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Inflation… How Does it Affect My Assets?

So last week, we learned what inflation is, why it exists, and how it really effects you.  

That’s all well and good, I hear you say, but how do we stop inflation from eating away at our savings year after year?

The key here is to look at how different types of items and assets respond to inflation.

First up is cash.   Obviously, as the amount of cash and credit in circulation increases faster than the amount of goods and services it represents, the value of each individual dollar will shrink.   Since pretty much every government in the world runs a deficit, they need to print more credit and cash to cover the overrun, and this isn’t likely to be stopping anytime soon.

So what about things that you buy with cash?  Basically you need to look at each item individually.  Not only do you have to take into account how inflation affects each item, but whether they appreciate or depreciate over time, as well.   Also, does it produce income?  Does that income keep up with inflation over time?

Take a television.  Sure, it’s value is not going to shrink due to inflation, but it is going to shrink based on the fact that every year newer TVs are released with more bells and whistles than the last.  And every TV dies eventually.  Like a car, it loses half it’s value as soon as you leave the store.   So technology is out.

OK, how about stocks?  Well, in theory, a company’s profits are going to grow right along with inflation, but there’s the other major factor that determines a stock’s price.   Picking a good company is only half of the battle.  The other factor that determines how well a stock does is how much money is flowing into or out of the market at any given time.   This is a concept known as price-to-earnings ratio, or P/E.  How many dollars are the smart investors like Warren Buffet or Ray Dalio willing to pay for one dollar of company earnings.  

If that number starts going down because of, say, a economic downturn where people start to withdraw money from the market or the amount of credit (that is used to hold stock) begins to contract, any given stock is going to have a hard time making any headway.  So when we’re in conditions where the money going into the market is increasing, stocks are some of the best investments out there.  When money is heading out, they’re some of the worst.

What about hard assets like gold?  Traditionally, gold has been thought of as a hedge against inflation, but it does not really perform as such.   As you can see from this graph (pay attention to the red line, the inflation adjusted one), the (inflation adjusted) price of gold declined by more than 80% from the height of inflation in 1980 to 2000, yet at no point in that stretch did inflation turn negative.   So what was the big spike in 1980, and the run up to that 1980 high again in the present-day?  Fear.   Back then, it was the fear that inflation would destroy your savings (which was totally legitimate) caused everyone and their dog to pile into gold.  When the inflation started to head back down to normal levels, the fear subsided and people took their money out again.   Today, the fear has been going for a long time.  Will the US be able to pay its debts?  Will the EU collapse?  Will inflation go crazy again?  Will the US housing market continue to sink like a stone?

So if you think that the fear will only increase from here, then you’ve found a home for your money.  But really, wouldn’t you need a nuke for that?   The EU now has a more permananent setup to control the debts of their members, Greece has been declared technically in default, and despite everyone’s worst fears years ago, the market didn’t so much as blink.  

If you don’t know and can’t tell if the fear is increasing, then gold is perhaps something best avoided right now.  But if the economic meltdown rumors start to fire up again, (after the US election is resolved, and still nothing is moving forward, for instance), then it would be time to add a little, to be sold immediately upon any meaningful resolution.


Next week I’ll reveal one of the safest places to beat inflation.  It’s definitely not going to make anyone rich, but at least your assets will be able to retain your value.  (Don’t worry, we’ll be working it up from there.)

One Comment

  1. Cenira says:

    it is a very nice educational article. keep it up for your hard work.

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