What is inflation? How will it affect you and your investments?
Using basic economic terms, inflation is the rate at which the general level of prices for goods and services is rising and the purchasing power is falling.
Inflation drives the value of stocks down. In today's market, 3 percent to 4 percent gains per year will not keep up, so expect another downturn. The impending inflation will probably be close to double digits. Long term bonds will be under the same stress as stocks as their values decrease.
Why discuss this? Are we experiencing inflation? Not now. Not yet. But we may soon be looking at a type of inflation most have not known – hyperinflation.
Hyperinflation is caused by a large increase in the money supply not supported by the gross domestic product growth, which results in an imbalance in supply and demand for money. Left unchecked, businesses find it necessary to increase prices as the dollar loses its value.
The government will create this potential hyperinflation in two ways, and both are just around the corner. The fed is bound to raise the discount rate, thus raising the prime rate which means it will cost more to borrow money — essentially making money more expensive through higher interest rates. The Treasury printing more money will be the other way hyperinflation will be created. Our deficit requires it. When the fed floods the economy with new money, that act alone could take us into the double digits. More money decreases the value of our dollar, thus we pay more for goods and services.
Will these two actions come crashing down at once? It seems as if they could. Will it create a downturn in the markets? Yes. So, what do you do? Don't panic. There are inflation beating investments out there and will be presented in future columns. Buying gold or other precious metals outright is not a good idea because of the high commissions. However, commission-free precious metals mutual funds are good hedges against inflation. Since this will be the topic for the next column, study gold on the internet. Go online and type in 'precious metal mutual funds' and have a look.
Following the gold column, we will look into other inflation-beating investments, such as stock index mutual funds, structured investment stock CDs, foreign stock index mutual funds, and short term bond funds. And, for the stout-hearted, nerves-of-steel investor willing to take a gamble and go real long term, we will discuss real estate mutual funds. 'Til next time.
Jon Langione is an Oro Valley resident. He can be reached at firstname.lastname@example.org.