Don’t Get Killed by Inflation – Larry’s Ten Secrets
Inflation is going crazy – it’s now running at 8% a year, the highest rate in 40 years. The risk that inflation will remain high or go even higher is real. Ironically, the likelihood of inflation rising more than expected in the near term is actually increased by Federal Reserve Chairman Jerome Powell’s continued commitment to limit long-term price increases to around 2%. Regardless of the factors causing inflation, virtually everyone needs financial coverage. In the following, I offer you my top 10 Money Magic tricks to prevent inflation from ruining your finances.
Forget what Fed Chairman Jerome Powell and other hopeful, if not just wishful, inflation thinkers are saying. Forget that the market thinks inflation will slow dramatically almost overnight. Know that inflation is now 8% per year – the highest rate recorded in 40 years! Be aware that inflation has worsened, month after month, since last January, when its annual increase was only 1.4%. Be aware that inflation is widespread – last month more than half of American products saw their prices rise, measured at an annual rate, above 5%. Realize that the prices of the things we buy – the consumer price index (CPI) – reflect the cost of inputs – the producer price index (PPI), albeit with a lag. And the PPI is up 9.7% over the past year, which means core inflation is likely even higher than we think. And, most importantly, realize that we now have not only major inflation, but major inflation risk. Therefore, whatever inflation is likely, we all need to hedge against what it might actually be.
Why inflation on a tear?
Lots of reasons. Bottlenecks in the supply chain, less competition thanks to COVID-related business bankruptcies, the rising cost of energy, a labor shortage due to and a government that wins money by making money, that is, by printing it. Given the long-term insolvency of Uncle Sam – the deplorable, bipartisan, post-war achievement of our government, the prospect of much higher inflation abounds. President Powell can proclaim inflation expectations to his heart’s content. But it cannot control the prices set by the approximately 8 million businesses in our country. If they believe inflation is on the rise and they need to hedge against higher-than-expected inflation when they periodically raise prices, inflation can rush to the races.
If only everyone’s wages, profits, assets, debts, taxes and benefits would immediately adjust to current inflation. Then our real economy (corrected for inflation) would be inflation proof. This is hardly the case. Indeed, if you read the projected path of future inflation from the difference between nominal and real (inflation-protected) Treasury and bond yields, the market believes President Powell’s view that which inflation is very short term. But there is a certain economic irony here. To the extent that the Fed can credibly reduce inflation over the long term, it will likely exacerbate current inflation.
The reason for this is the price-level tax theory, discussed in Stanford economist John Cochran’s terrific new book with that title. John points out that since our tax system is not fully indexed to inflation, inflation, even when expected, increases the government’s real revenues. Therefore, as the Fed controls long-term inflation, it worsens the government’s long-term fiscal position. In the absence of Congressional response by raising taxes over time, there is only one release value – the rise in current prices, which reduces the real value of the outstanding nominal debt. of the government. (The immediate increase in prices reflects increased household spending in response to a decline in the perceived future fiscal burden.) Therefore, the less we worry about future inflation, the more we should worry about inflation current.
How much should we care about inflation. In many cases, a ton!
Let’s say you’re a middle-aged, middle-class couple with $100,000 in a money market fund. Last year’s inflation cost you $7,500 in purchasing power. Your burning question is how do you avoid losing another $7,500 this year? Here are ten answers.
1. To buy up to $10,000 in Treasury bonds for each member of your household. I-Bond interest rates are set by the government and generally exceed the market yield. They earn a fixed return (currently zero) plus a return fixed semi-annually based on inflation. The rate based on inflation is 7.22% until April. You can, but you don’t have to hold an I-bond for 30 years. You pay no federal tax on accrued interest until the bond is redeemed. In addition, the payment is exempt from state and local taxes. Best of all, if you use the redemption proceeds to pay for qualifying college expenses, you won’t be taxed!
2. Buy TIPS – Treasury Inflation Protected Securities. Principal and coupon payments are adjusted monthly for inflation. Today, you can invest in 30-year TIPS and earn a negative annual real return of 14 basis points (minus 14% of 1%). This means that $1,000 invested today will provide $959 in purchasing power after 30 years. It’s pretty awful. But if you’ve maxed out I-bonds and just want to preserve your true principal, long-term TIPS are a way to go. That said, the inflation component of the TIPS return is subject to taxation. With inflation high enough, a “safe” TIPS investment could mean paying much higher than expected taxes to Uncle Sam.
3. Borrow money against your home and use the proceeds to purchase TIPS of equal maturity. The FHA mortgage rate is now 4.23%. Suppose you borrow $300,000 for 30 years, use the proceeds to buy TIPS, and inflation is surprisingly high, averaging 6%. Your TIPS coupon and principal repayments will adjust for inflation each year. Thus their return will be isolated. But you will be able to pay off your mortgage in watered down dollars. All in all, you will earn over $60,000 in present value.
4. Buy real assets whose values will hold even with inflation. These can include houses, home improvements, land, rental real estate, cars, furniture, art, jewelry, gold and other precious metals, REITs (Investment Trusts real estate) and, yes, some bitcoin.
5. Hedge higher future inflation by buying stocks, like IVOL, that make money when the yield curve slopes up, which would cause higher future inflation.. In general, there are put options available that make money if interest rates for particular maturities rise. Therefore, if you think inflation could be higher than expected in the long term and put you at significant risk, you can buy securities that are designed to perform well when interest rates rise.
6. Buy shares of companies, like Microsoft
7. Spend more time comparison shopping. When inflation is high, the prices of the same products generally become more diffuse. Online services, like MoneyWise, can search for better deals, including finding you discount coupons.
8. Consider buying long-term Canadian inflation-linked bonds. These bonds yield about 1% real. That’s more than 100 basis points higher than comparable US TIPS. In addition, the Canadian dollar is historically rather low. And Canada is not dealing with our crippling long-term financial problems. That said, not all brokers trade Canadian bonds and you may need to take the foreign tax credit to cover Canadian taxes on your Canadian bond return.
9. Iinvest in commodities, including oil and gas companies, grains and metals. These are traditional inflation hedges.
ten. Invest in yourself. As I wrote, I generally hate student loans. But the federal undergraduate student loan rate is now 3.73%. If inflation remains high, you will end up paying a very high negative real return. In other words, Uncle Sam will end up heavily subsidizing your education.
Inflation has been remarkably low over the past few decades. Therefore, the track record of assets that hedge inflation will look worse as a result. The same goes for the return on your home insurance policy. If you suffered no loss, the police did not pay. But that’s the good news, because insurance policies pay off in the bad times, not the good times. If an insurance policy does not pay out, it means you have been spared a loss. Similarly, assets that hedge inflation are valuable not because of their average performance, but because they perform well when inflation is abnormally high. And if you’re significantly exposed to inflation, it’s worth considering getting inflation insurance in one or more of the ways listed above.