Inflation Protection Investment Strategies

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The debt situation currently facing the U.S. is not unique. Historically, other countries have followed two paths to deal with an overwhelming debt burden: suffer the distasteful consequences of default or monetize their debt and pay it off with devalued money.

Both paths are painful for investors. Either way, the value of the dollar will erode, and investors will be left to grapple with the inflationary consequences. As I will show, recent policies suggest steep inflation may be just around the corner.

Fortunately, investors have some options to bolster their portfolios against the threat of inflation, as I describe below.

The drivers of inflation

Before we look at investment strategies, let’s review the underlying causes of inflation today.

The monetization of debt refers to using inflation (which reduces the value of each dollar) to pay off the national debt. Paying off the debt with somewhat worthless dollars can be politically expedient. That said, inflation leads to many problems for investors holding investments in cash or investments denominated in dollars.

Theoretically, under normal circumstances, a country wants to keep its money supply under control, which should keep inflation under control.

Where does the U.S. stand with the money supply? 

One measure of money supply is the monetary base. The monetary base is highly liquid money that consists of coins and paper currency circulating in the public or in banks and commercial banks' reserves with the central bank.

The monetary base is also called “high-powered money,” because a given increase in the monetary base can cause an even larger expansion in the supply of money, an effect often referred to as the money multiplier. An increase of one billion currency units in the monetary base will typically result in an increase of many more billions in the money supply, as banks use leverage to supply credit to their customers.

The number of newly printed U.S. dollars currently flooding the U.S. and world economies is unprecedented. In January 2008, the monetary base was $848 billion, and today the monetary base has more than doubled to $2.035 trillion. That is an increase in the monetary base of $1.2 trillion in just two and one half years.

St. Louis Adj Monetary Base