March 11, 2012
BY: Robert Hallberg, Topics: Inflation Hedge
Inflation has been with us ever since the creation of the Federal Reserve in 1913, but it really started to escalate when Nixon took us off the gold standard in 1971. However, the reckless monetary policy really went into high gear after the crash of 2008. Since then we have seen prices rise across the board, especially in things like energy, food, college tuition and medical care. The bailouts, stimulus, and creation of money during the last couple of years only guarantee more inflation further down the road. Much of this money sits on the balance sheet in a number of banks and has never made it out in circulation. But once this happens we will feel a shock of rapidly increasing inflation; with more currency units required for purchasing the same amount of goods and services.
The Chart shows the spike in the money supply after the panic of 2008 as the Fed poured unlimited amounts capital to re-liquefy the system.
Concerns about inflation have been growing among the public and many investors have turned to the perceived safety of tangible assets such as commodities, real estate, and fine art, while a growing number of investors have loaded up on equities to hedge against inflation.
Stocks certainly have real value and represent companies with real assets and should at least in theory maintain its value during periods of high inflation. However, history has shown that stocks are usually poor inflation hedges. Partly because they are equally affected by rising input costs and partly because the difficult business environment that inflation brings along makes it difficult for companies to operate. So the performance of equities tends to lag behind as inflation ramps up. The chart shows a side-by-side comparison of the stock market and currency exchange market in Argentina and Mexico during the hyperinflation in these countries.
Mexican market:
It wasnât until after the hyperinflation had wiped out most of their citizens purchasing power that stocks started to gain in value. Stock certainly fared better than their local currency. Nonetheless, the owners of these equities were worse off after the inflation when returns are measured in real value.
Other assets such as real estate and commodities have been popular inflation hedges. However, these assets typically donât do much better than equities during highly inflationary environments. Because the real economy crash and business activity almost grinds to a hold during hyperinflation most commodities drop in âreal valueâ. And real estate is a function of how much cash flow can be generated from rents or leasing, which is also falling in âreal valueâ as money is being debased. For example, during the Weimar Hyperinflation in Germany it was possible to buy a hotel for just a couple of ounces of gold.
Time and time again gold has proven to be the best inflation hedge and protection of wealth. It has been used as money for over 5000 years and it fits Aristotleâs definition of money better than any other asset; it is durable, divisible, consistent, convenient, and intrinsically valuable.
While the dollar and other currencies have depreciated; gold has maintained its purchasing power. The chart shows a basket of major currencies versus gold over the past 12 years.
The reason behind the loss of purchasing power among fiat currencies is directly linked to the increase of money in circulation. The chart compares the increase of money in circulation versus the value of the dollar.
Chart â Dollar versus M2According to the Austrian school of economics; inflation is not the increase in prices but the increase in money supply. Central banks have already printed enough currency to ensure inflation in the future. But inflation does not happen instantly; it happens with a time lag as newly created money slowly makes it out in the economy and bidding up asset prices. To protect yourself from the coming inflation I recommend that you diversify some of your assets into gold.
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