Inflation is the great thief. It is a tax on wealth that takes away the money earned from a lifetime of work and saving even while it is locked away within a bank vault or hidden under a mattress. Governments use inflation as a last resort when they can no longer raise revenues through taxes or growth in the economy. It is a favorite tool of socialist governments which print money to pay for the benefits they’ve promised and well it should be – it makes everyone equal and equally poor.
Inflation is a modern invention. Up until the 20th century, people were paid in goods directly through a barter system or with coins made of precious metals. The value of the metal in the coins was equal to the value of the work performed or goods provided. If you did enough work to buy a loaf of bread, you were given a coin with enough silver in it to buy a loaf of bread in the future whenever you wanted. It was a perfect store of the wealth created by your work since it could be sold for the silver in the coin even if the government that issued it no longer existed. Even when people tired of carrying gold or silver around, governments issued certificates that could be traded in for gold or silver when desired.
That disappeared when governments needed more cash than they could collect from taxes to pay for wars and social programs. They stopped backing money with precious metals and instead issued bank notes whose value floated. Money could be created with the stroke of a pen, and then later the click of a mouse. Money magically appeared in bank vaults for which no labor was done. When that money was released in the economy through loans or as payments for services, the value of all cash in existence declined.
Eventually the value of the money becomes so worthless that even the coins made of non-precious metals became more valuable than their face value. The pennyl gained a zinc core when the value of the copper in a penny became worth more than one cent. Today even the zinc is worth too much – pennies are thrown to the ground and left in parking lots.
We’ve seen the effect of extreme inflation. Before WWII the German government printed so much money that people needed to take cash in a wheelbarrow to the market to buy groceries. In Mexico for years vendors would give a discount for US currency since they knew they it would hold its value better than the peso.
With the Federal Reserve printing unheard of amounts of cash to buy loan securities and provide money to Uncle Sam for purchases, we are likely to start seeing inflation pick-up in the US once the economy finally starts humming again. When that happens savers who saw their returns from traditional cash assets like CDs will see their purchasing power drop away as the price of utilities and food skyrockets.
So how can you protect your savings from this silent thief? If you are going to keep money around for any period of time, you need to invest it in something that will provide a return at least equal to inflation.
One thing you can buy are goods that do not wear out over time and which require little or no maintenance. These are things like quality wood furniture, formal serving dishes and silverware, and quality tools. These must be purchased used, ideally through an estate sale or through a classified ad since otherwise an immediate loss will be experienced from the retail mark-up. The amount of wealth that can be stored in this way is limited, however.
Another good store of wealth is real estate. Land will increase in value at the rate of inflation, at least over long periods of time. It may actually increase faster than inflation if the land somehow becomes more valuable, for example if a city grows up near the land. Land is a better store of wealth than a home or other building since the building will require maintenance and the property taxes will be higher. If the building can be rented, however, one might be able to cover these costs and make a small profit in addition to the appreciation of the land.
Probably the best hedge against inflation is common stocks. As inflation increases, the value of the assets of the company will also increase. The company will also usually be able to pass their increased costs for goods and employees on to the customers, so their earnings will increase at the rate of inflation or more.
What about the original inflation hedge, gold? If you want to store wealth for your great-great grandchildren with little care, you might want to bury some gold in a jar in the woods and leave a treasure map. Another alternative would be to store the gold in your home, and that of your heirs after your death, in a sturdy safe that is kept very secret. Otherwise, the cost of storing gold at a commercial facility will eat away at its value over time.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.