Inflation: The Pickpocket Among Us

Inflation is the economic equivalent of a human pickpocket, anonymous and unnoticed amid a crowd of revelers, sneaks close and pilfers the purses of the unwary.

"Inflation Accelerates Again in June as Economic Recovery Continues." So reads the headline on July 13, 2021, daily edition of Wall Street Journal. The Federal Reserve's July Monetary Policy Report suggests that the current jump in the rate is due to "likely still temporary upward pressure on inflation has come from prices for goods experiencing supply chain bottlenecks." The International Monetary Fund forecasts a similar cause of inflation and forecasts global inflation will moderate (for industrialized countries) to around the 3.0 -3.5% rate, about 50% greater than the U.S. projections.

Understanding Inflation

Inflation is an economic concept related to the purchasing power of money. As the general level of prices rises, each unit of currency buys less. For example, the price of a standard 4 oz. hamburger was $0.71 in 2008 and $2.64 ten years later (2018). A teacher could treat a school class of 35 with two burgers each for $50 in 2008. Ten years later, the same meal would cost the teacher $185. Economists refer to the hamburger effect as built-in inflation, i.e., a spiral of rising prices due to increasing costs. Inflation can also occur when demand for goods exceeds supply, causing prices to rise or when the Federal Government increases the money supply (demand-pull inflation). Rising costs can also push prices up (cost-push inflation). Those with the benefit of regularly increasing income are often oblivious to the effects of inflation unless it becomes uncontrollable.

Uncontrollable – runaway - inflation has occurred multiple times in modern history, devastating a country's economy and reducing its citizens to poverty. During ten months in 1989-1990, Argentina's national currency, the austral (₳}, lost one-half of its value every 19.4 days. At that rate, goods priced at ₳10,000 on January 1 would require a payment of ₳262,144 on December 31 of the same year. Venezuela is currently experiencing hyperinflation at an annual rate of 2,719%.

The Fragility of Forecasts

Investors are rightly concerned about the reliability of economic forecasts. Ezra Solomon, an American economist, was especially critical of predictions, saying, "The only function of economic forecasting is to make astrology look respectable." [iii] While history suggests that inflation will be present, its rate is uncertain. Will the U.S. economy continue between the 2%-6% rates experienced since 1980 or see a return to the higher rates of the 1970s? 

The possibility of higher inflation, i.e., more money chasing fewer products, is due to

• The appearance of new Coronavirus strains. Vaccines developed for the initial Covid-19 virus are less effective against more virulent and contagious mutations of the virus (Delta, Lambda), prompting countries to reinstate social restrictions and movement. The variants delay, if not discontinue, efforts to return to normalcy. Some scientists predict that coronavirus variants will always be a threat.
• Reduced global economic growth. Global Gross Domestic Product (GDP) fell almost 14% during 2020 before rebounding to 4% growth in 2021. The effects of the new Covid strains are just emerging on the world's economy as countries struggle to maintain a return to normalcy. Despite spending trillions of dollars in relief, advanced economies and the United States lag in economic recovery (growth is below the pre-Covid baseline).
• Increased government spending. Faced with humanitarian concerns for their populations, the world's governments significantly increased their money supply well above GDP growth, effectively devaluing their currencies. The result is demand-pull inflation as more cash is required to buy the same products a year ago. The United States increased its supply by almost 14% despite declining or level GDP growth in 2020-2021. The likelihood of further money supply increases is high as the U.S. government continues to provide Covid relief.

The expectation that "supply and demand should become better aligned, and inflation is widely expected to move down" is dubious at best, given the world's existing economic conditions. No one knows with certainty what the future holds. However, most observers concur that money will continue to lose purchasing power, the only question being the rate of decline.

A Hedge Against Inflation

The only countermeasure for the declining purchasing power of money is to earn at a higher rate than the constant loss. Though inflation will continue to reduce your investment values, the total real value of the assets will continue to grow. Some investors turn to stocks attempting to ward off their losses in purchase power. Others worry that the long-lasting bull market cannot continue and predicts drops of 40%-50% within the two to three years. The Blackrock Investment Institute predicts that the historic monetary-fiscal collaboration to bridge the pandemic will increase inflation. "This means we [Blackrock] don't expect another decade-long bull market in stocks and bonds."

In uncertain times, investors often overlook proven historical hedges against economic uncertainty. Gold is a global asset and a hedge against inflation, and the erosion of purchasing power as the value of a currency slowly declines as supply increases. Why invest in gold now?

• "The price of gold also goes up when the federal deficit grows, as it's doing now. This was the other reason gold more than doubled between 2009 and 2011: The government's annual budget deficit soared into the $1.8 trillion neighborhood. Now the government is talking about running the biggest deficit in the history of the United States. Even bigger than we had in World War II. And that bodes well for gold." (Jared Dillion, author of Street Freak: Money and Madness at Lehman Brothers)
• "Between November 30, 2007, and June 1, 2009, the S&P 500 index fell 36%. The price of gold, on the other hand, rose 25%. This is the most recent example of a material and prolonged stock downturn, but it's also a particularly dramatic one because, at the time, there were very rea­l concerns about the viability of the global financial system…When capital markets are in turmoil, gold often performs relatively well as investors seek out safe-haven investments." Motley Fool "Don't be shocked to see $2500 or even $3000 gold within 2-5 years, particularly if the U.S. government continues running large budget deficits." Jake Huneycutt, Aardvark Data, Seeking Alpha)

Strategy Shares Gold Hedged Bond ETF (GLDB) 

Strategy Shares' Gold Hedged Bond ETF is a unique portfolio of investment-grade corporate bonds that pays investors a yield that is hedged 100% to the price of gold. The combination providers investors the stability of a bond's interest payment with an effective hedge against inflation as the price of gold generally rises in line with inflation – the erosion of purchasing power. The EFT is designed to protect investment values during periods of

• High inflation. As the purchasing power of the interest and principal payments decline, the value of the gold hedge increases, offsetting the loss of purchasing power.
• Falling stock market values. The correlation between rising gold prices and falling market prices is historically valid. If stock prices fall, the value of the gold hedge increases.
• Uncertain interest rates. While higher rates negatively affect a bond portfolio, higher inflation positively affects the value of the gold hedge. Conversely, lower rates might negatively affect the value of the gold hedge, but the investment-grade bonds in the EFT will increase in value, offsetting any loss in gold prices.

In summary, the GLDB Gold Hedged Bond ETF is an excellent alternative to traditional bond ETFs. Since GLDB hedges against inflation through its exposure to gold, investors can benefit from the potential increase in the price of gold as the dollar's purchasing power erodes.

Final Thoughts

"We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don't let yourself be lulled into inaction. "   

---- Bill Gates

Inflation, spurred by the reckless expansion of the global money supply, is sure to steal the economic security of savers worldwide unless they take action to counter its effects. The risks of inaction in an ecosystem of rapid and continuous change are enormous. Protecting one's hard-earned assets requires constant vigilance and periodic adjustment in investments and investment philosophies. Sometimes, the challenge is not to maximize one's earnings but to keep those earnings intact.