Stocks: An Inflation Shelter

U.S government debt has given rise to much recent talk about future inflation and how to protect against it. Have you noticed how many TV ads there are these days from dealers in gold?

InflationGermany’s experience with hyperinflation in the 1920s suggests that gold is a good hedge against rampant inflation and it may still be despite high prices. There are some costs, of course: If you take possession of gold bars or wafers, you’ll pay for them to be assayed when you want to sell them. Dealers quite naturally try to make sure you don’t substitute gold plated lead. The alternative is for your gold to be held in a depository, for which you pay monthly rent.

What about stocks? What do they do under inflation? Other than those from companies producing consumer goods, they generally rise in value as the assets they represent become more expensive. As with gold or any other commodity, you may not gain purchasing power but you should at least protect the purchasing power you already have. Just be careful to avoid speculation; investments need proper diversification and a managed approach.

Inflation: a natural balance

The more any currency is devalued, the greater will be inflation. That is the natural balance of things. Devalue a dollar by half and it will take two dollars to buy what one used to buy. Those who are in debt will find relief in the fact they will be paying off that debt with devalued dollars. In Germany during hyperinflation, some were borrowing cheap money while they still could from banks that were afraid of the effect of raising interest rates. They used the borrowed money to buy gold and stocks and basically paid back the borrowed money at one cent on the dollar. Meanwhile, the assets they had bought rose in value (but not purchasing power) as inflation rose.

The other side of the coin is what happens if the government tightens, as it eventually must, to reduce the debt burden? When that happens is still uncertain and it is fraught with danger. It could well be that Ben Bernanke’s plan behind Q2 and any other Qs to follow is similar to what German borrowers were doing in the 1920s: pay back the trillions the U.S owes with shrunken dollars. Greece and other countries have shown how angry a population gets when governments cut back on entitlements.

If the government cuts back spending by, say, 25% there would almost automatically be a severe recession if not worse. Cutting spending, as a heavily indebted family might, is not as easy politically or economically as it seems at first glance.

One thing we can be sure of: The market will go up and it will go down again, as it always does, but maybe with more vigor. I am comfortable staying with stocks as long as they are properly managed.

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