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My First Ever Investment Advice

March 30, 2009, 10:51 am

I don't generally give investment advice, because I am not really qualified to do so and I make enough mistakes with my own investments that it seems silly to give other people advice.

But these are extraordinary times, and I do want to pass on one general piece of advice: Be ready for inflation.  If you are under forty, you probably don't even remember any real inflation, so you may need to seek advice as to how to handle it.

I just do not see how there is going to be any way to avoid a substantial uptick in inflation over the next couple of years. Crazy-large deficit spending, huge inflation of the money supply, absurdly low interest rates, massive government money-printing efforts, and government-mandated tilts in the balance of power between labor and management towards the unions can only add up to inflation,

Now, if we were really in the next Great Depression, as the Obama administration tried to tell us in its early weeks (mainly in order to pass pet legislation in a mood of total panic), then we might not see much immediate inflationary pressure. But I think most of us are realizing that the whole depression thing was over-sold. We are likely already on the first steps towards a recovery (if the Administration does not keep doing stupid stuff to kill it) and this recovery will become obvious by the third quarter (for their budget, the Obama administration is forecasting this now to be a milder-than-average recession). When the recovery starts, inflation is going to slam home hard and fast.

The smart money already knows this. That is why the government (as is the UK government) is having a hard time finding takers for long-term government bonds fixed at 4 or 5 percent. Such low rates could easily be under water after inflation.

So, find ways to hedge inflation.  Here are some general ideas:

  • If you need to borrow money, now is a great time if you can borrow long and fixed (as with 30-year mortgages).  With high inflation, the amount you owe effectively goes down every year.  Borrowers love inflation!
  • Avoid buying long-term bonds at fixed rates like the plague.  Again, you want to be issuing such bonds, not buying them.
  • Consider various US government inflation-adjusted bonds, or shorter maturities on traditional bonds
  • Equities tend to be a good inflation hedge.  Revenues and earnings go up with inflation, so equity prices and dividends tend to as well.  There will be, though, certain industries and companies that will not manage well in this environment.
  • Gold is OK, but I have always thought of gold as dead value.  Sure, it can hedge inflation, but it gives no real return.  Commodity producer stocks (e.g. oil companies) may be a better bet.
  • International stocks are really dicey in this kind of environment.  Added to the underlying risk of investing in less developed markets is the currency question, which basically boils down to -- we know the US is screwing up its currency, but will other countries screw theirs up worse?  If you think there is a country out there who is less likely to inflate their currency, by all means consider equities and bonds denominated in that currency.  You get the underlying return plus an exchange rate boost   (all things being equal, if the US has a lot of inflation and others don't, the value of the dollar will fall.  Thus investment returns in, say, Euros will return more dollars in the future.)

These are just some ideas, and I am not positive they are all good ones.  Talk to someone more knowledgeable than me, but whatever you do, I think you need to be planning for inflation.

Tags: ,
Category: Economics
  • Doug

    Here's my inflation story. I was all prepared to remodel my house (all by myself) at the beginning of 1980. I had the plans approved, so all I needed was the money to begin the work. However, interest rates were skyrocketing, and I watched as home loan rates went up to 14%, 15%, 18%, 20%, (in some cases, overnight), and finally were cut off completely. This lasted for a good 45 days, after which loans were again made available, but with far stricter requirements.

    I finally applied for, and was granted, a loan with a 15.75% interest rate and a loan-to-value ratio of 25%. I was able to start, but the paltry LTV severely limited the materials I could buy. For instance, I had to buy just about the crappiest windows out there, which later came back to haunt me because of their extremely poor energy efficiency (hello Greenies!!!!).

    At this same time, my (then) wife and I were trying to protect our feeble assets as well. We bought a $10k T-bill through my credit union with a 12% interest rate. We were mad that we bought it because about 2 months later, when we could have gotten 14%.

    That's the sort of hope and change that is in our futures again, BHO supporters. I hope you like the bitter medicine you have heaped on all of us. You're next.

  • http://www.tinyvital.com/blog John Moore.

    I have been considering TIPS (US Gov inflation adjusted bonds). One gotcha is that they throw off taxes annually as their base value is adjusted for inflation. Thus I think they are best in a tax sheltered retirement account (SIP, IRA, 401k).

    Gold was a great investment in the early '70s but has not been that great since. It is now just a little higher than it was in 1980. I also consider it "dead."

    Rental real estate, if the cash flow is right, makes big money on inflation. The mortgage is paid by the rent ( + tax deductions for depreciation ) and the mortgage leverage means the rate of return greatly outpaces inflation (all other things equal, of course). However, one has to beware of the tax trap if you don't manage it yourself. This trap, enacted in 1986, was a major contributing factor to the S&L collapse, as it removed the tax deductions for non-manager owners, effectively dropping the value of commercial real estate 30% overnight.

    Always beware the gov changing the rules!

  • http://vox-nova.com Blackadder

    Maybe you should just buy some 100 Billion Zimbabwe notes on ebay. They might hold their value better than the American dollar.

  • http://www.opinionatedraconteur.com Dave

    International equity exposure can be gained via ETFs traded on US exchanges, if one wants international exposure without either buying actual foreign-domiciled shares or ADRs.

    (None of this should be construed as advice on my part to actually by ETFs. Consider this informational.)

  • Max

    I think holding stock in European Euros and US Dollar grants very much the security one wants. Unlike the Feds, the EZB hasn't turned to printing more money (largely because it is in the center of political parties from 24 different nations, so I think it is a bit the Rousseauian cancellation of particular interests, the US has no such system of checks and balances for their printing presses anymore).

    If both governments turn to inflation, then there really is not much (currency-wise) you can turn to mitigate the effect.

  • Pieter

    First, I think you raise a very real and serious possibility. Throw in the FDIC (yes, FDIC) loan-guarantees under the latest bail-out/ PPIP program, and, if the economy doesn't recover, then the currently worthless assets will remain worthless and we'll have to pay an extra $500B to reimburse people that bought the worthless assets.

    Second, among the factors you list is shifting the balance back to unions from management. Putting money in the hands of ordinary people, instead of the ultra-rich capitalists, will be a big boost to the economy. The reason we're in this mess is that large wealth polarization had put too much money in the hands of the wealthy, who had little to do without, so they dumped it into housing and the stock market, driving prices beyond what was reasonable. It's the same situation as occurred in the run up to the great depression. Moving wealth and income to ordinary people will produce a more stable economy, with people spending on more useful things for the general economy, like putting better windows in their homes, fixing their cars, and, yes Coyote, taking vacations.

    Thirdly, the state is providing all this inflationary stimulus because the specter of the Japanese deflationary spiral, and the 10-years of recession or near recession, is truly frightening. The Japanese stock market is still at a quarter of where it was in 1989. Unfortunately, with the deregulation of the last 20-30 years, there are so few tools available that only extreme measures are available. It's like trying to drive a car with only a rocket engine and an anchor. In its effort to prevent deflation, the government is running a very serious risk of high inflation.

    Fourth, as for the economy getting better in the next year, a major problem is that this has been a finance-led recession, so that although the banking crisis of the last year had little immediate impact on the broader unemployment rate, that's now increasing. More troublingly, if you're correct and the stock market, and perhaps even GDP, start to recover later this year, unemployment will continue to rise, since unemployment typically lags other economic measures. In that case, expect to see the capitalists start crowing about the need for self-reliance and not hand-outs. Once the capitalists have managed to grab the money for their bail-out, expect them to conveniently rediscover fiscal discipline to prevent help for others in trouble.

  • Shenpen

    "If you think there is a country out there who is less likely to inflate their currency" - Swiss Francs, as always.

  • stan

    "among the factors you list is shifting the balance back to unions from management. Putting money in the hands of ordinary people, instead of the ultra-rich capitalists, will be a big boost to the economy. The reason we’re in this mess is that large wealth polarization had put too much money in the hands of the wealthy, who had little to do without, so they dumped it into housing and the stock market, driving prices beyond what was reasonable. It’s the same situation as occurred in the run up to the great depression. Moving wealth and income to ordinary people will produce a more stable economy"

    ??!!

    Hmmmm. That's certainly a "different" way to look at what happened.

  • tomw

    Please correct me if this is bogus. Seems to me that the thing to invest in today, if super inflation is expected, is commodities futures. Corn, wheat, pork bellies, and soy beans. Their current prices in dollars per unit, with delivery at some future date, increased by inflation should make them a viable conduit to maintain value while keeping some semblance of control over the investment.
    What am I missing? There must be some detail that makes this apparent 'hedge' ineffective, no?

    tom

  • DrTorch

    TomW,

    Commodities can be a hedge, but they are extremely risky. First, there is inherent risk on the production side of things. Second, when inflation kicks in is still a bit of a question. Not all of the stimulus money has made it into the system, and there are delays on some other fronts too. This means that current commodities buys may not be timed to be effective hedges.

    Do your own due diligence, those are just my thoughts. I appreciate John Moore's comments, b/c I am personally investigating rental real estate. That's the easiest thing for my brain to understand.

  • Peter

    In preparing for inflation for those without a lot of money there are a couple of things you can do. First as coyote recommends lock in all your long term debts at low interest rates. Second move what little savings you have into short term investments like 3 months cd's (no they wont keep up with inflation but will soften the blow). Finally when the inflation hits spend all available cash while it still has value (be careful not to generate new debt!). Of course you should start your spending with paying off variable interest rate debts. Spending could then move on to necessities like the dental work you've been putting off. The dentist hurts less when you find out that work you just paid $500 for last week now costs over $1000. Of course if things get really bad don't wait too long to buy that wheelbarrow to haul all of those dollars down to the local grocery store for some bread and milk.
    Now when you think inflation has hit its peak you can take what cash you have left and put it into long term cd's. My parents bought 10 year CD's in 1979 paying over 10%. Might not have seemed good at the time but by 1989 they were looking pretty good.