3 arguments for inflation, and 3 tactics to cope

[jk]

the solution to [credit] pollution is [credit] dilution.

we are on a path to a significant spike in inflation. this will "solve" the problem of too much debt. this is why tptb want to "get credit flowing again."

3 reasons to expect inflation:

1. fleckenstein's argument- although the fed says it will take back, or drain, what they have "quantitatively eased" into the system, they won't. the economy will be judged too fragile, and there will be too much political pressure for the fed to drain.

2. janszen's argument- there are already a plethora of dollar assets in existence. at some point foreign holders will get antsy and start to defect from the dollar- trying to cash in their dollar assets for real assets all around the globe, including in the u.s. there will be a sharp dollar drop and commodity based inflation.

3. amerman's argument- the present value of the social security and medicare and pension claims of the baby boomers is approx. $1million/younger- and non-boomer household above the poverty line. the only way the "promises" aren't broken [which would cause huge political turmoil] is to lower significantly the value of the dollar. there will be an inflation spike sometime in the next 5-8 years which will more than cut the value of the dollar in half. the inflation spike will not be much reflected in the official cpi, thus allowing for underexpensing indexed payments like social security.


strategies:

1. borrow fixed rate money now. rates are low and future inflation will eventually reduce or erase the burden of the loan.
2. use most of the borrowed money and other funds to buy precious metals and commodities.
3. consider buying income producing assets- real estate, energy producers, farmland..

timing- borrow now. you may want to wait on the purchases, or you may want to scale into purchases a bit at a time.

[thedanimal]

Re: 3 arguments for inflation, and 3 tactics to cope

Thank you for this cogent and succinct summary. I agree both with the premises and the conclusions.

[jpatter666]

Re: 3 arguments for inflation, and 3 tactics to cope

Jk,
I dunno -- I don't like the idea of leveraging myself up on the predication that inflation is going to hit and that commodities will rise. Sounds too much like the "borrow on your house and speculate on real estate" logic.
What if you're wrong?
I *do* think some sort of "event" is coming, but I'm diversifying in a bunch of ways. Still have stocks, cash, some RE, PMs, commodities -- and most important to me -- minimal debt. I dislike betting on the call and hopefully this will see me thru the days to come.

[jk]

Re: 3 arguments for inflation, and 3 tactics to cope

Jk,
I dunno -- I don't like the idea of leveraging myself up on the predication that inflation is going to hit and that commodities will rise. Sounds too much like the "borrow on your house and speculate on real estate" logic.
What if you're wrong?
I *do* think some sort of "event" is coming, but I'm diversifying in a bunch of ways. Still have stocks, cash, some RE, PMs, commodities -- and most important to me -- minimal debt. I dislike betting on the call and hopefully this will see me thru the days to come.

i understand your reluctance to borrow. in general, you should only follow this strategy if you've sufficient assets for the debt to be easily covered if you're wrong. otoh, if indeed there is significant inflation, the inflation-tax* will rob you of most or all of your gains and perhaps even eat into your original [real] capital.


*taxing as gains increases in price which only reflect inflation
e.g. consider an asset purchased for $25k. suppose the value of the dollar is cut in half and the asset moves exactly with inflation. then its nominal value increases to $50k. its real value hasn't changed at all. then if you sell it, you must pay taxes on the $25k "gain", reducing the real value of your capital to less than you started with.

[allenjs]

Re: 3 arguments for inflation, and 3 tactics to cope

1. borrow fixed rate money now. rates are low and future inflation will eventually reduce or erase the burden of the loan.
2. use most of the borrowed money and other funds to buy precious metals and commodities.
3. consider buying income producing assets- real estate, energy producers, farmland..

timing- borrow now. you may want to wait on the purchases, or you may want to scale into purchases a bit at a time.

Both #1 and #2 are dangerous, the way you have phrased them. The primary asset for which people can obtain fixed rate money is real estate, and it would be very foolish to leverage up on real estate right now.

I know people, particularly from other countries who experienced mass inflation in the past 30 years, who think this is a good idea -- take out a mortgage that is extremely painful, and after inflation kicks in, you'll be sitting pretty.

The problem with this theory is that we are still deleveraging a housing bubble. If you could borrow a million bucks now at 5% and then use it later, when the housing hits the bottom, you might have a point. But please show me a bank that lets you borrow large sums for asset purchases without using the purchased asset as collateral. Likewise show me the bank that would let you borrow a million bucks to buy gold -- gold is even more speculative than housing right now.

Now, OTOH, borrowing money now and putting into TIPS would seem like a pretty safe investment -- if you are certain that inflation is coming within 10 years (and I am pretty certain). But I still think its a fool's game. In this environment, people shouldn't be investing money that they don't have.

[jtabeb]

Re: 3 arguments for inflation, and 3 tactics to cope

strategies:

1. borrow fixed rate money now. rates are low and future inflation will eventually reduce or erase the burden of the loan.
2. use most of the borrowed money and other funds to buy precious metals and commodities.
3. consider buying income producing assets- real estate, energy producers, farmland..

timing- borrow now. you may want to wait on the purchases, or you may want to scale into purchases a bit at a time.

JK, I've been doing this for 5 years and I have done well with these stratgegies but there is a BIG CAVEAT that you need to spell out (and didn't).

I'm a not normal case because I have stable job (as long as there is a military, I have a job), not many people can say that and I understand how fortunate my situation is.

So I have a guaranteed level of income say of five years. I can buy at today's prices with fixed rate borrowing and then pay it off later with future earnings. I did this, but I NEVER went above what I could pay off, and that is key! I FORWARD PURCHASED, but didn't lever-up!

That was the only way I could find to keep the risk management tolerable.

I did the same thing with rental property. While people I knew had 3-30+ rental houses, I had 1, and it was one that I could afford to pay the mortgage on even if it was not rented for the entire year (I had set aside that amount from my consumeable monthly income).

Point is risk managment! I could follow the strategy that you outline above (WITHOUT ANY LEVERAGE) only because of the stability of my employment situation. How many non-gov employee's have that luxury?

I THINK A MUCH MORE RISK BALANCED STRATEGY is to take the money you HAVE (IRA, 401K, stocks, etc.) and CASH IT OUT AND BUY PHYSICAL PM's (50/50% gold and silver by dollar amount).

You get all of the return without the risk, that is the only way I would play this at this point.

LEVERAGE KILLS! (my dad was a gambler and I learned that lesson all to well from his experience).

Don't gamble with fixed rate leverage (unless you have a 100% secure and stable income stream, then go ahead, but don't take more than you income stream can pay off!)

I'll say it again LEVERAGE KILLS!

Now, I did tell my retired mother who was renting to go by a house on a 30yr fixed rate loan ASAP! (which she did).

But she MET the criteria I outlined above. Her risk is a currency depriciation risk during the length of her retirement. A house purchased using a fixed rate loan HEDGED that risk for her in her situation.

If you have a reliable pension and are in retirement and don't own a house, I think this is a good strategy. But the MAIN qualifier is a STABLE and STEADY monthly income. That is a HIGH HURDLE to cross in today's day and age.

[surfersdsb]

Re: 3 arguments for inflation, and 3 tactics to cope

Being a long term wall street commodity trader your advice on how to take advantage of the coming inflation (which I agree with) is fraught with peril.

Borrowing to put on long term commodity positions is a recipe for utter disaster. It makes sense to try and ease into long term commodity positions, real estate not being one of them, but be prepared for volatility.

Best to build a position that you afford and leave the borrowing to others.

[jk]

Re: 3 arguments for inflation, and 3 tactics to cope

Best to build a position that you afford and leave the borrowing to others.

build a position you can afford.
only do borrowing you can afford, if any. i.e. without any significant risk because any risk is mitigated by other assets or reliable income streams.

i just want to add that although suggesting debt is certainly provocative, it was not the intended main point of my post. my main point is that these 3 lines of argument/mechanisms, each entirely independent of the others, all point in the same direction.

[jpatter666]

Re: 3 arguments for inflation, and 3 tactics to cope

Fair enough.

I'll admit to not having a hard-core iTulip position. I've still got stocks, didn't sell my primary residence and then rent, etc, etc. iTulip remains my guiding financial philosophy source, but I leaven it here and there from other areas.

I do think that we are bound for some hard times, very likely some serious inflation, but I'm not in the "I need guns, gold and cipro" camp either. I'm hoping for the best, preparing for the worst -- but not letting that totally dictate my investing.

[FRED]

Re: 3 arguments for inflation, and 3 tactics to cope

There's more to our inflation forecast than that. From Everyone is wrong, again – 1981 in Reverse Part II: Nine Signs of Inflation the relevant factors for near term inflation:

• Credit crunch induced supply shock
• Weakening dollar and cost-push inflation from energy imports
• Inflationary impact of excessive money growth
• Inflationary institutional policy bias
• Bankruptcies induced industrial concentration

Result: Rising PPI by Q3 2009 and rising CPI by Q4 2009 but no later than Q1 2010.

[herbkarajan]

Re: 3 arguments for inflation, and 3 tactics to cope

3 Counter arguments articulated by Hugh Hendry:

Quant. Easing has been tried only once before (Japan) and didn't succeed

Private sector is countering Fed measures by tightening credit, longer maturity rates are up, which leads to the economy crashing back down

Turning point events in Debt cycle take very long time (decades)
http://www.youtube.com/watch?v=PYi91...eature=related

[jk]

Re: 3 arguments for inflation, and 3 tactics to cope

There's more to our inflation forecast than that. From Everyone is wrong, again – 1981 in Reverse Part II: Nine Signs of Inflation the relevant factors for near term inflation:

• Credit crunch induced supply shock
• Weakening dollar and cost-push inflation from energy imports
• Inflationary impact of excessive money growth
• Inflationary institutional policy bias
• Bankruptcies induced industrial concentration

Result: Rising PPI by Q3 2009 and rising CPI by Q4 2009 but no later than Q1 2010.

[emphasis added]
fred, then what happened to ej's reallocation of part of the cash position?

[jimmygu3]

Re: 3 arguments for inflation, and 3 tactics to cope

the solution to [credit] pollution is [credit] dilution.

we are on a path to a significant spike in inflation. this will "solve" the problem of too much debt. this is why tptb want to "get credit flowing again."

3 reasons to expect inflation:

1. fleckenstein's argument- although the fed says it will take back, or drain, what they have "quantitatively eased" into the system, they won't. the economy will be judged too fragile, and there will be too much political pressure for the fed to drain.

2. janszen's argument- there are already a plethora of dollar assets in existence. at some point foreign holders will get antsy and start to defect from the dollar- trying to cash in their dollar assets for real assets all around the globe, including in the u.s. there will be a sharp dollar drop and commodity based inflation.

3. amerman's argument- the present value of the social security and medicare and pension claims of the baby boomers is approx. $1million/younger- and non-boomer household above the poverty line. the only way the "promises" aren't broken [which would cause huge political turmoil] is to lower significantly the value of the dollar. there will be an inflation spike sometime in the next 5-8 years which will more than cut the value of the dollar in half. the inflation spike will not be much reflected in the official cpi, thus allowing for underexpensing indexed payments like social security.


strategies:

1. borrow fixed rate money now. rates are low and future inflation will eventually reduce or erase the burden of the loan.
2. use most of the borrowed money and other funds to buy precious metals and commodities.
3. consider buying income producing assets- real estate, energy producers, farmland..

timing- borrow now. you may want to wait on the purchases, or you may want to scale into purchases a bit at a time.

I agree that inflation is coming and with most of the reasons you outline.

As for Amerman's argument, I would suggest that dollar debasement will not change the real cost of health care that much. Artificially low CPI will keep Medicare co-pays low just as much as it reduces real gov't outlays. In the end, Medicare has to pay for sick old people and no accounting tricks can change that. Maybe the level of care will drop, but voters will not be happy about that. As for Social Security, they just need to raise the retirement age, which could also keep more people on private insurance and off Medicare.

And to your recommendations, frankly I was quite surprised. After reading your later explanations, it appears that you are not advocating over-leveraging, but it certainly reads that way. The reality is that the only way to get cheap money now is on a conforming mortgage or ARM. Problem with that is, when inflation goes to double digits, so will rates, and the market value of the house will drop accordingly. I'm selling my house right now and I think it is going to feel mighty good not to have that leveraged debt anymore.

Jimmy

[medved]

Re: 3 arguments for inflation, and 3 tactics to cope

strategies:

1. borrow fixed rate money now. rates are low and future inflation will eventually reduce or erase the burden of the loan.
2. use most of the borrowed money and other funds to buy precious metals and commodities.
3. consider buying income producing assets- real estate, energy producers, farmland..

timing- borrow now. you may want to wait on the purchases, or you may want to scale into purchases a bit at a time.

What about buying LEAPS for commodity ETFs? Gives you some serious leverage without borrowing and with limited risk.

Also, talking about risk in general, don't forget about increased regulation. Rationing, price controls and excessive taxation can kill the profits you get from income-generating assets. I am sure, e.g. energy/oil companies will be taxed to death and sued for every new development. Even when/if you get a sizable income/gain, something like enhanced AMT will come about to make sure "the rich" pay their "fair share". So, eventually, your borrowing will not be justified. Unless, of course, your trades happen in the black market (physical PMs, anybody ;)).

[dummass]

Re: 3 arguments for inflation, and 3 tactics to cope

Fred gives us 5 reasons to expect inflation, yet your counter arguments only respond to two of them: excessive $ growth and institutional policy bias.

From a simple stand point of debate, you failed to counter his other three arguments: credit crunch induced supply shock, weakening $ and cost-push energy imports, and bankruptcies induced industrial concentration.