release of QE1-QE3 has created an enormous pool of money, a large amount of money chasing fewer goods can destroy your purchasing power.  Only growth can slow down inflation as was the case in the 90's when the economy was roaring.  Are U.S. growth rates (-8.9% - 4.1%) for 2008-2012 reported by the Bureau of Economic Analysis enough to stop hyperinflation or stagflation?

Not all the money created is circulating in the U.S. some of it is overseas but when that money comes back home it can trigger an increase on inflation.  Is the U.S. likely to enter a period of stagflation?  The unemployment rate has been slowly decreasing to a current 7.8%, inflation rate is below 2% and earnings season has brought hopes that the global economy may be on the road to recovery.  For now it appears that we are not in any danger.

When inflation picks up it can do so rapidly as it did in the 1970's.  A period of stagflation is bad for stocks as you can see from the inflation chart below during the 1974-75 period of high inflation the Dow Jones dropped from 1050.71 in 1973 to 577.60 in late 1974.  It happened again in 1979-81 the inflation rate was averaging 13% the Dow Jones was trading at 907.74 in 1978 it dropped to 759.13 in 1980. 

Hyperinflation is always a traumatic experience for those who witness their cash value disappear right before their own eyes.  In 1923 Germany experienced serious inflation one U.S. dollar was worth 4 trillion German marks.

How to fight rising inflation, hyperinflation and stagflation:

Commodities are good ways to fight inflation of any kind even if a country's currency is losing value the demand for oil and gold will not disappear, people need to eat as well, farmers will not stop producing.  Gold is a universal currency but for now with the Dow nearing all time highs gold (GCG13.CMX) has dropped in value it appears investors are not as concerned with inflation.

As mentioned earlier stocks are not a good way to hedge during stagflation, stocks are a good way to fight inflation except when inflation is accelerating rapidly and above 5%-6%.  If stocks are bad for short term hedges during hyperinflation then bonds are far worse, long term bonds give investors a fixed income rate and once the inflation rate moves above the interest rate the bond holder receives negative returns.  When interest rates rise bond values drop our interest rates are currently near zero therefore rates can only rise from here on and if we experience high inflation interest rates will rise rapidly. 

Buying a house is a pretty good way to fight inflation real house price changes do not seem to be affected much by inflation over the long term, the return on investment and appreciation has been similar to that of gold.  We just came out of a real estate bubble therefore it may be one of the best ways to fight accelerating inflation now that prices have dropped. 

Although Treasury Inflation-Protected Securities (TIPS) are a good way to fight inflation as an investor it may be difficult to want to buy them unless you are sure inflation will be a problem.  It is like buying car insurance before having a car.  It is impossible to predict exactly when inflation will begin to accelerate but when it does it may be too late to start preparing if it gets out of hand. 

U.S. Historical Inflation Rates 1970-1982


 Dow Jones Industrial Average 1970-79 (

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