Inflation Protection | Wealth Management

What is inflation? How does inflation affect you? What can you do to protect yourself from inflation?

Inflation in the financial realm generally refers to increasing prices of goods and services. There can be several ways in which inflation appears. One obvious sign is that what you bought last week or month is now more expensive. Or what you buy now for the same price is smaller, or lower quality.

Either way there is a sense that your purchasing power has been reduced. It takes more currency to buy the same thing or you get less for what you used to be able to afford. “Things cost more.”

There are circumstances when prices increase due to supply and demand. If something is in high demand then usually the price is high or increasing as people are willing to pay whatever it costs to obtain it. Likewise if the supply is low then whatever inventory is available is soon snapped up. Examples of this vary widely and frequently. For example there can be a high demand and low supply of cabbage patch dolls or Wii consoles, or iPhones, ammunition, medical masks, red roses and many such items due to seasonal shopping, public panic, or pent up demand.

High prices can also be an instance of a protected or proprietary market. High prices in itself is not necessarily due to inflation. Once a market reveals high demand competitors rush similar items into production and can offer more or a cheaper comparable. This is seen as a temporary or seasonal pricing that usually disappears within months as soon as production increases or more providers arise.

Aside from trendy products there can be increasing pricing of goods and services that are expanding in demand faster than can be provided by production. An example of this was the housing market in the 90’s and 00’s.

Increasing prices can also be related to added features and performance such as automobiles. As more safety and comfort and luxury features are added, the cost of production keeps rising. But most long-term price increases can be a symptom of an uncompetitive marketplace and one that is suffering from interference by regulation and controls. Regulation prevents free choices, alternatives, and market price signals. Production of an inexpensive car is limited by mandatory compliance to 5mph bumpers, minimum fuel consumption, emissions levels, freon-less air-con etc.

One aspect of healthcare that keeps raising the price of treatment is that techniques for diagnostics and procedures are becoming more sophisticated and more expensive to perform compared to several decades ago. Another aspect is that enforced regulations prevent cheaper alternatives from appearing. It is difficult or impossible to purchase health insurance plans from another state. It is government mandate that insurance plans include maternity coverage and breast exams even if the customer is male.

The source of inflation that is least talked about and most misunderstood is monetary devaluation. Prices increase when the buying power of people’s currency gets lower. Or in other words the value of your earned dollars keeps dropping as people lose confidence in the currency being a store of value. A wage packet of paper dollar bills, or a digital mark of numbers in a bank account, becomes a hot potato to be rid of before it buys less and less in the days or weeks ahead. Instead of saving these dollars for future use it becomes more desirable to spend them for items that can be bought now instead of later at a higher price.

This is the real scourge of inflation and there is really only one cause of it: there is an excessive supply of money chasing goods and services. The supply of this excessive money can be from government funded credit or lending programs, government spending, or government printing more paper money than is supported by production.

Monetary inflation is insidious in that it is slow to manifest, is incrementally small at first, and is hidden by accompanying wage income increases. Mainly, the effect is that the numbers just keep getting bigger. What used to cost one dollar soon becomes ten; ten becomes 100 and 100 goes to 1000. As the numbers increment geometrically and then exponentially, increasing prices escalate to hyper-inflation. As soon as people realize debasement manifests as rising prices, they quickly pass on the increasingly worthless money. The velocity of money transactions increases rapidly such that there becomes a ‘shortage’ of available cash. The government becomes unable to physically supply banks with enough cash to meet demand and begins to print higher denomination notes until the paper itself is worth more than the face value. This was experienced in the Weimar Republic and in Zimbabwe where paper currency lost value so fast there were barrel loads of money being used to buy a loaf of bread, and yesterday’s one million banknote is replaced by a 100 million banknote. Eventually the paper is better used to burn for heating than to buy fuel.

In a different but similar way many countries have simply just moved the decimal place. France made the old franc one hundredth of the new franc. Debasement of the currency discourages saving and promotes spending while at the same time increases tax revenue, allowing government to ‘inflate’ the economy quickly and temporarily at the same time reducing the value of debt obligations, which can be paid back in less value. The effect is temporary because the actual cost will not be felt by most people until years later. Then instigators deceit is postponed when consequences often fall on a different administration that will have to deal with it. Meanwhile asset values may not keep up and savings are decimated, while the cost of living sky-rockets. At the same time debt becomes cheaper to pay off, which can be to the loss of the creditor or bond holder. The battle is always between the savers and the debtors.

Once confidence is lost in the currency as a store of value people look for alternatives. The usual examples are land, real estate, equities, commodities, collectibles and precious metals.

Placing savings in land has been a time proven method of retaining value, based on the often quoted phrase “it is not being made anymore”. However, usable land has increased as fast as necessary when heavy machinery sculpts mountains into build-able lots.

Real estate has also been a store of value. Improved land with houses, and commercial buildings have often gone up in numerical terms, while barely maintaining purchasing power after taxes and repairs. Technology, transportation and energy make once undesirable areas viable for dwellings, and taller buildings make higher density possible.

While land and real estate have some advantages their carrying costs can be substantial. Land taxes and property insurance and maintenance eat away at asset value. Liquidity is low and these assets may not be sold quickly or easily when desired.

Equities, or stocks, have the benefit of high liquidity if they can be bought and sold on a stock exchange. This is not always the case if a company stock is obscure or loses favor but good quality shares can be a safe haven of value when currency inflation occurs. However there is no floor to the value of share prices. They can fall to zero if the company goes out of business and company assets do not cover liabilities. Manipulation of company asset value and share trading can obscure true value.

Commodities are the materials from which other goods are made. They are typically in steady demand by the factories and industries that manufacture the products that turn up in the grocery shelves, department stores, showrooms and warehouses. Everyday many tons of sugar, corn, pork bellies, wheat, oil, minerals move from farms and mines to be sliced and diced, ground, blended and fabricated into the vast variety of items we get to consume and enjoy everyday.

Because the supply is not unlimited and the sources are vulnerable to weather, politics, and shipping, prices of commodities can fluctuate widely from season to season and day to day. But the demand is often more predictable due to known population numbers and factory throughput. Oil is the obvious commodity that bounces around in value in less predictable ways because of political interference even as demand is steady. As grain is politically redirected from food making to fuel making there is likely going to be an increase in the cost of basic items like bread and cereal.

Trading in commodities is a well-established market but not for the uninitiated. Understanding stock market trading is one thing but buying and selling commodities is a different world. You can buy 100 shares of Google and ignore it but you can’t just buy a 10 tons of sugar and ignore that or in 3 months you’ll have a truck arriving at your doorway! Unless of course you want to make a lot of candy. Investing in commodities requires a more hands on approach and constant analysis of trends and current events.

One asset that acts differently than all the commodities and other assets mentioned above is gold. Unique features of the metal element make it perfect and time-tested for many attributes required of inflation and deflation protection. It is rare, dense, easily transportable and tested for quality. The supply is limited and stable and it is also relatively useless. Although there is a small manufacturing sector consuming gold for electronics most gold is used for jewelry and as a store of wealth. It cannot be reproduced or diluted undetectably. For 5000 years gold has been used and respected as a reliable measure of value.

New mining is barely going to affect the 160,000 tonne that exists now. Purchasing power of an ounce of gold has barely changed since it became money. The same weight buys about 350 loaves of bread now as 2000 years ago; a tailored suit now or a senator’s toga in Roman days. In shorter time periods it has behaved with more variation if measured against fiat paper currency. During the growth of the last century gold stayed stagnant while productivity gains from technology allowed business value to grow rapidly. During the US administration under Carter’s inflation, gold maintained purchasing power while dollar prices skyrocketed 1500%. During the deflation of the Depression gold grew 1700% in purchasing value. While fiat money is easy and tempting to manipulate in quantity and value, gold cannot.

Paper based digital currency can be created infinitely at will, lent and borrowed without collateral, debased and defaulted with impunity. Although currency is useful and convenient as a unit of account and a means of transaction, it is not a store of value over the long term. What value will your savings and fiat investments have in 10, 20 or 30 years, or to your beneficiaries? What would you like in your hand today if ninety years ago you could have chosen a one ounce gold US eagle coin or a twenty dollar bill, a quarter ounce British sovereign or one pound note? What would each buy today?

As we enter a new era of human civilization, rapidly expanding population, lobbying for limited resources and manipulated by power hungry politicians spending the future for present day expediency, now is the time to take stock of our assets and be positioned for our own financial self-responsibility.

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