Keeping a wary eye out for inflation

November 01, 2018

Inflation is dangerous in part because it's dull.

"Inflation is taxation without legislation," said conservative economist Milton Friedman. That's still a bit of a sleeper, so let's go to our backup source of capitalist brilliance, Vladimir Lenin, for a bit more spice: "The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation."

Good ol' Vlad could have used a massage chair from time to time.

Without question, inflation represents one of the largest threats any investor faces. It's not just that it diminishes the real value of savings and investment over time, it's that it does so quietly, year in and year out.

Long term inflation from 1914 to the end of 2017 averaged 3.24% per year, according to the Consumer Price Index published by the Bureau of Labor Statistics. This may not sound significant, but keep in mind that it compounds, which means you lose half of the real value of your money every twenty years.

That's a lot. And inflation may be underreported. Because Social Security payments are pegged to inflation, the government has an incentive to report low inflation numbers to keep budgets in check. And no politician is going to surf high inflation numbers to victory at the polls. John Williams explains more on his site Shadow Stats.

On the other hand, with the national debt nearing $22 trillion on federal revenue just over $3 trillion, and interest rates rising, the government needs inflation to occur. This allows debt to be paid with dollars in the future that are each worth less, effectively decreasing the real returns of bondholders with a numerical sleight of hand.

So far this newsletter is not winning any blue ribbons for optimism. But let's not get crazy and start storing rice and beans in the basement yet, posting on gold forums at 1 AM. Some inflation is good, and likely better than deflation. For example, when I was in college I wouldn't buy a new computer because the PC business was in a deflationary spiral and every few months machines were cheaper. So I would do nothing except wait. The same thing happens on a larger scale if inflation goes negative.

And from an investment level, it can be addressed. Certain asset classes respond well to inflation. For example, imagine if you owned an apartment building and had a fixed debt payment on the building. If inflation rose, you would have the same payments to make on your debt while your sales to tenants would increase, and might do so quickly if that was written into the lease. For this reason, the income component of a REIT would do well.

Dan Cunningham

Sources: U.S. Inflation Calculator, U.S. Debt Clock