What could work if we enter a high – hyper-inflationary period?

If (when?) the dollar’s purchasing power starts its inevitable serious decline due to out of control deficits what could protect us from keeping good nominal wealth while seeing our inflation-adjusted net worth relatively intact?

This is truly the $64,000 question. Only the older folks in the crowd will remember that TV quiz show. Imagine anyone getting worked up over $64,000 anymore. Talk about inflation!

            If the $US is going to lose buying power you’ll need to own ‘things’ that can be marked UP to market as opposed to paper that stays level or worse in dollar terms. Some of the answers to my question might not seem intuitive.

A greatasset would be to have as large a fixed-rate debt (like as mortgage) as you can safety afford to service for as long a period as you can obtain. If you could take out a 30-year 4.7% fixed rate loan now and we get back to 15% inflation you’ll be able to park the cash in  riskless CDs or T-bills at 15% and simply use 31.3% [4.7%/15%] of the interest you’d collect to pay off the loan interest. Best of all, you’ll be paying back principal with cheaper and cheaper dollars.

          Back to the chart. Even the 5^th quintile (6.6% – 14.7% annualized inflation) may not be as high as we can expect to see in the future but that’s the best historical data we have. The four best asset classes you could have owned were:

            Many unsophisticated investors might glance as the data immediately above and opt for the 100% positive returns on T-bills over the higher return but less predictable asset classes. Why would that be a bad choice? Let’s take a look on a ‘real world’ basis- after tax and after inflation.

            Of the four assets classes that did best during historical high inflation periods the only one that didn’t maintain full buying power (after-tax and after-inflation) was the ultra-safe appearing T-bills. In fact, they were guaranteed losers to the tune of almost 4% per year in reduced buying power.

            Nobody wants to see hyper-inflation but if you want to protect your wealth you’d better be in something that has a fighting chance of success – not a 100% chance of failure.

Long-term government bonds were, by far, the worst performing asset class with a 1% average annual nominal return and a negative (9.2%) per year loss of purchasing power. Buyers of 30-year treasury bonds today are playing with one of the worst asset bubbles in history and they are likely to suffer the biggest losses if inflation rates pick up dramatically. Ironically, these are seen as safe-havens today while history says they will perform horribly overall and will decline in 42% of all high inflation periods.

Dr. Paul Price

www.BeatingBuffett.com

June 23, 2010