Inflation Winners And Losers.
Posted: April 21st, 2010 | Author: Joe | Filed under: Debt, Economy | Tags: commodities, Debt, Economy, Inflation, Mortgage Rates, Saving, Stocks | No Comments »We often hear that the record spending of the U.S. federal government is going to lead to an increase in inflation – either a moderate increase of 3-4% or hyperinflation on par with Weimar Germany of the 1920′s, depending on who you listen to. I’m not going to get into the hyperinflation debate, but I will say that a little bit of inflation is a good thing (that’s what leads to your “standard of living increase” in your paycheck) and it is in fact the goal of the U.S. government – regardless of the party in control.
In very simplistic terms, you have a spectrum that runs from deflation (a shrinking of the money supply – think Great Depression) all the way to hyperinflation (rapid and uncontrolled growth of the money supply – Weimar Germany in the 20′s, or Zimbabwe in the early 2000′s). The ideal situation is someplace near the middle, but leaning slightly toward the inflation side of things.
As with many things in life, there are winners and there are losers. Here’s the break down of who falls into which category if inflation spikes.
Winners in an inflationary environment.
- Fixed rate mortgage holders.
- Auto loan holders.
- Investors in stocks.
- Investors in commodities.
Anyone with a loan that is backed by an asset, be it a car or home, is a winner because the value of the asset rises while the amount owed remains constant and is paid back in devalued currency (assuming the loan is fixed rate). The fixed rate is also a benefit because one of the first things to rise with inflation is interest rates.
On the investing side of things, stock holders receive some protection from inflation because the underlying companies can raise their prices to keep up with inflation, thus preserving their value. Commodities investors do well because the supply of the underlying commodity cannot be manipulated as easily as fiat currency (i.e. you can print more paper money, but it’s much harder to mine new gold).
Losers in an inflationary environment.
- The U.S. economy.
- Savers.
- Retirees.
- Investors in long-term bonds.
- Variable rate mortgage holders.
- Those with credit card debt.
- Consumers.
- First time home buyers.
The economy loses because inflation erodes the value of the currency and the purchasing power of consumers. Consumers lose their standard of living and can no longer afford the latest and newest “thing”, let alone groceries, gas and other essentials. Savers lose in an environment where inflation rises faster than the interest they earn on their savings, and their purchasing power erodes more quickly than their savings grow. In essence, they can’t save enough to afford the things they want or need to buy because the prices rises too quickly.
Anyone with variable interest rate loans is going to end up paying more as the rates rise, and credit card holders will be hardest hit. First time home buyers will have a difficult time saving for a home, when the value of the home grows faster than their savings. For existing home owners, the value of their home will help negate the rising value of other homes.
How to be a winner.
The takeaway here is that you can position yourself to be a winner, or at least lose less, by taking the following steps:
- Live on less than you earn (live frugally).
- Save while you can.
- Only buy appreciating assets, where you can.
- If you borrow money, make sure it’s a fixed rate loan.
- Own a home and don’t rent (where appropriate).
- If you invest, favor short term bonds, stocks and commodities.
