This is where inflation fears are coming from

The Fed is inflating the money supply to the mother-Blagojeviching moon. I read that last week, but I didn’t get it until I saw this chart From Mish with the vertical trend line at the end:

That’s why people are worried about inflation: the amount of money the Fed has injected into the economy these last few months is unbelievable.

The only reason we don’t have inflation now is that the banks aren’t releasing the money. In small part, that’s because fewer qualified people want to borrow, now that everyone realizes we’re in a serious recession. In larger part, though, it’s because the banks are afraid to loan out the money for fear it won’t be paid back. Too, many banks are essentially insolvent right now, if what Jim Rogers says is true. They’re hoarding the cash for a bailout of themselves rather than others.

For more about the Fed and how it affects the money supply and interest rates, see this earlier post: “The Nov. 13 H.3 bulletin shows that the Fed increased this monetary base by 50 percent over the past 12 months, from $825 billion to $1.236 trillion. Such an increase is unprecedented in U.S. history.” That economist notes that inflation usually occurs between the time the economic recovery begins and the time the Fed is sure the economy has recovered and therefore drains the supply of money down to sane levels.

Inflation occurs when too many dollars chase too few goods. The Fed’s money takes care of the first part (too many dollars). From some of the things I’m reading the recession itself causes there to be too few goods, as companies cut back on production and the capital investment necessary for production. From that CNN article I linked the other day:

Virtually the only asset class I know where the fundamentals are not impaired – in fact, where they are actually improving – is commodities. Farmers cannot get a loan to buy fertilizer right now. Nobody’s going to get a loan to open a zinc or a lead mine. Meanwhile, every day the supply of commodities shrinks more and more. Nobody can invest in productive capacity, even if he wants to. You’re going to see gigantic shortages developing over the next few years. The inventories of food worldwide are already at the lowest levels they’ve been in 50 years. This may turn into the Great Depression II. But if and when we come out of this, commodities are going to lead the way, just as they did in the 1970s when everything was a disaster and commodities went through the roof.

Inflationary investing

So probably some deflation now, followed by inflation during the recovery. During inflationary times you want your money out of things that are in fixed interest, like ordinary bonds and treasuries whose interest rates will be overwhelmed by inflation. Who cares if you’re getting 3% interest if inflation is 8% – you’re losing money the longer you hold the investment.

I’m still getting my head around what to invest in for inflationary times. There are TIPS (Treasury Inflation Protected Securities) that pay a fixed rate plus the official inflation rate. TIPS are extremely cheap right now because people are more worried about deflation than inflation. The next TIPS auction is in January.

Commodities will inflate, but investing in commodities is difficult and risky. In Andrew Tobias’s The Only Investment Guide You’ll Ever Need he says something to the effect of “Ninety percent of professional commodities traders lose money in most years. I submit that is all most people need to know about commodities trading.”

Gold seems like a good investment for uncertain times. (And there’s more uncertainty than just inflation. In my opinion our very banking system could be at risk, FDIC insurance or no.) I picked some up in my 401K the other week at $750 per ounce, though that could turn out to be premature.

Real estate is a good thing to have going into inflationary periods, for two reasons. One, a house has a certain utility attached that fluctuates with the overall economy. As the economy inflates, so do housing prices. Second, inflation diminishes existing debt. My mortgage is at 5.7%. When inflation was 3% my effective interest rate was 5.7 – 3 = 2.7%. But if inflation goes to, for example, 8%, then my effective interest rate is a negative 2.3% – my house would be gaining in value at a faster rate than what I’m paying in mortgage interest.

If inflation is coming there is less incentive to prematurely pay down low, fixed-interest debt like car loans, student loans, or fixed-rate mortgages. Just keep making regular payments and pretty soon you’ll be paying off the old, expensive debt with the new, cheaper dollars. As always, you should still pay off high interest credit card debt.

Bear in mind that inflation won’t happen until the recovery begins, and that isn’t going to happen for a while. Before any recovery can happen we have to hit bottom, and in my opinion we aren’t close to being at bottom yet.

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5 Responses to This is where inflation fears are coming from

  1. Pingback: SayUncle » that’s why it doesn’t grow on trees

  2. TheGunGeek says:

    I would worry about real estate as an inflationary investment this time around simply because so many people will be fearful of what the housing market will do. Even if it stats going up, they’ll be afraid it will just come crashing down and they’ll lose money.

  3. Les Jones says:

    I think you’re right that people will be leery of paying crazy prices in general, but I don’t think inflation will begin until a recovery begins, so it shouldn’t be as much of an issue.

    Also, I don’t mean to say you should run out and buy real estate now as an investment. For one thing, I don’t think prices have hit bottom. But if you have real estate already that was purchased at a sane price and a favorable interest rate, it should appreciate nicely during the inflationary period.

  4. Pingback: What if they had an inflation and nobody came? | Les Jones

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