Inflation: In Pictures and How to Beat It
Inflation: in pictures and how to beat it; some call it a tax on the poor and middle class because the rich have it figured out and know how to beat it. Today we’re going to show you what inflation looks like in first and then we’ll show you how to hedge it, and even profit from it. Before we get into that let’s round in the definition first.
Inflation Definition
It is the rise in the general level of prices where a unit of currency effectively buys less than it did in prior periods. Often expressed as a percentage, inflation thus indicates a decrease in the purchasing power of a nation’s currency.
Generally speaking inflation is a good thing as it serves to incentivize the consumer to spend their money now instead of saving or hoarding it because the good or item to buy will be more expensive in the future. Most developed nations target a 1-3% annual inflation rate. So year over year you probably won’t feel it, but over a generation you’ll notice it.
How is it Controlled?
The most common method by which governments control inflation is by contracting or expanding the money supply through raising or lowering interest rates. As governments lower interest rates this lowers the cost of borrowing and introduces new money into the economy as consumers or businesses borrow. When loans are paid down you are effectively destroying money and contracting the supply. By slowly raising or lowering rates this balance of 1-3% annual inflation can be controlled.
Monetary Abuse
However because a currency can thus be manipulated there are times when a government will abuse the currency to meet short term objectives. The faith and trust in the currency is exploited to meet immediate needs or fix structural problems as they surface. Take for example the financial collapse of 2008, the 9/11 terrorist attack in 2001, and the most recent economic lockup in 2020 brought on by COVID-19. Without strong fiscal action by governments to artificially stimulate the economies through easy lending, lowering interest rates, and purchasing corporate credit we would be in worse shape today. However these short term justifications have their long term consequences which cannot be avoided – only delayed.
“Paper money eventually returns to its intrinsic value — zero.”
~ Voltaire
Inflation in Pictures
How Do We Beat It?
In short, we need to buy assets that the dollar has difficulty valuing and keeping up against. Some assets like government bonds, money market instruments, corporate credit are super easy to put a dollar value against them. They are dollar denominated, and pay a future stream of payments for a given term. Upon expiry it is expected the borrow will pay the principle in full. In the wording of the bond or credit agreement, there is nothing that stipulates what happens if inflation rises unexpectedly; with the notable of exception of TIPS or Real Return Bonds where the principle and coupon is based on an accepted measurement of inflation like CPI.
Expected vs Unexpected Inflation
We all expect some inflation and in such cases we expect inflation to hover in the 1-3% range each year. In this case the following assets do well and can take advantage of rising money supply:
- Domestic Equities in companies with pricing power
- Real Estate
- Gold
- Land
- Crypto Currencies like Bitcoin with a declining supply of the currency
In the case of hyper or unexpected inflation, things change a bit and we’re trying to get out of cash into any of the following:
- International Stocks priced in their foreign currency
- Domestic stocks that produce a tangible good that has global demand like oil, gold, steel, timber, food, etc.
- Gold and Silver
- Diamonds
- Land
- Crypto Currencies – save them on a hard wallet
- Artwork by a known artist with global appeal
- Foreign Currencies or Bonds of developed nations (GBP, EUR, CAD, USD, JPY)
- Hard goods like food, guns, ammo, tobacco, alcohol
- TIPS or Real Return Bonds
Financial Seismic Plates
Even in a good year more and more currency will be created to keep the 1-3% inflation target in scope. Some crypto currencies, like Bitcoin, are actually designed to be a deflationary currency. Over time, the mining of bitcoins will decrease and become scarcer. As bitcoins become scarcer and if demand for them increases, Bitcoin can be used as a hedge against inflation as the price, guided by price equilibrium is bound to increase. On the flip side, fiat currencies, inflate over time as its monetary supply increases, leading to a decrease in purchasing power. These opposing forces of supply are at odds with each other and act like two financial seismic plates rubbing against each other.
Look at the chart below and focus on the blue line which shows the total amount of coins in circulation.
The above numbers are as of Oct 15, 2020. Go look it up and see what numbers you see today at bitcoinblockhalf.com.
So long as trust, security and demand exist for Bitcoin the future of it is nearly certain as an effective, powerful, valuable, and portable store of value against all fiat currencies.
Keep your eye on it.
“I think it’s important, especially for old guys like me, to understand the crypto world because that’s the world that’s coming into view right now and us real estate and gold guys are being phased out.”
~Robert Kiyosaki Author Rich Dad Poor Dad
Are the Rich Really Getting Richer?
Are the Rich really getting richer or is the dollar just getting weaker? They probably are getting richer, but in real terms its just not as dramatic as we think. Rather the dollar is just getting weaker and losing its ability to measure wealth. Consider in Oct 2000 one share of Berkshire Hathaway traded for $65,900. The equivalent $65,900 investment in gold would get you 236 ounces of gold.
Fast forward 20 years and the investment in gold wins out. Demand has increased and people could be crowding it while they discount BRK-A. Though it is absolutely certain that some of that increase is due to the dollar getting weaker and losing purchasing power.
Inflation Action Plan
Inflation, Death, and Taxes are the only certainties in life; you can’t avoid them, they can only be prepared for. Hedging the risk that inflation brings is quite easy and can actually be used to your advantage and build wealth. Consider the assets we discussed above and adding some to your portfolio. Our standard recommendation is to hold 5% of your portfolio value in Gold. Given the strength of Bitcoin it could also be a good idea to put 1% of your portfolio here. Add it on top of gold, or take away a point from gold, you decide. We don’t need a lot is our point. Given the worst case scenarios of inflation and hyper inflation the value of these will skyrocket and compensate the losses you’ll take in the cash or bonds portion of your portfolio.
Next Steps:
- Like and Share this article
- Subscribe to our Newsletter (Right Pane)
- Read our article Get Rich Keeping it Super Simple – even this strategy includes room for gold; maybe add some Bitcoin too.
- Review our Four Pillars for Investing Success as this gives a solid foundation to stand on.
- Want to read the opposite article? Read our views on cash and why its so important: Cash is King (Always)
