Inflation

[Nepa]

Where should I be putting my money if I thought the U.S. is headed towards High inflation?

Should I short the market?
Look oversea?
Gold?
Cash?
Bonds?

I don't remember how it was during the '70's

[FishHooks]

Is this purely hypothetical? I hope it is because good luck trying to find when inflation will go though the roof.

[Nepa]

[ QUOTE ]
Is this purely hypothetical? I hope it is because good luck trying to find when inflation will go though the roof.

[/ QUOTE ]

I hope I'm wrong. But it is hard to hide that fact that we are going to get some sort of hit from inflation do to the super fast rising gas prices. Sooner or later it is going to effect the cost of everything.

Short answer: commodities and foreign currency will hold their real value if inflation explodes. Cash will do okay, because money market rates will rise to at least match inflation. Bonds, especially long bonds, will get killed as interest rates rise.

Commodities are difficult to invest in for the retail investor. Yes, you can buy precious metals, but the transaction costs will kill you. Also, if inflation doesn't increase, you probably won't make much money. One possibility is to buy the stock of commodity-producing companies.

Personally I think the best way to hedge against US inflation is investing in foreign companies and secure foreign government bonds. That way you protect your money by having it denominated in other currencies, so if the dollar falls, your investments will rise in dollar terms. Also, your money is invested and gaining interest or dividends while you protect it, instead of just sitting there like a bar of gold would. I would suggest an unhedged international bond fund (I own LSGLX, but there are others). If you invest in foreign equities, you should realize that a falling dollar will often hurt exporting companies. So if you buy, say, Sony, as the dollar falls, they'll make less money selling Playstations to American consumers. This will limit whatever gains you make on the currency change. One way around this is to buy companies which don't serve an export market: utilities. I own KEP and EN, and I'm keeping an eye on UU. In the case of a weak dollar or worldwide recession, I expect these to hold up better than most alternatives. If there isn't any recession or disruption, I'll still get a decent dividend and shot at capital gains.

[CardMinger]

Another option to consider is investing in US Treasury inflation indexed securities. I believe they are called I-bonds or TIPS (Treasury Inflation Protected Securities)

Please correct me im wrong...

Kevin

[FishHooks]

Yea TIPS are a great way to protect againt inflation.

[r3vbr]

hmm how about buying berkshire hathaway?

[r3vbr]

Supermarkets are also good investments i think.
here in brazil during hyperinflation, supermarkets got rich because they recieved a lot of cash and had like a 1 month period to play suppliers, when they do pay them, the money is worth much less.

[chardog]

[ QUOTE ]
[ QUOTE ]
Is this purely hypothetical? I hope it is because good luck trying to find when inflation will go though the roof.

[/ QUOTE ]

I hope I'm wrong. But it is hard to hide that fact that we are going to get some sort of hit from inflation do to the super fast rising gas prices. Sooner or later it is going to effect the cost of everything.

[/ QUOTE ]

I know this is counter intuitive but higher energy prices actually act as a contractionary force in our economy (i.e. just the opposite of inflation). Higher energy costs act as a de-facto tax on consumers as almost everyone buys energy to live their daily lives. That money could have otherwise gone to non-energy goods and services creating greater demand and increased pricing power for them.

Runaway job and wage growth would be a much better indication of higher inflation on the horizon. Companies spend most of their $$ on paying worker's salaries. Watch the montly non-farm payroll report. The latest just came out on Wednesday. 169K new jobs v. 190K expected with an upward revision of 44K on previously reported numbers. Basically almost a perfect report. If you started seeing 300K-400K+ every month then I would be worried about inflation and an over-heated economy.

FYI, the next CPI (consumer price index) report is on September 15.
http://www.bls.gov/cpi/cpireldates2005.htm

Check out the last one (http://www.bls.gov/news.release/cpi.nr0.htm). The important line in the first table is the "All items less food and energy" (aka the CORE CPI rate). You can see as oil prices have spiked in recent months the growth in the core rate has diminished.

[squiffy]

In addition to some of the other answers, real estate tends to keep pace with inflation, long-term, as it is a real asset. As the value of the dollar drops, the owner of property, in theory, can charge more for the land.

[squiffy]

You are correct in the long run. But you are skipping an intellectual step.

High demand for energy in China, U.S., and India due to growing economies causes them to bid up the price of energy. Then natural disasters and terrorism may sharply reduce the available supply of oil, further increasing prices.

These higher energy prices translate to higher inflation in the economy in general, if the price rises last long enough. Period.

Then eventually, as prices rise enough, people change their behavior in response to the prices, in theory, by buying less gas, seeing fewer movies, driving less, buying smaller cars, taking fewer vacations on airplanes, etc.

And yes, in theory, this slows the economy down, which hopefully will eventually cool off prices.

BUt the economy is very complicated and there are political problems at work too.

If you are involved in a huge and expensive war for 20 years, this can keep pushing inflation up for a long long time, and prices won't necessarily drop naturally through reduced consumption. Or Congress can waste tax money building useless bridges in the middle of nowhere that no-one uses, or by increasing welfare payments to people who have 11 children and don't work or pay taxes.

Do you remember inflation in the 70's. Post-Vietnam inflation, oil embargo inflation, aging U.S. factories and low productivity, high union wages and restrictive work rules, etc. Inflation can always rise very high to 15% or more, and stay high for a long time, if the right devilish mix of conditions arises.

[chardog]

[ QUOTE ]
You are correct in the long run. But you are skipping an intellectual step.

High demand for energy in China, U.S., and India due to growing economies causes them to bid up the price of energy. Then natural disasters and terrorism may sharply reduce the available supply of oil, further increasing prices.

These higher energy prices translate to higher inflation in the economy in general, if the price rises last long enough. Period.



[/ QUOTE ]

I am "correct in the long run".. meaning you think I am incorrect in the short run? In the short run we have seen the price of oil more than double and core CPI (not to mention the 10year US treasury yield, a barometer for future inflation) has trended DOWN. How do you explain this? Because the "price rises have not lasted long enough"....?

[wiseheart]

To the person who didnt believe we will
see short term inflation.

The Philips curve. Unemployment is down.
Those familiar with economics see that
this leads to short-term inflation.

[squiffy]

The long term bond market is a barometer for nothing, but the rates buyers are stupid enough to accept. Have you seen the speeches by Greenspan and by various Board Governors.

What happened to banks that loaned out money at 5 or 6% in the 1960s after the inflation of the 1970s. And what happened to bond holders? Was the bond market in the 1960s a barometer for hyperinflation and stagnation in the 1970s? I think not.

If oil prices are high for one day and drop back down, of course they won't affect core inflation. But if energy prices are high enough for long enough, of course they will affect inflation.

What do you think caused the inflation in the 1970s? Low energy prices????

This is a greatwebsite that everyone should check out. Saw it mentioned in the papers the other day.

http://www.federalreserve.gov/boarddocs/speeches/2005/

[squiffy]

First of all, the distinction between CORE inflation and energy prices is an artificial distinction, which I presume is drawn to determine how persistent long term price changes are.

If oil prices jump for one day, that won't necessarily produce price rises that are transferred to other products by businesses with pricing power.

But you cannot ignore the short term effect of higher oil prices on the spending power of Americans and businesses. If you have to spend more money on gas and transportation, you have less money in your budget for food, clothing, entertainment, etc.

Of course, you can also reduce your driving. So it's really a question of what consumers will do less of. In theory, they should buy less because oil prices are higher. If their driving is essential, and their demand for gas is highly inelastic, then they should by about the same amount of gas, pay more for it, and have less left over for other things.

You are saying that INFLATION is NOT causing the economic slowdown. But you are ignoring the INFLATION in oil and energy prices, which are a commodity which Americans purchase.

It is precisely that inflation in prices for a key commodity that is draining Americans' budgets and reducing the volume of gas they can buy, and or reducing the other items they can purchase, thereby slowing economic growth.

You are relying on the ARTIFICIAL distinction between CORE inflation and energy prices to cloud your characterization of the economic cause and effect.

Oil and energy are a key good. For purposes of analyzing economic growth, you need to put energy prices back into the analyis.

If you only use the CORE inflation rate, then you are ignoring energy and oil. If that is the case, there is no way to explain the slowdown in the economy that you are predicting.

If CORE inflation is down and nothing else matters, then people should be buying more and the economy should be growing faster.

[squiffy]

If you predict high inflation, you definitely would not buy bonds, unless they have some sort of escalator or inflation protection.

Generally bonds have a fixed price and long term bonds are at a 40 year low or so. So if you lock in record rates, and war and energy shortages cause the government to fund debt by printing huge amounts of money, that is not supported by actual work or wealth that Americans have generated, then rampant inflation could destroy the value of your bonds.

As another poster mentioned, commodities are one possibility but we need to be careful here.

If you physically owned 1 billion pounds of magic non perishable food, you would be in great shape. The food is inherently valuable, and in theory, you can just keep charging more money for the food, so that your real profit keeps pace with inflation. Or I suppose you could just barter, to take theinflation risk out of it.

But if you buy a company that makes money selling some commodity it's a bit trickier.

It's never been clear to me how well the stock market in general does in inflationary periods. I suppose it depends on the cause of the inflation and the degree of the rise. Mild inflation does not seem to be a problem.

But ultimately high inflation seems to be bad for most stocks and bad for the economy. It seems to slow economic growth and wreak a lot of havoc. And its not always easy for businesses to pass the high prices on to the consumer. And if they do, the consumer should buy less, slowing economic growth. If consumers buy less, business may start laying people off and you can get into a nasty stagflation cycle as in the 1970s.

So in an inflationary period, if you were going to invest in stocks, you would try to choose some product which people will NEED to buy, without regard to the high prices. Food, household items, and health care, to name a few.

I mean people do adjust. If heart operations get too expensive, I guess you could go to a shaman or pray a lot instead, but most people would be reluctant to substitute prayer for a skilled surgeon. So demand for food and health care should be relatively inelastic, and even with price rises, people will pay for those items.

But with everything else, people will just try to buy and spend less, in theory, as prices rise. Eat out less, travel less, fly less, subscribe to fewer magazines and cable channels, buy fewer CDs and DVDs, buy fewer computers, etc.

[FishHooks]

In theory it does, when unemployment is up people dont spend as freely and save more becausethey dont feel economically secure and they value the dollar more. However when unemployment is low people spend much more because they feel much more secure, but this is defiately not a bad thing.

[FishHooks]

[ QUOTE ]


Of course, you can also reduce your driving. So it's really a question of what consumers will do less of. In theory, they should buy less because oil prices are higher. If their driving is essential, and their demand for gas is highly inelastic, then they should by about the same amount of gas, pay more for it, and have less left over for other things.

[/ QUOTE ]

Very good point here. Gas is highly elastic in the long run, but in the short run its usually highly inelastic untill people adjust their behavior. People will defiantly start driving less and conserving more, which will bring the price back down. However the refinery problem is huge and I'm not sure how that will affect us long term, it very well could move the demand curve into a more inelastic state.

[FishHooks]

In theory stock prices should keep price with inflation. People spend more the company makes more (in terms of dollars not purchasing more). Then the company has a big cash flow and they can either give higher divident yeilds or buyback stock. They usualy buyback stock which will normally increase the price of stock and since the company will hold more of the stock it also becomes less volitile. So the stock market should go up. However long periods of inflation will really hurt because the buyers can't keep taking the hits of higher prices.

[squiffy]

In practice many stocks don't do well in times of high inflation. If you have stagflation, higher inflation and higher unemployment, people are not earning enough to pay the higher prices.

Pick one commodity, like energy. Hold everything else constant. Energy prices are rising faster than people's salaries now. So hold money supply and earnings constant.

As gas prices go up, everyone has less left in their budget, after buying gas to buy everything else.

Stock prices, over the long run, depend on profits earned by corporations. If people have less to spend, most corporations will not earn as much profit.

So stock prices should go down.

Only certain companies, selling certain essential high demand products, will keep pace with inflation.

[Sniper]

[ QUOTE ]
As gas prices go up, everyone has less left in their budget, after buying gas to buy everything else.


[/ QUOTE ]

Squiff, maybe I don't drive enough, but how much impact do you really think the higher gas prices have on an individual basis? $30/month?

[squiffy]

Multiplied by 250 million Americans? Trucks, trains, and airplanes use gas.

[Sniper]

[ QUOTE ]
Multiplied by 250 million Americans? Trucks, trains, and airplanes use gas.

[/ QUOTE ]

There is no doubt that the total impact is large, and the impact widespread across many industries.

However, looking at the issue of just paying a little more each month to fill your tank, how much impact do you really think that issue taken in isolation really has?

[squiffy]

That's just it. You cannot separate the two. Impact on Bill Gates may be small. Impact on businesses nationwide is huge. And on middle income or lower income people huge. Depends how much you make.

Electicity costs for this one business have gone up from 5K to 7500 K or so. That's not significant?

http://money.cnn.com/2005/08/31/news/economy/consumers_gas/index.htm

http://www.honoluluadvertiser.com/apps/pbcs.dll/article?AID=/20050904/BUSINESS/509040310/1071

It's kind of like this. I am not serving in Iraq. No brother or sister there. So no impact on me, day to day whatsoever.

But financial impact on our society and psychological impact of deaths huge. Can you really separate the two?

I don't lose any sleep over Iraq on a day to day basis. Does that make my relative indifference valid? It's my reality. But in analyzing the impact on society, my personal experience is almost invalid.

It's one experience out of 250 million experiences that you need to consider.

Everything's connected. http://money.cnn.com/2005/09/02/news/economy/katrina_retailimpact/index.htm

And psychologically, I am thinking twice before taking weekend trips out of town, due to high gas prices.

[laserboy]

Inflation is most often associated with increasing consumer prices. But inflation, in the true monetary sense of the word, is actually the result of increase in money supply or in available credit. When the government starts printing dollars bills at full steam or opening the credit spigots, this reduces the value of a dollar. The side effect of this is increasing consumer prices as excess liquidity in the markets chases up prices.

My personal view is that we have already had massive amount of inflation. This is evident in the exploding prices of such things as real estate, education, energy, healthcare and so forth.

Rising prices as a result of rising commodity prices is not true inflation, as there is no accompanying increase in wages or money supply. The current rise of commodity prices is due to external conditions of supply and demand, not an increase in money supply. In fact, as someone mentioned, absent the wage increases, rising commodity prices is actually net deflationary as consumers will have less money left over to spend on other things. Needless to say, this is a complicated topic.

If you want to profit off the increase in commodity prices, why not just buy commodities? Check out collateralized commodity funds such as PCRDX, QRAYX, or Rogers Raw Materials Fund. These have historically high correlation with "inflation".

http://www.kitco.com/ind/Puplava/jan252005.html

[laserboy]

[ QUOTE ]
Another option to consider is investing in US Treasury inflation indexed securities. I believe they are called I-bonds or TIPS (Treasury Inflation Protected Securities)

Please correct me im wrong...

Kevin

[/ QUOTE ]

The main problem with TIPS is that their return is based off the CPI, which is a highly doctored statistic. The government uses things such as hedonic adjustments or outright manipulation so at the end of the day you have a nice small and steady figure. In my opinion the CPI is basically just another piece of government propaganda designed to keep the proles in the dark about how the government is sticking it to people.

The government tells us that inflation has been steady at 3% a year or whatever, but the fact of the matter is most important expenses such as housing, energy, education and healthcare have been skyrocketing over the past several years. If you had been invested in TIPS for the past five years, saving for a house, your kids college education, or your retirement, you would have gotten completely owned by inflation.

Remember inflation is just another way for the government to steal your money. You would be wise to keep your money in countries whose cnetral banks are fiscally responsible and whose leaders are not financial buffoons.

"By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens... Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose. " - John Maynard Keynes

[FishHooks]

Gas prices are highly elastic in the long run (and are inelastic in the short run)which means they take up a decent part of someone's budget. So when gas prices go up it forces people to conserve, thats why in history when gas prices rise they eventually fall back down because people conserve.

[squiffy]

Yes, but the fed was lowering short term rates substantially due to recession, economic slow down, and fears of possible deflation.

I thought the Fed does this by open market operations, buying and selling treasury bonds and the interbank lending rate.

So didn't the Fed increase the money supply, easing short term credit rates, which produced the housing boom and car selling boom, and triggered lending and economic growth?

The Fed did increase the money supply.

[squiffy]

Fed did start reducing rates during the last recession. They do this by changing the money supply. We have been printing money. But now are increasing rates, decreasing the money supply.

http://www.minneapolisfed.org/pubs/fedgaz/97-04/edi-ajr.cfm?js=0

http://www.federalreserveeducation.org/pfed/##

[laserboy]

That is correct.

The Fed lowered interest rates to historically low levels following the last recession, essentially giving money away at negative real interest rates. This provided a short term boost to the economy and spurred a rise in lending and liquidity.

Like I said, this has driven up the prices of most asset classes over the past several years. The accompanying rise in real estate prices is a good example of true inflation.

That type of "fix" is unsustainable, as it leads to the devaluation of your currency and the erosion of citizen's wealth.

My opinion is that there is a very real possibility of deflation in our future as credit tightens up and systemic problems in our banking system start to surface. I think that many of the credit that has been extended will eventually go bad (real estate is again a good example), essentially sucking out billions of dollars of fake "money" from the asset markets and resulting in a decrease in the money supply. This is similar to what happened in Japan in the 1990's, but I don't want to get into that discussion again. /images/graemlins/smile.gif

I think that rising commodity prices are a separate issue altogether, based on global supplay and demand factors. Prices of goods can rise and fall regardless of monetary inflation. For instance, prices of DVD players and various Walmart goods have "deflated" the past several years due to the effects of Chinese labor.

Prices of some goods will rise and some will fall, but I do believe that we are in a long term secular bull market for many commodities.

[chardog]

I stand corrected. Long term bond yields react in no way to inflation expectations. Furthermore, our productivity today is no better than it was in the 1970's despite any technological advances you may have heard of in the past 30 years. Lastly, per squiffy's examples, I admit that our economy obviously is as dependent on energy prices now as it was before the PC was invented. In fact, I'm thinking about quiting my current employment and looking for a manufacturing job.

And to the original poster, yes, despite a 100%+ rise in oil prices, completely tame inflation, and a cyclical bull market only a few percent off its recovery high... I would recommend moving all of your assets into gold.

See you at S&P 1300 goldbugs...

[Il_Mostro]

I'm not an economist, and most especially not a US one, but I found the following article interesting. Puplava is dissecting the CPI and basically, to his mind, showing that it's just a bogus concept.

The article is long, I'll only paste the introduction below
The Core Rate (http://www.financialsense.com/stormwatch/2005/0624.html)
[ QUOTE ]
A caller into a Washington D.C. talk show asked a very pertinent question regarding the business of living. “Have they changed the way they measure the rate of inflation? The CPI report in May was zero percent, excluding food and energy. If you take those things out, that is what is primarily driving up everything. What would be the real inflation rate, if you add back everything they take out?" The host of the show turned to his guest, a financial reporter from The New York Times. The host of the show and the Times reporter were caught flatfooted. The Times reporter couldn’t answer the question. The host then went on to say, "The inflation rate as it is reported has been quite low over the last few years. Next caller."

The caller to the show reflected the growing disconnect between Main Street, Washington and Wall Street. Each month consumers see their living costs go up—whether at the grocery store, the gas station, or at the end of the month when bills are paid. Personal income has stagnated, failing to keep pace with the rise in the cost of living. In the meantime the media keeps spinning any increase—whether it is booming real estate prices, rising gasoline prices, grocery bills, doctor and dentists bills or movie tickets—as nonevents. Prices keep going up. Wages keep falling further behind. It is a repeat of the staginflationary 70’s taxes and inflation. Inflation is on the rise and so are taxes. Property taxes go up each year, making it difficult for homeowners to hang on. The social security base rises each year making more of a worker's income subject to the tax. States are raising sales tax and auxiliary fees, while some states have raised income tax rates. Like many of the items of the CPI index, rising taxes never get counted.

In effect, what this caller was asking was how and when did they change the way they measure the rate of inflation? On a first hand basis he was experiencing inflation in his personal life with rising food and energy costs. There was a major disconnect between what he experienced in real life on a day-to-day basis and what he was told in published inflation reports. The host of the show and the financial reporter from the Times had no answers.

[/ QUOTE ]

[FishHooks]

You would have to have a ton of assests to make transaction costs worth while. You could always buy more of the funds/stocks you own as part of a dollar cost averaging strategy.

[chardog]

Apparently my sarcasm wasn't thick enough...

[FishHooks]

I didn't read all your previous posts in this thread, maybe thats why I didn't pick up on it....

lol

[Nepa]

[ QUOTE ]
My personal view is that we have already had massive amount of inflation. This is evident in the exploding prices of such things as real estate, education, energy, healthcare and so forth.

[/ QUOTE ]

This is also my thinking. I'm getting killed by Health Care costs. another tread for another forum.

I'm looking to buy a house but I don't want to get stuck buying at the top of the market and college savings is a whole other tread as well.

At least it seems like prices at the pump have topped out for now which should have a limited short term impact on CORE inflation.

[theben]

you can buy bonds indexed to inflation (i.e bonds that always give + real growth)

id mix my assets in a diverse set of stack based mutual funds, bond funds (corporate and definetly muni), some personally held inflation indexed bonds, and some $$ in a money mkt savings for fast access/liquidity

[FishHooks]

[ QUOTE ]
you can buy bonds indexed to inflation (i.e bonds that always give + real growth)



[/ QUOTE ]
Known as TIPS, treasury inflated protected securities.