How to Profit From Inflation
In a very real sense, credit put the roar in the Roaring Twenties.
Before 1913, the majority of loans had been commercial. Loans on real estate, or auto loans, were nonexistent, and interest rates were very very high.
After 1913, and the creation of the Fed, credit for cars, homes, and stocks was cheap and easy. With the effect of low-interest rates and the rise of these new types of loans, bubbles began to form.
During the 1920s, many Americans stopped saving and started treating their brokerage accounts as a savings account — much like Americans treat their homes today.
The problem is a brokerage account — or your home for that matter — should never be used as a savings account. The value depends solely on the perception of others. If someone thinks your home has value, then it does. But if they don’t think it has value, then it doesn’t.
In a credit-based economy, whether the economy does well or does poorly is largely based on people’s perceptions. If people believe things are great, then people borrow and spend currency, and the economy flourishes. But if people have the least bit of anxiety, if they have doubts about tomorrow, then watch out.
In 1929, the stock market crashed, the credit bubble burst and the U.S. economy slid into depression.
That’s why our government is issuing record numbers of bonds to raise money. That’s why it’s engaging in deficit spending like never before. The government’s greatest fear is deflation, and the one way to combat deflation is by inflation. And the one way to create inflation is by debt.
So if the government is stoking inflation, what does that mean for your investments?
Here’s what you need to know…
Covid-19 and Free Money for Wall Street
In March 2020, to save the economy from destruction amid the pandemic outbreak, the Federal Reserve fired up the printing presses and created dollars out of thin air at an unprecedented rate.
“The way you and I have checking accounts in our banks, that’s how all these other banks have accounts at the Fed,” said Pavlina Tcherneva, an economist at Bard College in New York. “All the Fed does is credit them. They just type it in.”
In other words, virtual money printing. But not for you and me and Main Street. This cash goes straight to Wall Street.
Once the printing presses were turned on, credit was easier to obtain with a larger money supply and lower interest rates.
Central banks all over the world are fighting deflation by printing trillions of dollars. They are printing money to prevent the stock market and economy from crashing. This is why the crisis we are in today is the most dangerous in world history.
Two Opposing Threats
Inflation and deflation are caused by governments and banks attempting to control the economy by printing and lending money out of thin air — that is, without anything of value backing the money other than the “full faith and credit” of the United States.
In the last 14 months, the Fed created an estimated $5 trillion… and Chairman Jerome Powell has pledged economic support “for as long as it takes.”
Two forces are working against each other: inflation and deflation. If they get out of balance, chaos erupts.
One would make us look like the failed state of Venezuela. The other could eventually bring a repeat of the Great Depression, only potentially worse.
But a look at the government’s current game plan tells us that even if we see deflation first, the central banks will print and spend even more money… which brings us right back to, you guessed it, inflation.
How to Profit From Inflation
The rich, however, have learned how to make money during 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 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 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 a product that hedges against inflation in relatively real time. They’re 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.
Play it smart,
Editor, Rich Dad Poor Dad Daily