Posts Tagged ‘Hedging’

HEDGING AGAINST INFLATION

June 29, 2010

HEDGING AGAINST INFLATION

Behind each currency stands a central bank. Each central bank, guided by Keynesian economic theory, is inflating the currency. Money supplies in all countries are always increasing. As a result, prices increase as money loses value. That’s inflation. If you have any savings, the value of your savings is decreasing. What to do? How can you protect your savings from the erosion of inflation?

One answer is, don’t have savings. Go into debt. Spend as fast as you can to acquire real goods instead of bad money. Real goods will keep their real value. This is what our governments, also guided by Keynesian economic theory, encourage us to do. Keynes said that this is the road to prosperity.

Since the 1930s, in the USA, this has been good advice, if you’re borrowing to buy a home. The US government set out in the 1930s to make home-buying irresistible with subsidies, loan guarantees, and tax breaks. In the long run, for most people, a mortgage to buy a home has proven to be a good investment. Many of those who lost out in the recent housing bubble were those who bought a house they really couldn’t afford.

This happened because the government pressured the banks to lower their standards for credit worthiness. Others were caught out because of the euphoria of a boom. The oft-repeated statement “you can’t lose” was the consensus until the bubble broke. Home prices were much higher than the cost of building them. People paid such prices because they “knew they couldn’t lose”.

Of course the incentives to buy a home heaped on by the government pressured many to tie themselves down geographically. It limited their options to find new jobs in a recession, when it was harder to sell your home to move to a new job. Otherwise, the risk was small and the long-term gains were great because the government was subsidizing your purchase with loan guarantees, low interest rates, and tax breaks.

Supposedly, the zero risk option to escape the erosion of your savings by inflation was to buy US government bonds. You can believe that if you trust your government. But if the government decides to default on its debts, who can prevent it? And government has the option of repaying you with cheap money by inflating the currency.

In fact that is already happening. The debasement of the dollar by inflation is more than enough to wipe out the value of the interest that the bonds supposedly pay for the loan. You’ll lose a bit less than you might lose if you keep your money under your mattress. After all, this is the same government that stole all the gold that backed the dollar when we were on the gold standard back in 1930.

So what other options are there to escape the theft by inflation? Many investments can pay much higher interest than government bonds. The more interest an investment pays, the more risk of loss goes with it. Perhaps corporate bonds are the safest. The stock market can pay much more, but it takes expertise to know which stocks or bonds to buy.

I have twice invested small sums in mutual stock funds with fair success. For a modest fee (less than 2% per year) a specialist manages the fund for some goal: maximum earnings, maximum growth, minimum risk, etc. This is fairly safe in the long run (several years) and can pay with growth in excess of inflation. In the short term, the value of your fund will bounce around a bit. Just sit tight, ignore the daily static, and leave your fund to grow until you need the cash. Find a fund with a record of growth over many years, including bubbles and recessions.

Another safe long-term investment is in gold. This will show even more short-term static than stocks, but gold has inherent value and in the long run is a very good hedge against inflation. However, you earn no interest on gold, you may have to pay storage fees, and transaction fees when you buy and sell. And there’s always the chance that the government may confiscate it. They have done it before.

Let’s face it. We are powerless against the total power of government. We are their only means of support, and they will take it from us , somehow.