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Q&A – What’s The Best Way To Prepare For Higher Inflation?
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Today’s entry: Hi Brian, I’ve always appreciated your financial commentary and know that you know what you’re talking about. It seems that increasingly more people are waking up to the reality that high inflation is here and may stay for some time. You have some talking about hyper-inflation right now. I have two questions for you. What has to happen to take us from the high inflation we’re seeing now into hyper-inflation and what’s the best way to prepare for higher inflation and potentially hyper-inflation?
Bottom Line: These are great questions because to your point, high inflation has been with us since March, there’s no end in sight, and increasingly top experts have been warning that it’s here to stay and, in some cases, worsen. Billionaire star investor Paul Tudor Jones said he views inflation as the greatest threat to our society today. In addition to Jones, hedge fund investors Carl Icahn and Jeffrey Gundlach have specifically adjusted their investment strategies for high inflation. And most notably, because of the significance of the warning, Twitter and Square founder and CEO Jack Dorsey recently tweeted out that Hyperinflation is going to change everything. It’s happening. I’m going to start with hyperinflation. There’s a specific definition that applies.
Hyperinflation occurs when the cost of a product rises by 50% or more on an annualized basis for a minimum of one month. Hyperinflation of any product is extremely rare and to the extent it exists in our society it’s been limited to products, not our whole economy. None of us want to begin to imagine what our whole economy entering hyperinflation would mean. Even for a month or two. That’s what makes Jack Dorsey’s claim all that much more alarming for some. Dorsey’s a lot of things but he’s never proven to be a fool or just to throw comments like that out there for effect. He is right about one thing. If hyperinflation happened, it would change everything. You wanted to know what would have to happen for hyperinflation to occur. Hyperinflation can occur with a particular product due to a severe supply issue or other specific factors. For hyperinflation to occur to an entire economy, especially one the size of ours, it almost certainly would have to be the byproduct of a collapsing of our currency.
If you’ve ever heard me discuss inflation previously, you’ve likely heard me say the first and most important factor in determining the cost of goods is the currency you’re using to pay for them. You’ve been hearing a lot of reports about inflation, but have you heard any reporting on the value of the US Dollar? That’s where the inflation conversation for Americans needs to start. The value of the US Dollar is best determined through the US Dollar Index. The index values the US Dollar against a basket of leading world currencies. Earlier this year, when inflation really started taking off, we saw the US Dollar was a major catalyst. At the start of the pandemic in March of 2020, the US Dollar via the index was valued at over $102. As we passed trillions of additional dollars of spending, taking on debt to do it, along with the Federal Reserve creating additional money supply – the value of the US Dollar was eroded. By the time third major spending package within a year had passed early this year, “The American Rescue Plan”, the value of the US Dollar hit $89. It stayed around there through May spurring inflation independent of other factors. With the US Dollar having lost around 10% of its value over the previous year, we saw inflation take off independent of supply and demand factors. This is where there’s a bit of a good news/bad news dynamic to this story...
With gridlock in Washington holding up additional debt spending and with the US economy growing, the dollar has been able to recover some of its lost value in recent months. The dollar has consistently been creeping back up in value with a current value of about $93.80. The five percent recovery in the value of the dollar from lows hit earlier this year is great news. Imagine how much worse inflation would be in real-time otherwise. That’s also the bad news. Especially against the backdrop of developments we’re hearing regarding potential deals in Washington.
Throughout the course of this year inflation has been about a 50-50 proposition. Producers of goods have absorbed about half of the cost of inflation while passing on about half of it to us. That’s why consumer inflation’s been near 5% most of the year. Gross inflation however has been at around 10%. Early this year the biggest factor was the devaluation of the US Dollar. Now it’s about half the result of value of the dollar and half supply-chain issues, Biden regulations curbing domestic energy production, artificial demand created through all of the previously passed government spending washing its way into the US economy and the higher cost of labor due to shortages. Currently there’s no end in sight to any of those factors. That’s why the best opportunity to curb inflation is by passing no new spending in Washington and hoping that the economy can continue to grow adding to the value of the dollar. That’s also, among many other reasons specific to policy, why it’s especially concerning that we’re hearing “progress” being reported out of Washington on a slightly slimmed down version of the George Constanza inspired Human Fund reconciliation bill – which would also mean the bipartisan infrastructure deal, which would also mean trillions of dollars of additional spending, which would mean more debt, more debt spending and a weaker US Dollar. Likely weaker than we’ve seen before. Though even if it only tested the lows hit earlier this year that’d mean 5%+ more inflation on top of what we’re already experiencing. That’s why no matter what bill of goods anyone tries to sell you out of Washington about the virtues of “free puppies, candy and Biden bucks” that are anything but free, no news is the best news. As for how to position yourself...
First and foremost, debt. If you have any try to get rid of it with a priority placed on any variable rate debt. That will eat you alive if inflation runs hot enough. But I put all debt in the mix as well. While fixed rate debt protects you considerably, if you have debt, you have something to lose if you can’t pay it back. If inflation were to take down the US economy over a prolonged stretch, there's no telling what the impact might be from an employment/cash flow perspective. From an investment/asset perspective, you have assets which retain the ability to inflate along with the economy. Historically energy has been the best performing asset class during high inflation, which we’ve seen once again this year already, real-estate has also been a solid inflation investment. The ultimate inflation hedge has historically been gold. But the rules may be a bit different now. What I said remains true. You want assets that can retain value and inflate with the economy. The question is will the old rules as to what those look like apply? Already cryptocurrencies, led by Bitcoin, have served as a better inflation hedge than gold and there’s reason to think that at least some of what’s worked in the past won’t be viewed the same way today. There’s a vast difference in the conversation when it flips from high inflation into hyper-inflation. Hopefully the Human Fund fails in Congress, Jack Dorsey’s wrong and we never find out what hyper-inflation looks like in the cycle.