Inflation, Hyperinflation, Stagflation & Deflation
The government and Federal Reserve like to pretend that inflation is near zero, but unless you live in a cave, you have probably noticed that inflation is very much alive and well.
You can see it every day in rising prices for food, health care, energy and just about every other segment.
Many economists, politicians and central bankers will try to claim that inflation is good, as long as it is kept in check. The reason they claim it is good is because inflation is used to transfer wealth from savers to borrowers, which often includes the proponents of inflation.
What they won’t tell you is that inflation cannot be kept in check and it is unhealthy for any economy.
Many remember President Jimmy Carter when inflation was raging in the late 1970s and peaked near 15% in the early 80s. President Carter may not have understood how to stop inflation, but he did understand the impact:
“Inflation is the cruelest form of tax, since it effects the elderly and poor more than anyone”
Stopping inflation isn’t complex. As economist Milton Freedman said, stopping inflation is as easy as “flipping the switch on the printing press.”
What Exactly is Inflation?
Inflation is not actually rising prices. Rising prices are the symptom of inflation.
Inflation is an increase in the supply of currency in circulation. It is often referred to as “money printing,” because until recently inflation was created by printing paper money.
Today almost all inflation in countries like the United States is created electronically. New dollars are created simply by entering a few key strokes at the Federal Reserve. But whether made on a printing press or in a computer, the effect is still the same.
So when we say “money printing” we are really including all forms of inflation, especially electronic dollars created by the trillions out of thin air.
As more money enters the financial system, each dollar decreases in value. It is no different than counterfeiting, except in this case only the government and banks are allowed to do it.
If the supply of money doubles, eventually people will figure this out and prices will double. It takes some time, but it always happens and eventually the currency depreciates to its true market value.
Inflation and Debt
Inflation and debt go hand in hand. When politicians spend too much (often using spending programs as bribes to get votes) they create deficits and debt.
As the debt increases there reaches a point where tax revenues are not enough to pay the debt as it becomes due. Inflation is then escalated by printing more currency, which the government borrows to pay the debt that is due.
It does not take a Harvard financial analyst to figure out that paying debts with more borrowed money is a really bad idea.
Because most politicians are too weak to do the right thing, they continue to spend more to satisfy more voters. They don’t dare cut the spending significantly, because those receiving the benefits would revolt (or at least vote them out of office).
This vicious cycle feeds on itself until it eventually spirals out of control. When that happens, the result is usually hyperinflation.
Hyperinflation is when the rate of currency inflation and price inflation accelerates out of control (control of inflation is really an illusion anyway). This results in double digit or even much higher increases month by month.
The highest recorded hyperinflation rates have nearly exceeded the ability to even name the number. The German Weimar Republic in 1923, Hungary in 1946 and Zimbabwe in 2008 had hyperinflation rates so high that prices doubled by the hour.
Hungarians experienced the worst hyperinflation on record with a rate that peaked at nearly 42 quintillion percent per month in mid-1946! Here’s what the number looked like: 41,900,000,000,000,000%.
In Zimbabwe in 2008, ATM computers were malfunctioning due to the extreme number of zeros in each transaction (a fault called arithmetic overflow).
The result of hyperinflation, which has happened frequently in the past century, is to wipe out the savings of anyone holding the inflated currency or other paper assets like life insurance, stocks or bonds. People that are unprepared are often left in financial ruin in a matter of months or even weeks.
If hyperinflation can be that bad with printed paper currency, imagine how quickly it can get out of control with electronic currency. No one really knows how bad inflation will get in the United States, but there is no doubt that it will get much worse before things get back to a normal, free market society.
In other words, government spending and money printing has gone well beyond the point where there are still “comfy” solutions left on the table.
Stagflation is simply inflation in a stagnant economy. You may remember the late 1970s and early 80s when the term stagflation was coined (no pun intended).
At the time economists of the Keynesian variety were dumbfounded that inflation left the economy in a slump while prices kept rising. Increasing government spending wasn’t working to “stimulate” the economy. The annual inflation rate hit 15% in the mid-80s before the Fed clamped down on dollar printing to finally reign it in.
This was back when deficits and the national debt were still measured in billions rather than trillions.
While no one seems to be talking about it today, we have similar conditions as those in the late 70s. The real inflation rate is about 10% and climbing while unemployment is high and the GDP is flat (when adjusted for inflation).
You may also remember what happened with interest rates when the Fed slowed down the printing presses to put the brakes on inflation that hit 15% at its peak. Reducing inflation led to tightening lending, which caused interest rates to increase well into double-digit territory. The prime interest rate hit 21.5% at the end of 1980.
It has been said that if the US Treasury debt interest rate was to rise to only 11% that it would take 100% of the US government’s tax revenues just to pay the interest on the national debt, leading to at least a partial default.
When a nation defaults on even a portion of its sovereign debt, the interest rate on future debt rises to offset the increased risk to creditors. Even a partial government default can create a runaway effect of rising interest rates and more defaults as the ability of the government to pay falls in lockstep.
Deflation is the opposite of inflation or a shrinking money supply. As the supply of dollars or other currency shrinks the currency becomes more valuable and prices measured in that currency will eventually go down.
Many (Keynesian) economists are terrified of deflation and seem to be of the opinion that it must be stopped at all cost. They cite the Great Depression as an example of deflation in action, but there are many more examples of deflation during periods of growth and prosperity in the United States and elsewhere.
In a properly functioning free market economy, deflation is natural due to improvements in technology and productivity. Electronics are a great example.
In 1984 an Apple Macintosh personal computer retailed for $2495. Today a MacBook Air starts at $999 and has orders of magnitude more computing power than a Mac in 1984. If it wasn’t for inflation, a MacBook Air should only cost around $100 today (using the real inflation correction from shadowstats.com).
The Danger of Inflation to Your Portfolio
Inflation is always working in the background, even when you don’t notice it. If a price jumps suddenly for something we buy every day, we take notice. But when it is more gradual we have a vague recollection of “the good old days,” but seem to dismiss it as unimportant.
If you only take away one thing from this site, it should be the dire warning that you must protect your savings and investments from inflation.
Even at the moderate rate of 10% inflation in just ten years you will lose 60% of the purchasing power of your portfolio to inflation. And based on real calculations of the CPI (not the government’s bogus numbers), inflation is running around 10% right now and is trending higher.
Inflation is especially hard to spot when it attacks your portfolio. Most often you are making regular contributions, so as your statement increases each month the effect of inflation is easily masked.
Many people make the mistake of dismissing inflation because they believe their investments are growing much faster. But try subtracting 10% from the growth of your portfolio and see if you still maintain that attitude.
Protecting Your Savings from Inflation
Inflation is an unfortunate fact of life (at least for a while), but you have the power to choose whether you will pay the “inflation tax” or decide not to pay it.
If you know you can take easy steps to avoid paying a 10% tax on your wealth, which choice will you make?
When you decide not to pay the inflation tax you will free yourself from the largest wealth transfer in history. What many investors don’t realize is that wealth is not easily destroyed.
For example, when the Dow plummeted by 54% in 2008 it wasn’t that all of that wealth simply disappeared.
No, the truth is that trillions of dollars were transferred from people with vulnerable assets to those that were positioned to gain from it.
But this doesn’t mean that someone has to lose so that you can win. While that happens in some cases, it is the exception and not the rule.
You can win by investing in the right assets and position yourself to preserve and protect what you have earned. And in some rare cases you can also position yourself with the same assets to experience incredible growth.
Protecting your savings from inflation requires assets that are immune to inflation, no matter how high it gets. Some refer to this as a hedge against inflation. To have true protection you need assets that will maintain their value even in hyperinflation.
The Problem with Paper Assets
Paper assets, like stocks, bonds, bank accounts, mutual funds, money market accounts, life insurance, annuities, ETFs and any other contracts that promise to pay you back in dollars when you redeem your investment are vulnerable to inflation.
Some of these may do well when inflation is moderate (annuities for example), but many of them will actually lose because the rate of inflation is higher than the return on investment. Nearly all bank products fall into this category.
However, not one asset that promises to pay in dollars will be worth the paper it is printed on if inflation turns into hyperinflation. And since neither you nor I control how many dollars the Fed will print, counting on hyperinflation not to happen is nothing more than blind hope against the historical precedent.
A savvy investor does not bet on blind hope. A savvy investor will make intelligent choices using the best information available to take imperfect action that is within their control.
The Problem with Real Estate
Some investors use real estate as a hedge against inflation. Like some paper assets, real estate may do well during moderate inflation. But during hyperinflation real estate is not a liquid asset.
Real estate is not practical to trade or barter with and when no one is buying the value may drop by 90% or more. The government may put rent controls in place making the income from real estate worthless during hyperinflation.
Neither real estate nor paper assets are true protection against inflation. There is only one class of assets that will not only hold its value during inflation and hyperinflation, but there may even be a small window when this asset class increases in value by hundreds of times.
Gold and silver are the asset class of choice to protect your wealth from inflation.
Gold and Silver – The Safest Asset Class
Inflation can be a complex topic and there are many opinions about it, but few proven facts. Let’s review a few of the facts about inflation and hyperinflation to see how gold and silver fit into the picture:
– Inflation is underreported by the government in the CPI. Real inflation is about 10% and climbing.
– As the Fed prints more dollars the rate of inflation will continue to rise.
– Government spending causes the national debt to increase by hundreds of billions or even trillions of dollars per year. Politicians are unwilling to make the necessary cuts to reduce the debt.
– The debt is so high that the government has to borrow more dollars from the Fed to refinance the debt it already owes.
– Paying debt with more debt increases the rate of inflation.
– History shows that massive debt plus inflation eventually results in the collapse of the currency, usually by hyperinflation.
– Hyperinflation and currency collapse wipes out the savings of those that have assets payable in the failed currency.
Gold and silver are largely unaffected by all of these problems. These precious metals have a track record of thousands of years as real money and stores of wealth, including during times of hyperinflation and currency collapse.
Gold and silver are always liquid and recognized worldwide, so exchanging them for other goods and services (or even stable currency) is never a problem.
Jeff Nabers pointed out that “Gold and silver have never gone bankrupt.”
What other asset class can make that claim?
Gold and silver are like insurance for your portfolio against inflation, hyperinflation and currency collapse. But the premiums are lower and it’s like owning your own insurance company. You don’t have to count on someone else’s promise to pay since you own the payment in advance.
Every investor should hold a portion of their portfolio in physical gold and silver. We call this a balanced portfolio and usually recommend 10 to 40% in gold and silver, though the exact number varies depending on your situation and goals.
We are teamed up with Jeff Nabers to provide you with the safest assets and the safest environment in which to store them. Jeff calls this program “Protected Gold” and you should download the free Protected Gold Formula here so you will understand the best way to protect and balance your portfolio.
The Protected Gold Formula helps you understand how to choose the safest form of gold and silver and shows you the result of 2 years of due diligence to find the safest and most secure means of storing your physical precious metals.
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