Risk of Inflation is VERY Real

Sometimes things are so obvious as to be hard to see.

That is certainly the case right now with the incredible flood of federal stimulus pouring into the economy – both in terms of fiscal and monetary policy.   But saying it in this way, as it is often done by the chattering media classes, makes the issue unnecessarily opaque and complex.   We agree with Milton Friedman (and not just because of his long Stanford connection) when he describes inflation as “always and everywhere a monetary phenomenon.”

Or, more colloquially, if the feds continue on their money-printing spree, then inflation is INEVITABLE.  So let’s look at the numbers to see how bad it could get, and how fast.

The M0 money supply (currency in circulation) from September to December of 2008, expanded from $905 billion to $1.65 trillion, or a WHOPPING increase of 82%.

Now the argument has been made that the main reason for this is not solely due to the printing of more money by the Fed, but because of the fact that banks, as opposed to actually lending out all of the bailout money poured into them by the Treasury, have simply turned around and bought treasury securities with it.  While this is certainly part of what has happened in the last few months, it by no mean explains away the whole 82% increase.

Rather, with the federal budget deficit predicted to swell to a record $1.2 trillion for fiscal 2009 (ends September 30, 2009), combined with ongoing and systemic large trade deficits, combined with declining federal tax receipts, combined with a strong bipartisan consensus around stimulus-focused fiscal policy, there is only one way that the Fed can keep its book in balance.

By printing more money.  And a lot of it.  As in over 20% on an annualized basis.

While here at Growthink we are absolutely the opposite of “sky is falling” economists, this very real risk of significant inflation should give all investors and entrepreneurs pause and should be incorporated into their investment and strategic plans.

How to hedge against inflation risk?

Three ideas:

1. Let go of the false belief that cash is a safe investment.  Just a few years of double-digit inflation can reduce the purchasing power of your savings by half.

2. Move cash assets to inflation-hedged vehicles.  Equities, both public and private, have historically grown in value at at least the rate of inflation.

3. Be wary of bonds.  Both because of the fundamental dysfunction of the debt markets caused by the huge governmental intervention in these last few months, and because a high inflation environment is always a high nominal interest rate environment (driving down bond prices), don’t be overly seduced by the very high-paying yields on a lot of corporate debt.   It is a LOT riskier than advertised.

As John Wooden would say, “Be quick, but don’t hurry.”  All business and investment planning should be undertaken deliberately of course, but the current environment is a VERY fast moving one.  Greatly avoid the temptation to just “wait out” the storm and take action now with New Year’s business and investment moves.

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