Inflation Worries

 I have read several articles recently about ways for people to prepare for and cope with inflation. Some people are getting worried, and they have good reasons. The trillions of dollars manufactured by the government since the start of the epidemic will be spent somewhere. The prices of stocks, some types of real estate, and some other assets look at least a little inflated now. The prices of government bonds are very high, propped up by the fed and producing yields on the ten year bond well below the price inflation rate predicted by the spread between TIPS and ordinary treasuries. The people at the fed have announced they are fine with the CPI going above their former target of two percent per year.

Many writers recommend stocks as protection against inflation, pointing out that over long periods American stocks have produced returns several percentage points above the official rate of inflation. Owning stocks is a good idea, but one should not assume that stocks always will protect against inflation in the short or medium term. In the 1970s when the country had both high price inflation and a bad economy, stocks did not do well and were not good protection against inflation.

 Gold, silver, and some foreign currencies did much better then. It is not certain that they would do so in a future inflationary period. There were political changes in the 1970s and late 1960s involving the way national currencies were valued against each other and the collapse  of price controls on precious metals that boosted them. Still a one ounce gold piece at today’s prices will buy a lot more than it would a hundred years ago, and the value of a silver quarter is still good for a hamburger and a Coke at lots of places. 

The return on cash in the form of T bills and short term CDs has usually matched or come close to matching the rate of price inflation, but that is not true now, and the people at the fed plan to keep it not being true for a good while. Long term bonds can suffer doubly from inflation with the real value of their interest payments and payment at maturity declining over time and their prices declining as long term interest rates (which are harder for the fed to control) rise. TIPS are a partial exception – offering protection against losses due to price inflation as measured by the government though not to declining bond prices due to generally rising interest rates. This second risk is especially important for people investing in bond funds instead of owning bonds directly.

Then there is a simple, fairly surefire way to counter price inflation. One can buy durable things, including real estate, that one wants to have and use for years now and use them over time. Changes in the CPI have no effect on your price for something you have already bought. However, it can be hard to decide what durable things one can be sure of wanting to use over long periods and difficult to store some of them.

Planning for and overcoming inflation is a hard problem. Inflation is a wealth tax imposed by the government on assets in general. Even at two percent or less, it has its effect. At higher rates it can get really rough.

Of course predictions of coming increasing inflation -  just as predictions of coming recessions, booms, market crashes, and so on -  are often wrong, and there are other risks to deal with. As usual diversification is a good idea, but perhaps with more attention to inflation than has been needed in the last few decades.