This is a guest article by Greg McFarlane, the author of Control Your Cash: Making Money Make Sense, a financial primer for people in their twenties and thirties who know nothing about money.
People have feared inflation ever since… well, since the dollar’s last rampant bout of inflation in 1977. However, there’s every reason to believe that this time inflationary pressures are too overwhelming to discount. Or two colossal reasons, at least:
1. Legislative and executive leaders of the federal government, for whom fiscal restraint is a dirty term. No matter how laudable their objectives, they propose to spend and borrow an ungodly amount to achieve them. Any non-politician reading this blog knows the term “regardless of cost” can never be taken literally, but our elected betters think otherwise and aren’t concerned about the inevitable results.
2. A federal funds rate that resembles Carlos Pena’s batting average, or Countdown with Keith Olbermann’s Nielsen ratings. Here’s a really quick primer, because a lot of people act like they know this stuff but don’t:
The Fed (Federal Reserve) is the nation’s central bank. It actually creates our money out of thin air, which it sells to the federal government to conduct its business with. Commercial and investment banks like Chase and Wachovia also borrow from the Fed. The interest rate those banks pay is determined by the Fed and called the federal funds rate, which thus serves as a basis for just about every interest rate in the economy.
Most countries’ central banks set a single rate. The Fed instead sets a range — the more you borrow, the less you pay. This of course favors larger banks, although “favors larger banks” has been a relative term ever since the federal government confiscated $678 per United States citizen and
gave lent it to AIG. Since December the range has been 0% to 0.25%, an all-time nadir. Inflation has kept pace, barely registering and keeping the dollar’s value intact while jobs disappear. The range eventually has to rise, since it can’t go in any other direction. Once it rises, in concert with the demand for additional dollars that government spending is creating, inflation should ensue.
What does this mean in practical terms? It means getting your assets the hell out of cash, or at least out of U.S. dollars.
The immediate temptation is to shop the world for the currencies the dollar will lose the most money against. There are candidates such as the New Zealand dollar and the CFA franc, but again, your investment will only then be as safe as that government’s fiscal conservatism.
One strategy that goes a step farther is to look at blue chip stocks that don’t trade in U.S. dollars. If the stock’s fundamentals are strong enough, it shouldn’t matter if it’s measured in Swedish kronor, Swiss francs, or almost any currency short of Zimbabwean dollars. Even if a localized bout of inflation causes the stock’s nominal price to artificially rise, its real price should remain consistently strong.
Here are some examples of giant corporations that don’t necessarily trade on the Big Board nor NASDAQ:
- Royal Dutch Shell (which trades under the symbol RDSA on the London Exchange)
- British Petroleum (BP, London)
- Toyota (TYO, Tokyo)
Yes, Toyota. Exhale. And while extolling the benefits of a particular security might make the author come across as a boiler room stock promoter, I’m not telling you to buy anything. I’m telling you to look critically at the reasons for a stock’s atypical behavior.
If you think a recent week of questionable publicity in one market can turn the world’s largest and most respected automotive company into a bad investment, you shouldn’t be investing in anything more demanding than an index fund. A few months from now, no one will remember the recent uncomfortable performance that the parent company of two of Toyota’s major competitors forced the company to undertake.
Furthermore, this is a perfect time to go contrarian. Toyota shares have dropped 20% in the last month. Think about why that might happen to a stock.
- Is it a volatile small-cap? No, it trades at $71.
- Are its financials questionable? No, they’re healthy. Toyota made money last quarter after several quarters of losses. The company routinely buys back treasury stock, showing that on the investor relations side, it cares about preserving value.
- Did it suffer a one-time public relations hit, illustrated by unconvincing former customers telling stories of narrowly averted carnage and crying into the camera on cue? You can field that one.
Gold is the traditional inflation hedge, but when you see an investment being sold during commercial breaks on general-interest TV shows, that opportunity has clearly evaporated. Besides, gold’s value has quadrupled in the last 8 years. That’s swell, but if you’re looking to preserve wealth, remember that time continues to move forward, not backward.
What about Treasury Inflation-Protected Securities, whose defensive strength is written right into their very name? These are a type of U.S. bond whose interest rate, as you can probably figure out, factors inflation in. TIPS are great in theory, as long as you can trust the government’s consumer price index numbers and you can trust the government’s ability to honor its debts. “Full faith and credit of the United States government” doesn’t mean quite the same now as it did when the phrase was coined.
Updated April 7, 2010 and originally published April 1, 2010.