Is Inflation Transitory?

By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. - Sir John Templeton

Is Inflation Transitory?

I wrote an article in February warning that public policy and a convergence of events would likely produce inflation after a forty-year dormancy. It now appears that the question is not if we have inflation but when it will be gone...

I don’t think anyone knows the answer to that question. However, we can identify those whose decisions will ultimately determine the answer. National public policy makers – specifically the Fed and to some extent congress and the executive branch will all play a part determining if inflation is a temporary visitor or makes an unwelcome extended stay... What we know thus far is that the Fed is not concerned. I’d suggest that is reason for your concern...

Since inflation has largely been dormant for the last forty years – I thought I’d provide some suggestions on how to navigate inflation IF it becomes more than just an overnight guest...

Consumers: Inflation actually benefits borrowers - those who have locked in low interest debt. Think mortgages and car loans. Perhaps consumer anticipation of future inflation has been some of the fuel which has caused recent surges in both home and car purchases.

Investors: Stocks, real estate, commodities and precious metals generally gain in value during inflationary times. However, all stocks are not created equal. Stocks which generate cash now as opposed to a promise for cash flows in the future generally do better during inflation (“bird in the hand as opposed to bird in the bush”). That is because you receive the cash returns sooner as opposed to a promise of cash in the distant future when you are unsure about the present value of those cash flows. Generally, stocks with higher immediate cash returns are considered value stocks while stocks with expected cash returns far into the future are classified as growth stocks. So, in general value is preferable to growth during an inflationary environment.

Cryptocurrencies? That remains to be seen... While many of the enthusiasts for crypto suggest that it will function as a hedge against rising prices there is no history of this since Bitcoin and other cryptocurrencies did not exist the last time we dealt with a bout of inflation. I think precious metals are a safer bet.

Cash is not good and bonds with a specified rate of interest for any time frame over a couple years are probably the worst investment during an inflationary period. An exception to bonds doing poorly are very short term bonds and TIPS (Treasury Inflation-Protected Securities) which are indexed to the Consumer Price Index (CPI) and will preserve buying power during an extended bout of inflation.

In general, any cash flow which is indexed to inflation (Social Security, etc) should preserve buying power but annuities and pensions which do not have a COLA (Cost of Living Adjustment) will fare poorly.

While the prospect of inflation may produce angst – the natural response to that angst may be counter-productive. It may be rhetorical – but sitting on a lot of cash is NOT a good plan during inflation. You will lose buying power as your cash will yield less than inflation leaving you with less buying power.

Inflation is largely harmful to the economy and families – but does its most damage to those who have the least amount of assets but still need to buy the necessities to maintain their lifestyle. Since it also produces a high degree of uncertainty, it generally means less projects for businesses which need a high degree of certitude on costs of capital - thus reducing economic output.

The biggest beneficiary of inflation is government. Since they are the largest borrower and much of that government borrowing has been at very low rates in the last couple decades – a bout of inflation will mean paying back government debts with dollars that are worth less. This is called by some “taxation without legislation”.

If you are unsure how to navigate inflation as an investor you should consider engaging an experienced investment advisor to help. A recent national survey indicated that while 90% of the public thought that investment advice was too expensive, 95% of those who actually had an investment advisor felt they were worth the money...