The two most powerful economic policy officials in the U.S. have been singing the same song about inflation for the past 3 months.
“Inflation is not a problem,” they croon.
But their cheery tune sounds off-key for most sensible people.
After all, just look at how prices have gone up over the last 12 months:
- Lumber — up 270%
- Gasoline — up 185%
- Corn — up 85%
- Copper — up 80%
- Soybeans — up 75%
- Sugar — up 60%
- Cotton — up 55%
- Wheat — up 20%
- Coffee — up 15%
You don’t have to be an economist to know that inflation is already skyrocketing all around us.
And it’s not hard to understand WHY either.
Just go back to your grammar school days and recall…
Economics 101 — “Supply and Demand”
The basics are simple. When supply is low and demand is high, prices will rise.
And that’s what’s been happening with almost everything over the last 12 months.
Over the last year, governments around the world tried to prevent the spread of COVID-19 by stopping people from getting together.
This closed up factories, stores, offices, and shops — the very places where goods and services are created and sold. It’s the “Supply” side of the equation.
Then the government gave people money to offset the economic damage caused by these lockdowns.
When people are paid not to work, supply goes down (no one is producing goods) and demand goes up (people have “free money” and decide to spend it).
And with the federal government’s extra unemployment payments, millions of people found that it was more profitable to stay home than go back to work.
This double whammy is one of the chief reasons we’re seeing such high inflation right now.
How bad is it?
Well, you saw the list of price increases above.
Those “symptoms” are obviously bad to any person with a pulse.
But the underlying causes are equally alarming.
The reported unemployment rate remains well over 6%, even though there are plenty of jobs available. Employers across the country report that they can’t find anyone willing to work for them.
At the same time, thanks to the feds, personal income jumped by more than $4 trillion last month, a record 21.1% increase, according to the Bureau of Economic Analysis.
Stimulus money and hefty tax refunds are hitting personal bank accounts like a financial tsunami, and households have never had more money to spend.
So the equation is pretty simple:
Less people working (low supply of goods being produced) + lots of free money (high demand for buying stuff) = inflation goes up.
The Trillion Dollar Question…
The biggest question (with the most significant impact on your life) is, will this trend last?
In other words, is the obvious inflation we’re seeing just temporary, or is it systemic?
Now the powers that be, like Treasury Secretary Janet Yellen and Fed chief Jerome Powell say, “Don’t worry. This is all temporary.”
Maybe it is.
But what if it’s not?
“Don’t worry,” says Powell. “If inflation were to move up in ways that are unwelcome, we have the tools for that, and we will use them.” He means raising interest rates.
Yellen agrees: “I don’t think there’s going to be an inflationary problem. But if there is, the Fed will be counted on to address them.”
So both agree that any such issue with inflation is easily fixed with a hike in interest rates. But both say “That’s not coming any time soon.”
And so in the meantime, the schemers in charge somehow think they can continue to print and spend fake money forever.
Reasonable people understand the party’s gotta end sometime.
Common Sense and Warren Buffett Agree…
Now we don’t have a crystal ball to prove our government officials wrong.
But we do have facts and figures:
The Fed has increased its monetary balance sheet by over $7 trillion so far this century. And $3 trillion of that was added just during the last 14 months.
The National debt is now over $30 trillion, which means less tax money is going toward funding the government, and more is going toward servicing the interest on the debt.
Meanwhile, Congress continues to spend more than they collect in taxes (not even counting the stimulus). And their plans for spending just keep growing.
So common sense tells us that the inflation we’re seeing is not going away anytime soon.
You see, once prices go up, it’s hard for businesses to rein them back in. And when prices do pull back, they usually never come back to “normal.” They are always higher than before — and everyone accepts that as the “new normal.”
Even Warren Buffett agrees. The Berkshire Hathaway chairman and CEO said at the company’s most recent annual shareholder meeting:
“We are seeing very substantial inflation. It’s very interesting. We are raising prices. People are raising prices to us and it’s being accepted.”
So what happens to my personal finances during inflation?
High inflation brings a mixed bag of effects to consumers and investors — both good and bad.
On the good side, if you have any long-term debt, you will likely be able to pay it off more easily. That’s because as inflation increases, wages also must rise so people can buy the staples they need.
But the debt stays the same, and becomes a smaller percentage of income each year.
There are a few exceptions to this rule. Here’s a good article that explains it well.
Other “good” effects of inflation are if you own assets or other types of inflation hedges. More on that in the next section.
The bad effects of inflation are that prices always go up first before wage increases catch up.
So with the same amount of work, your buying power actually goes down. This means many people need to get 2nd jobs or work overtime just to keep up their current lifestyle.
Inflation is also horrible for savers. Anyone who has money in the bank will see its buying power erode over time.
To illustrate, think of an extreme example like the hyperinflation Venezuela has experienced recently.
Imagine you save up $5M over your entire life to retire on. Your mind races with dreams of luxury living.
Then in one year, the price of a loaf of bread goes from $1 to $5,000. Gas goes up. Clothes go up. A cup of coffee now costs $100k.
Suddenly, it costs you $100M a year just to “get by.”
Yes, wages go up too. But your money in the bank is now worthless. Your $5M in life savings is less than what a burger flipper makes in a month.
While that’s an extreme example of hyperinflation, even moderate inflation has a similar effect on eroding savings over time.
Certain investments also do poorly during inflation. Historically, bonds perform horribly. Mutual funds do poorly. And the stock market, in general, has underperformed during inflationary times.
How to hedge against inflation
So how can you protect your money during high inflation?
There are several “inflation hedges” people have successfully used in the past.
How does a hedge work? As inflation rises, the value of the “hedge” also rises, so you don’t suffer the effects of rising costs as much.
Inflation means rising prices, and commodity prices usually rise the most, as it takes a long time to build new capacity to satisfy the demand.
So commodities are always a classic hedge against inflation.
For example, during the height of the hyperinflation in Venezuela, eggs were more valuable than cash, and many people walked around with a dozen eggs to barter for other goods.
This works well on a smaller scale.
The trouble with using commodities as an inflation hedge on a larger scale is that unless you have an oil tanker or a gigantic warehouse, they have to be bought through futures contracts.
That’s too technical for most folks and has its own set of dangers including a price gap that traders call contango.
In practice, contango simply means a long-term investor is constantly buying high and then later selling low, because the market already anticipates inflation and prices that into the futures contracts.
So commodities (like hoarding food or gas or even vodka) only work well to hedge inflation on a small scale.
Stocks With Low Pricing Power
If you invest in the stock market, “Value” companies usually become more valuable in inflationary times.
You see, when prices are rising everywhere with inflation, all companies can increase prices more aggressively, so the difference between a strong company and a weak company becomes blurred on the balance sheet.
That’s why, during times of high inflation, it can pay to look for the exact opposite of what shareholders usually look for in a company.
There is no point in paying a premium for strong companies like Apple or Amazon. That’s why cheap, or “value,” stocks in competitive sectors like telecommunications or cable TV can outperform as inflation rises.
Historically, these kinds of stocks have outperformed during each inflationary period in the U.S. since World War II.
A Small Business
A small business can offer a great hedge against inflation in 2 ways. First, as the cost of doing business rises (higher wages, higher material costs, etc.), you are able to raise your own prices to keep pace with the rising cost of living.
This is exactly what Warren Buffett was talking about in his shareholders’ call (noted above).
The second hedge is the tax lag. When your business sells things, you’re taxed on how much you made when the product or service was sold. But you usually pay the taxes on that months or even up to a year later. When inflation is high, your prices are always going up so you’re making more money, but you’re only paying taxes on how much money you made back then (usually much less).
This tax lag is only a minor hedge unless hyperinflation hits. Then it becomes huge (and actually stokes the inflationary pressure as the government is forced to print more money due to lagging tax receipts).
Overall, the most important factor is that your business needs to cater to the types of goods and services that people value in inflationary times.
Real Assets With Long Duration
Land and property have always been a great store of value in inflationary times.
Even in places where hyperinflation wiped out life savings, people with homes or property were able to live through it and even thrive.
With historically low mortgage rates, homeowners and investors have been taking advantage of this phenomenon, which is one reason the housing market is red hot all throughout the country right now.
So a property purchased with a 30-year fixed interest rate means that the underlying value of the property will go up in inflationary times, while the loan amount stays the same, and becomes easier and easier to pay off as income increases.
This is one reason wealthier individuals usually do much better in inflationary times. They own assets that go up in value, that were often bought with “cheap” debt.
Gold, Silver, and Crypto
Precious metals, especially gold, have been used as an inflation hedge and a store of value for centuries.
The problem is gold itself is just a chunk of metal, that’s all it is.
Its value is what humans put on it, and the demand for gold as a store of value has been diminished in the last year by the “new gold” of cryptocurrency.
And while there are plenty of people who still love gold as a more stable inflation hedge, investors like Warren Buffet have never favored gold.
Buffett’s take on gold is that it has little utility and produces no value.
Here’s what the Oracle of Omaha once said about it:
“Gold gets dug out of the ground. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
A similar argument could be made against cryptocurrency, especially Bitcoin.
The desire to hold both crypto or gold is primarily based on fear and security, the two most basic and powerful human emotions. In a bad economy (fear), we want to hold something that makes us feel secure.
But right now, another powerful emotion is fueling the crypto market, and that’s greed. People have FOMO and don’t want to see everyone else get rich except them.
And then we’ve also seen how quickly and easily the crypto market can swing based on the tweet of a modern-day titan or a knee-jerk ban by a foreign government.
So while precious metals and crypto can certainly act as an inflation hedge, they are still speculative in nature, and there are never any guarantees.
How to get a safe, secure DOUBLE hedge against inflation
So inflation hedges are not as easy as we’d like to think.
The biggest problem we face is finding a “hedge” that protects our money against inflation but also won’t lose horribly if the Fed surprises everyone and jacks up interest rates to kill inflation.
At Wealth Factory, we’ve studied this issue inside and out, and there’s one solution that stands out above the rest.
It’s called Cash Flow Banking. And while it may not sound like keeping money in a “bank” is a wise move during inflation, this special kind of bank is quite different.
In fact, once you set up a Cash Flow Banking system correctly…
- It builds lifelong wealth for you, automatically…
- Keeps your money safe and sound in locked-down security, yet…
- Gives you easy access to cash whenever you want and for whatever you want.
- Grows your money consistently without any loss of principal, and…
- Provides a double hedge against rising inflation so you don’t lose your life savings if the dollar is devalued.
If that sounds like something you’d like to install in your life, Wealth Factory founder and Chief Wealth Architect, Garrett Gunderson, recently held a special webinar that explains exactly how it all works.
You can watch the presentation here:
That’s all for this week.
Build the life you love,
The Builders at Wealth Factory