How To Profit From Inflation
I’ve often referred to situations this past year as either “BC” – before coronavirus or “AC” – after coronavirus.
2020 was a turning point for millions around the world. It’s hard to escape the financial impact of the pandemic. The stock market has crashed and risen many times, unemployment rates have spiked, and entire industries have been decimated amidst “stay at home” orders across the country.
My long-term prediction for the United States is for higher inflation. Maybe not necessarily hyperinflation, but history has shown us this: when governments have to keep the printing presses going, the value of the dollar falls.
The simple definition of inflation is when prices rise and the purchasing power of a currency drops.
It means that you can buy less with your money than you used to be able to.
All economies experience inflation (and deflation) at some point. But where it gets troublesome is when the income levels of a population don’t track with or exceed inflation. In that case, people become poorer, even if they think they are making more money.
There are many types of inflation but the main three are creeping, walking, and galloping – or hyperinflation.
1. Creeping inflation is the normal, mild inflation most economies want and expect. For instance, the Federal Reserve sets its policies hoping to target a 2% inflation rate. This is considered healthy for an economy, and theoretically, employee wages can keep up with this.
2. Walking inflation is an acceleration of inflation in the 3-4% territory. This starts to become harder for wages to keep up with and people begin to feel poorer.
3. Hyperinflation is extreme inflation that can go as high as 20%, 100%, 200%, or even more. In the Weimar Republic, hyperinflation was so extreme that “A loaf of bread in Berlin that cost around 160 Marks at the end of 1922 cost 200,000,000,000 Marks by late 1923.”
History has proven that printing fake money never ends in prosperity. History is evidence that printing fake money always ends in poverty for those who work for fake money.
Historically—from the Chinese, the Romans, the German Weimar Republic, and Venezuela today—printing fake money has never produced sustainable prosperity. Historically, printing fake money has always ended in either depression, revolution, war, or all of the above.
The Chinese were the ﬁrst to print paper money. The Romans “debased” their currency as the Roman Empire collapsed. Hitler rose to power in 1933 because the Weimar government printed money to pay for losing WWI. Printed money led to WWII and the deaths of millions of people.
Many people believe 1971 was the beginning of the end of the American Empire. Prior to 1971, every dollar used to be backed by gold or silver but is now an IOU guaranteed to be paid by the taxpayers of the issuing country. As long as the rest of the world has confidence in the American taxpayer to work and pay for this IOU called money, the world has confidence in our dollar. If that key element of money, confidence, suddenly disappears, the economy comes down like a house of cards.
Take the example of the German Weimar-government marks that became utterly worthless just before World War II. As one story goes, an elderly woman was pushing a wheelbarrow full of marks to buy a loaf of bread. When she turned her back, someone stole the wheelbarrow and left the pile of worthless money all over the street.
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The Destruction Of The Production Base
When you have a severe drawdown in the productive base, as we’ve seen in many industries during the pandemic, you can’t make enough goods and services to satisfy the needs.
Take for example the auto industry. Car production was cut back due to the pandemic, but also because automakers expected a drop in demand.
When the government issued stimulus, consumers were still willing to spend and the new car demand didn’t drop as much as the new car supply. As a result, the price of new cars surged higher.
So, regardless of how much money the government printed, when you destroy the production base as we saw in 2020, prices start going up rapidly.
The Effect Of Inflation Is To Make 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.
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.
How To Profit From Inflation
The rich have learned how to make money during inflation by 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 use less of my own money to increase 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 grows is that I purchase assets that hedge against inflation.
For instance, in inflationary economies, rents generally rise. When I purchase an 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 rises 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 a product that hedges against inflation in relatively real-time. 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 to 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.
Editor, Rich Dad Poor Dad Daily