Use Inflation to Get Richer
First off, Merry Christmas and Happy Holidays!
In My Book…
Fake: Fake Money, Fake Teachers, Fake Assets, I write about how the middle class is screwed. Some might question why I say this despite The Dow being up 14% this year, it’s the best start to a year since 1999 when it gained 17.51%.
Traders don’t think this will last much longer given the mild inflation over the past few months despite the Fed’s pause in rate hikes since January.
Recent data showed that core personal consumption expenditures, the Fed’s preferred inflation gauge, rose 1.6% year over year in March, its slowest pace in 18 months.
I agree with those traders. And the biggest losers of all will be the poor and middle class.
When a currency is not tied to real money, governments are able to print more and more money out of thin air. This leads to inflation, the devaluing of the purchase power of that currency.
This is nothing new. Countries from ancient Rome to Weimar Republic Germany to modern day Zimbabwe have printed or debased money to the point of no return. This results in hyperinflation where money literally becomes worthless and people use it to create fires rather than to buy things.
Traditionally, inflation was measured by a fixed basket of goods period after period. This basket of goods was an agreed upon basket of what it would take to have a good standard of living.
But as shadowstats.com writes, that formula was changed in 1990 to match a popular academic concept called “constant level of satisfaction,” as a “true cost of living concept.”
The general argument was that changing relative costs of goods would result in consumer substitution of less-expensive goods for more-expensive goods.
Allowing for a substitution of goods within the formerly fixed-basket, the maximization of the “utility” of money held by consumers would allow attainment of “constant level of satisfaction” for the consumer.
This type of inflation-measure is more appropriate for the GDP concept—where it is used today—measuring shifting weightings with actual consumption, rather than with the fixed weightings needed to assess the costs of maintaining a constant standard of living
In simple terms, the statisticians made the assumption that if you were buying steak you would switch to less expensive hamburger if the price went up. This allowed the government to constantly switch the goods in the basket in order to manipulate the inflation rate to a lower rate, rather than to track the same goods each period.
Why would they do this? Shadowstats.com gets into the details, but basically it was a way for the government to save money by, for instance, not having to increase Social Security payouts to match true inflation.
Inflation Makes People Poorer
Now, to some, inflation is bad news because they don’t know how to use inflation to get richer. So, instead, inflation makes them poorer.
For instance, employees are hurt by inflation because they can only sell their time, and time generally does not hedge against inflation well. Raises, if they come at all, generally come on an annual basis after inflation—not with it.
And as I share below, now they’re only coming for those who are highly-skilled and hard to replace (for now).
Additionally, people who are deep in credit card debt or who have interest ARM loans are hurt by inflation because the Fed generally raises interest rates to combat inflation. Much bad debt is based on adjustable interest rates that go up during times of inflation, making debt payments more expensive.
Finally, people who play by the old rules of money are hurt by inflation because they believe it is wise and prudent to save money in the bank. But the bank is smart, not dumb. And the bank plays by the new rules of money.
They pay interest on money that doesn’t keep up with inflation. Money loses purchasing power as the bank uses your money to make more money.
No matter where you turn, things look grim for the middle-class worker. But rather than focus on the negative, I want to share what my rich dad taught me about how to thrive in an economy with inflation.
Using Inflation to Get Richer
I use a very simple formula to get richer from inflation: leverage and hedging.
I play the bank’s game. I borrow money from the bank at a fixed rate, buy a cash flowing asset that covers the debt payment, and using less of my own money increases my return on investment.
In an inflationary economy, if the debt payment is fixed, it becomes less of a cost as the dollar loses purchasing power and my investments and income grow.
The reason my investments and income grow is because I purchase assets that hedge against inflation. For instance, in inflationary economies, rents generally rise. When I purchase investment property, the debt payment stays the same while my rents rise due to inflation.
This creates more cash flow. I owe the bank only the agreed payment. The rising costs for rent flow straight into my pocket.
The same thing happens for businesses. As the cost of goods rise for consumers, businesses can adjust their pricing and benefit from inflation.
This works because business owners and investors aren’t selling time. They’re selling product that hedges against inflation. They are in control. Employees aren’t in control of their product—time—nor are they in control of their money (the bank or mutual fund is).
One other thing I do to hedge against inflation is invest in commodities. Recently that has been energy products like oil, a great investment when there is inflation. Not great when there’s deflation.
Therefore, while I believe they are good investments for me, they’re not good investments for everyone—especially people who are still learning about the economy and investing who may not be able to react quickly to changing economic conditions.
At the end of the day, what I’ve been preaching all along—invest for cash flow—is the safest and soundest strategy that will serve you well in an inflationary economy. It’s a sure way to grow richer.
What Can You Do?
One of the most common questions I get is why I wrote Rich Dad Poor Dad.
The reason is because I saw the financial crisis of today coming and I wanted to help as many people as possible to get out of the rat race. Bernie Sanders and I agree that inequality is a crisis, but we greatly disagree on how to fix it.
Another question I get is how I feel my friend Donald Trump is doing as President. Even though I have great respect for Donald, I don’t think it matters who is in the White House. It is the banks and Wall Street that control our money.
Now, more than ever, it is imperative to stop playing by the old rules of money. The middle class is dying, and the government won’t save it. The rules have changed, and the cards are stacked.
Editor, Rich Dad Poor Dad Daily