Is Inflation in our Future?

Inflation is always and everywhere a monetary phenomenon. - Milton Friedman

I wrote it - "inflation"...

This is the first time in my 25+ years as an investment advisor that I've written a newsletter or article about the boogeyman of past generations of retirees.

My only memories of inflation are 1970's stagflation and Arab oil embargo - admittedly a very distant but still unpleasant memory of economic challenges for my family. It’s been almost 40 years since inflation was a problem in the United States. That’s long enough that almost none of the people who faced it as either academics, financial advisors, economists or public policy makers are still working. Those that are were both very young then and very old now…

What makes me think inflation could be a potential issue in the coming years? In the last month, polar political opposites Phil Gramm and Clinton’s Secretary of the Treasury Larry Summers have written op-ed pieces about their fear that a confluence of events and policy could generate consumer price inflation as opposed to more benign asset price inflation (inflation of stocks and real estate) that we've had with us for some time.

In addition, a new generation of economists (those who have never faced inflation) are not concerned. They assert that as long as the economy grows faster than the rate of interest charged to finance that growth (yields on treasury bonds), we are better off. While that is true – I believe there are great risks in assuming that government bond interest rates will be lower than growth rates in perpetuity. And my experience is: when you least expect it - expect it.

I acknowledge this discussion may be a little esoteric for many who read this – but the consequences of inflation are not. What will happen if consumer price inflation is stoked or uncontained?

Here’s how the rubber would likely hit the road:

1) Higher interest rates for home purchases and the consequences to home prices.

2) Decimated finances for retirees living on pensions which do not have cost of living adjustments

3) Higher federal taxes to pay for debt service of a ballooning national debt at higher interest rates.

If we experience inflation in our lifetime this is likely the set of circumstances which will produce it. IF we get inflation than protection will come in the form of owning assets which protect against inflation, namely: value stocks, TIPS, precious metals and other commodities. I'm not confident real estate will be a good hedge because much of the current boom in real estate is because of low rates which have made purchases affordable.

I know well enough not to make predictions. While I'm not predicting inflation I do believe this unique set of circumstances and policy is the highest likelihood of producing it in my career. I’m just not confident we can avoid it.