Inflation Protection

[copyright1997reloaded]

Isn't inflation only really bad for people who have long term, non-inflation adjusted fixed income? Otherwise, it seems like real interest matter more than inflation. If inflation is 10% but CDs are paying 13% wouldn't that be a good thing for most investors? They'd have a 3% real yield for a change.

First, it is unlikely your CD will be yielding 13% if inflation is at 10%. If inflation ramps up quickly, a lot of money will be tied up in lower rate terms AND rate increases will lag inflation. This was the case in countries that went from "inflation" to hyper-inflation.
https://www.businessinsider.com/worst-hyperinflation-episodes-in-history-2014-4#yugoslaviarepublika-srpska-april-1992-january-1994-3

Secondly, even without hyper-inflation, you also need to account for taxes on phantom gains. If the magical CD yielded 12% and inflation was 10%, your CD return after taxes (assuming a 25% combined Fed+State) would be 9%...and you would be losing purchasing power.

 

[daylatedollarshort]

First, it is unlikely your CD will be yielding 13% if inflation is at 10%.

If inflation ramps up quickly, a lot of money will be tied up in lower rate terms AND rate increases will lag inflation. This was the case in countries that went from "inflation" to hyper-inflation. https://www.businessinsider.com/wor...viarepublika-srpska-april-1992-january-1994-3

Secondly, even without hyper-inflation, you also need to account for taxes on phantom gains. If the magical CD yielded 12% and inflation was 10%, your CD return after taxes (assuming a 25% combined Fed+State) would be 9%...and you would be losing purchasing power.

Globally and historically, 3% real interest rates would seem to be on the high side but not all that unusual if you look at the table on real interest rates in this article:
https://www.minneapolisfed.org/article/2016/real-interest-rates-over-the-long-run

I don't have any control over inflation, but we've planned for it as best we can. From my spreadsheet modeling we actually come out ahead under most scenarios due to factors like TIPS in retirement accounts, expensive house that would likely increase in value with inflation, Prop 13, low fixed rate mortgage, floating rate bond funds, etc. Our retirement pan is based on a zero real return and spending half of what we could so I think we will still be fine no matter what happens. There was really high inflation when I was younger and from what I remember my grandparents did fine with Social Security, pensions and safe investments like CD ladders because they had very low over head - paid off small house, one car, cheap hobbies, not into travel, low cost of living area.


ETA: Inflation was high when DH started working and bought our first house. I think our fist couple of mortgages were in the 12% territory. At the time that just seemed normal as we didn't have any experience with other types of rates as adults.

 

[Islandtraveler]

I am a simple man with simple analysis. It is my understanding that inflation is caused by to much money chasing to few goods. if you have a gazillion dollars in an economy and the government decides to print another half a gazillion, how does that not increase the cost of goods? Sorry. Not getting the "New Math".

 

[Montecfo]

I am a simple man with simple analysis. It is my understanding that inflation is caused by to much money chasing to few goods. if you have a gazillion dollars in an economy and the government decides to print another half a gazillion, how does that not increase the cost of goods? Sorry. Not getting the "New Math".

Your logic is correct. But we did not get inflation after the last Fed intervention, although I recall some very smart people making the same observation. Tepid growth and other pricing pressures made deflation more of a worry. Savings rate went up too.

My guess is you will have some of the same now. But holding some TIPS is not a bad plan.

 

[Closet_Gamer]

I am a simple man with simple analysis. It is my understanding that inflation is caused by to much money chasing to few goods. if you have a gazillion dollars in an economy and the government decides to print another half a gazillion, how does that not increase the cost of goods? Sorry. Not getting the "New Math".

Its the "chasing" part that we've seemed to lack a bit...lots of people holding onto their cash, notably big companies and the wealthier among us.

Some would argue that the reason the equity markets went so high is that we've had inflation in investment assets. You're paying more (in real dollars or underlying risk) for less yield. Courtesy of Fed's impact on interest rates and the wealth gap where money accrues to the people who are most likely to spin around and re-invest it, further bidding up asset prices.

 

[eytonxav]

Isn't inflation only really bad for people who have long term, non-inflation adjusted fixed income?

Probably something to consider if you are a retiree without a COLA pension. Not sure I want to rely solely on SS cost of living adjustments. If you are working, probably not as much of a concern.

 

[copyright1997reloaded]

I am a simple man with simple analysis. It is my understanding that inflation is caused by to much money chasing to few goods. if you have a gazillion dollars in an economy and the government decides to print another half a gazillion, how does that not increase the cost of goods? Sorry. Not getting the "New Math".

Because you also have to account for the velocity of money.

Suppose $100 is added to the money supply (either printed or digits in a computer) and given to person A. A buys something with that money (person B). B then spends some/all of that money on C. And so on. Thus, how quickly money is spent in the economy (not just the first time but through the cycle) is a factor (i.e. Money*Velocity).

This holds true even if the money is saved and lent, but limited in that a bank must have reserves (e.g. keep 2% or whatever as reserve). However, the fed can encourage lending by reducing the reserve requirement and also by letting a bank put up other collateral to them in exchange for reserves (e.g. T-Bills and now all kinds of crap).

On the other hand, in crisis situations someone lending money goes from thinking about "return on investment" to "return OF investment". Instead of an expansionary cycle we can have a contraction cycle. For example, a little virus causes everyone to stay home. The store in the mall doesn't sell things, so they can't pay their rent. The owner of the mall has no money in, so they can't pay their bond holders. The bond holders get less income, so they can't buy things, ... and so on. This is DIS-Inflationary.

So we have an epic battle going on -- a whole bunch of deflationary things because of the virus and resulting slowdown/shutdown on one side, and on the other side attempts at massive stimulus which would in normal times be extremely inflationary.

Who will win this epic battle? I dunno. The Fed's job (and I'm glad I'm not working there trying to figure this out) is to somehow walk the tightrope between too little stimulus = deflationary spiral and too much stimulus = inflationary spiral/hyper-inflation.

Me? At first, the deflationary forces are STRONG. Fear, massive loss of jobs, people staying at home - all point to big time contraction. But eventually someone will need to know and be able to quickly take some of that massive stimulus back out - or we will end up with your picture of a LOT more money chasing a LOT less goods and services.

In the meantime, I'm glad I have some TIPS, and I continue to pick away at precious metals. Quite frankly, if it gets really really bad in terms of hyper-inflation, neither of these will be enough.

 

[daylatedollarshort]

Interest rates, real and nominal, have been decreasing world wide for decades now. The U.S. is printing money to cover the pandemic costs, but does this change things in a world economy where the average Joe can invest in mutual funds that buy international bonds? Most other governments have their own pandemic spending programs so maybe significant inflation and/or higher interest rates will eventually occur in a year or two when people get back to working and spending, either through a vaccine or herd immunity.

I don't have any good guesses on the subject. We try to prepare for different scenarios, inflation, deflation or a middle ground. I do know from the last recession that the best time to buy TIPS is when the press is all over deflation fears. It seems like the possibility of prolonged deflation over 5 - 30 years, the life of new TIPS bonds, is not that likely. I made some good TIPS purchases last recession on deflation fears but in hindsight could have bought more.

 

[morriss003]

Without an increase in demand, inflation is not likely to be a problem

 

[ragabnh]

Nobody is talking about the Petrodollar, there is a worldwide demand to accumulate dollars as reserve currency in tough time and for countries to buy oil as it is the traded only in dollars, as long as there is this demand, dollar should be ok and inflation should not be high as the printed currency would circulate worldwide rather than just the US.

Other countries do not have this thing and their currency is impacted significantly when printing starts.

This is my opinion and I might be wrong but I believe the dollar is the safest currency to be in at this time.

 

[OldShooter]

Nobody is talking about the Petrodollar, there is a worldwide demand to accumulate dollars as reserve currency in tough time and for countries to buy oil as it is the traded only in dollars, as long as there is this demand, dollar should be ok and inflation should not be high as the printed currency would circulate worldwide rather than just the US.

Other countries do not have this thing and their currency is impacted significantly when printing starts.

This is my opinion and I might be wrong but I believe the dollar is the safest currency to be in at this time.

The rest of that story, though, is that almost every economically significant country in the world would like to knock the dollar off its pedestal. The main reason for this is the US's propensity to use its banking system as a weapon against people it doesn't like.

The problem so far is that there is no obvious contender to replace the dollar. The EU has already worked out a small step, though, a non-dollar scheme that prevents the US from interfering with their trade with Iran. This week's The Economist speculates that the Chinese will see increasing success in international bodies. There have been experiments in pricing oil in a basket of currencies, too. Probably the demise of the dollar will be a via a basket of currencies like the IMF's special drawing rights basket: Presently the Chinese Renminbi, U.S. dollar, euro, yen, and British pound. The Russians would like to get in on this too, but Crimea has knocked them back quite a bit. More: https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/14/51/Special-Drawing-Right-SDR

Hard to say when, where, or how much but the dollar seems to be in long-term jeopardy. As it loses its exalted status it will also lose its FOREX value, leading to inflation in the US. A 20% decline in the dollar will result in 25% increases in the dollar price of most imports and most commodities traded on world markets (think food, oil, steel, and oil-based products like plastics). If that kind of inflation happens it will not be fun.

 

[ejman]

Your logic is correct. But we did not get inflation after the last Fed intervention, although I recall some very smart people making the same observation. Tepid growth and other pricing pressures made deflation more of a worry. Savings rate went up too.

My guess is you will have some of the same now. But holding some TIPS is not a bad plan.

I'm not so sure about that. My take on why we didn't have inflation after the 2008 unpleasantness is that China became a major supplier at an extremely low cost that drove all higher priced wannabes into submission. Comply or die so they didn't have a choice. This time around? Dunno my Chrystal ball is having some Win 10 update issues

 

[Bongleur]

Shortly after we retired in our 50s, 2006/7, we bought TIPS in a quantity sufficient that we felt our retirement was inflation-proofed.

For anyone serious about retirement inflation insurance, I think the approach to TIPS has to be "go big or go home." If one doesn't buy enough to matter, they won't matter.

I don't think many people are fortunate enough to have enough assets to do that. And of them, few are willing to forego the upside potential of a 60/40 Trinity Study Proven type AA.

And unless you can keep it in Tax Advantaged space, you have the arcane tax rules on phantom income every year. Need to hire someone to do that !.

 

[Bongleur]

What is happening with the "flow" in or out of TIP oriented Funds & ETFs?

If TIPS are yielding negative, they are "expensive" right now. If people are buying into funds, they will have to buy the expensive new-issue TIPS (or even ? more expensive ? off the run TIPS) to cover the new money. Which dilutes the NAV for the previous investors. So will these funds close to new money? Seems to me like they should do so. OTOH, you should buy in before they close you out...

 

[OldShooter]

I don't think many people are fortunate enough to have enough assets to do that. And of them, few are willing to forego the upside potential of a 60/40 Trinity Study Proven type AA. ...

Life's a tradeoff and some tradeoffs are tougher than others. But don't forget that nothing about the future is "proven" except that black swans are expected. We just don't know what kind.

... If TIPS are yielding negative, they are "expensive" right now. If people are buying into funds, they will have to buy the expensive new-issue TIPS (or even ? more expensive ? off the run TIPS) to cover the new money. Which dilutes the NAV for the previous investors. So will these funds close to new money? Seems to me like they should do so. OTOH, you should buy in before they close you out...

TIPS are difficult to evaluate because you have to pick an inflation number before you get a YTM that can be compared to standard govvies. And since the interest is paid on the inflated value of the bond, the YTM rises, possibly dramatically, with inflation. YTM is kind of a fuzzy concept as a result.

Re funds, NAV, etc. that is why we just buy the TIPS directly. There's no yield curve of any significance, so no need for angst trying to design the perfect ladder. If/when we need cash, we just sell some TIPS into a highly liquid market. We only hold two issues.

Re "new money" and "will these funds close" I am not a bond fund guy but it seems to me/not thinking really hard, that whatever issues like those that might exist with TIPS would apply to non-govvie bond funds as well, no?

 

[ownyourfuture]

Personally, I hope the world backs off their dependence on China after the hell that nation caused. I would much rather pay more for US made goods.

I agree, but I'm pretty sure we're the minority here.

 

[Jerry1]

Personally, I hope the world backs off their dependence on China after the hell that nation caused. I would much rather pay more for US made goods.

I agree, but I'm pretty sure we're the minority here.

Not sure if you're in the minority, but I think it's possible that people will see the value in paying more.

IMO, the "hell that nation caused" is just part of the true cost, the full cost or outsourcing so much of our manufacturing. Sure, we outsourced labor and that cheap labor helped us get "things" cheaper. But we also outsourced things like quality (think food ingredients) and environmental safeguards. When you factor in all of the real costs, it may be a lot closer in cost to manufacture in the US. Are willing to pay that cost? Maybe if they understood this. Of course, that education is the difficult part.

Also, one of the things we've realized from this situation is how much critical medication is produced outside of the US. I can't imagine that is anything other than a highly automated operation and therefore, find it hard to believe that labor cost is the reason for the lower cost. Not sure why we couldn't make them in the US for about the same cost.

 

[Sunset]

Not sure if you're in the minority, but I think it's possible that people will see the value in paying more.

IMO, the "hell that nation caused" is just part of the true cost, the full cost or outsourcing so much of our manufacturing. Sure, we outsourced labor and that cheap labor helped us get "things" cheaper. But we also outsourced things like quality (think food ingredients) and environmental safeguards. When you factor in all of the real costs, it may be a lot closer in cost to manufacture in the US. Are willing to pay that cost? Maybe if they understood this. Of course, that education is the difficult part.

Also, one of the things we've realized from this situation is how much critical medication is produced outside of the US. I can't imagine that is anything other than a highly automated operation and therefore, find it hard to believe that labor cost is the reason for the lower cost. Not sure why we couldn't make them in the US for about the same cost.

I think there are a number of critical things, now being revealed that are really a national security issue and should be manufactured here.

A secondary issue of outsourcing so much manufacturing, is that other countries like China got to practice, practice, practice, making things, and developed their skills at manufacture and innovation, while our country has lost some skills in manufacture.

 

[njhowie]

With all the money the gov't is injecting, inflation pressure seems likely. Anyone adding tips at this time?

We recently changed wife's 401k contribution allocation from 100% money market to 50% VAIPX with the remainder split evenly between a fixed income fund and a small cap fund.

 

[OldShooter]

I mentioned in post #36 my concern about the dollar getting knocked off as the world's reserve currency. This morning there is an article from Forbes about fairly specific proposals involving digital yuan: https://www.forbes.com/sites/billyb...s-coming-true-for-the-us-dollar/#31699d0a3835 I don't understand what a digital currency brings to the party, but the general goal remains clear.

Re trade with China, I don't know nuthin' but I do see some forces that will eventually move us to a new worldwide normal.

• Devaluation of the dollar, if it happens, reduces the buying power of China's biggest customer and reduces the value of China's dollar-denominated assets. This may cause them to tread carefully. Or maybe not.
• Worldwide, people have clearly seen the danger in supply chains that are single-sourced from one company or even one country. Diversification will occur to some degree both with reduced business for China and reduced business for US technology industries.
• Chasing low labor costs in SE Asia (even lower than China's) will continue be a factor in supply chain diversification. A year ago we saw a Samsung factory in Hanoi that employed 50,000 workers. The rice prepared for lunch was measured in tons. 100% of the plant output was exported.
• Any devaluation of the dollar makes our exports cheaper and our imports (most notably food and oil) more expensive.The silver lning in this cloud may be slow re-industrialization as we export more and as some manufacturing is re-shored.
• China's relentless efforts to become more of a military, economic, and political world power may run into economic or political rocks. Or maybe not. Their extensive loans to second- and third-world countries are certainly shakier now.
• Between collapsed oil prices and the pandemic, can we write Russia off as a world power?
• Will there eventually be a war between Iran and Israel or Saudi?

Are we having fun yet?

 

[Montecfo]

I think a result will be a move of manufacturing from China, but not all to the US. I see other destinations such as the Asian Tigers and Mexico benefitting. That is, locations with lower costs but different aspirations than China.

But I do see a move to re-shore strategic assets such a drugs, let metals, etc.

The new approach to globalization will have greater financial cost but still be "cheaper" when considering all costs.

 

[Markola]

The rest of that story, though, is that almost every economically significant country in the world would like to knock the dollar off its pedestal. The main reason for this is the US's propensity to use its banking system as a weapon against people it doesn't like.

The problem so far is that there is no obvious contender to replace the dollar. The EU has already worked out a small step, though, a non-dollar scheme that prevents the US from interfering with their trade with Iran. This week's The Economist speculates that the Chinese will see increasing success in international bodies. There have been experiments in pricing oil in a basket of currencies, too. Probably the demise of the dollar will be a via a basket of currencies like the IMF's special drawing rights basket: Presently the Chinese Renminbi, U.S. dollar, euro, yen, and British pound. The Russians would like to get in on this too, but Crimea has knocked them back quite a bit. More: https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/14/51/Special-Drawing-Right-SDR

Hard to say when, where, or how much but the dollar seems to be in long-term jeopardy. As it loses its exalted status it will also lose its FOREX value, leading to inflation in the US. A 20% decline in the dollar will result in 25% increases in the dollar price of most imports and most commodities traded on world markets (think food, oil, steel, and oil-based products like plastics). If that kind of inflation happens it will not be fun.

Until there’s a viable alternative to the U.S. dollar, I’m not going to worry about this. Also, the dollar’s strength goes up and down over time. When it’s strong, imports are cheaper, when it’s week, our exports are competitive. Yen/Yang.