Hedging against inflation and the devaluation of the dollar

[monothemonkey]

After 1971 when Nixon took the US Dollar off the gold standard, it because fiat currently, backed by nothing but the full faith and credit of the US government.  I guess it's also backed by men with guns and the threat of violence.   The Federal Reserve is actually not part of the government, despite it's name.  The Fed has a mission of 2% inflation per year.  I believe this is because of the fear of a deflationary economy and the possibility of a death spiral.  The situation where people wouldn't spend money based on the assumption that it would be worth more tomorrow.  Our current situation is that 2% annual inflation massively degrades savings that we have that are not indexed to inflation.  The purchasing power of the US Dollar has continued to decrease and the US government has continued to increase it's debt.

I just don't see how this system is sustainable!  Is it possible there will be a debt jubilee?  If not, does the dollar continue to lose value and should we be storing wealth in places that are indexed to inflation, and have minimal cash?  The obvious answer seems to be holding real estate investment properties that create monthly cash flow.  What else can we do?  Gold and Silver are periodic elements, there is a fixed amount (although we don't know exactly what that is) and have been valued for thousands of years.  There is some use in industry, although much more use for Silver than Gold from what I understand.  The silver price has also been artificially manipulated by JP Morgan.  People are attracted to gold, though it doesn't make sense, because it doesn't return a reward and if you buy it just to speculate on it's price, you actually pay a cost to store it.  Another option is Bitcoin, which I know isn't very popular on this forum.  I see the blockchain industry being bigger than the industrial revolution and the invention of the internet.  Time will tell I guess.

So how can we hedge against dollar devaluation?  I really do welcome any info contrary to what I believe and look forward to a discussion that I can learn more about why I might be wrong.  I have already read the blog post about "why bitcoin is stupid" and found some arguments there, but I'm not satisfied with dismissing this technology.  I don't intend this discussion to be entirely about blockchain, but welcome any and all topics on how to store wealth.

[DreamFIRE]

The 4% rule factors in inflation.  There's a long sticky thread in the investing section about it.

Also see:

https://forum.mrmoneymustache.com/ask-a-mustachian/protect-your-nest-egg-from-inflation/

[PiobStache]

If you're worried about fiat currency just move your money to a currency that isn't fiat...but good luck with that.

[Retire-Canada]

So how can we hedge against dollar devaluation? 

Equities are an excellent inflation hedge as is a 30yr low fixed rate mortgage.

[bacchi]

Annual inflation actually encourages investing because keeping it in the bank is a money losing game. Best to put it in equities or real estate development.

How will blockchain be bigger than the industrial revolution or the internet? The technology can do cool things but bigger than using factories to make cars or washing machines?

[cosine88]

You could go for oil producing companies, or other commodities, for example Lithium. That's going to be needed for a long time for electric cars and etc.

Or solar energy companies, or food companies, or hedge yourself by buying both emerging markets AND domestic stocks.

If you're worried about fiat currency just move your money to a currency that isn't fiat...but good luck with that.

I'm going to just go ahead and be a jerk - that was a completely useless statement.

[PizzaSteve]

I just attended an economics lecture by the top analyst of one of our major fin services firm.  2% is actually the target set 10 years ago. Inflation is slightly rising but right at this goal level and very stable.  You can get almost 2% in a savings acct.  Where are these fears 9f massive devaluation coming from?

Blockchain is very useful tech, but not at all limited to or equal to bitcoinmtype currency substitutes. For example, it likelymwill revolutionize stock trading by allowing decentral trades and disintermediation of large markets someday, but since currency is fundamentally based on trust, I doubt very much your fears are well grounded.

Tin foil hat stuff IMHO.

[maizefolk]

Our current situation is that 2% annual inflation massively degrades savings that we have that are not indexed to inflation.  The purchasing power of the US Dollar has continued to decrease and the US government has continued to increase it's debt.

I just don't see how this system is sustainable!  Is it possible there will be a debt jubilee?

Inflation is actually a slow moving debt jubilee. The more inflation you have, the less weight the overhang of old debts exerts on debtors. That's why in many countries that run up huge long term debt, you'll see their central banks start to increase inflation targets.

As for how to hedge against inflation, just own anything other than cash or debt (bonds). Stocks are good. Real estate can be good (but it's generally more work). Commodities (oil, gold, pork bellies) can be okay, but generally cost money to store and don't produce any real (post inflation) return on investment, even if their nominal price increases with inflation.

[Jon Bon]

I think you have already answered your own question. Precious metals, real estate, stocks.  All are all wonderful hedges against inflation.

Do you just want to have a conversation about the monetary policy of the fed and the United States? We can do that too, but I am not sure why you would be worried about the worlds reserve currency. For example I bet the president of Venezuela keeps his money in dollars, and not Bolivars. Non-American folks often hold dollars for a reason.

If you are super risk averse and worried about inflation there are always TIPS.

[monothemonkey]

I think you have already answered your own question. Precious metals, real estate, stocks.  All are all wonderful hedges against inflation.

Do you just want to have a conversation about the monetary policy of the fed and the United States? We can do that too, but I am not sure why you would be worried about the worlds reserve currency. For example I bet the president of Venezuela keeps his money in dollars, and not Bolivars. Non-American folks often hold dollars for a reason.

The US is clearly the best currency to hold.  The monetary policy here is probably as good as it gets.  I just think that world monetary policy is going to hit some tough times ahead.  Evidence of troubled currencies like Venezuela seem to enforce my fear that fiat currencies have a finite lifestyle before they fail.

I appreciate the other comments above and the information given about commodities, real estate, emerging markets, etc.

Thanks guys!

[Pylortes]

Own wide moat stocks who can raise their prices over time, or commodity stocks such as energy companies, or real estate.

I have a very small % of my net worth in precious metals.  I keep very little cash in the bank due to inflation risk.  Normally once it gets to a few thousand, I send $ out to stocks/investments.  If I can't find an investment currently to my liking and my cash is getting too high, I convert some $ into precious metals.  This is a replacement for what otherwise would be cash.  A further hedge, but really stocks and real estate are the best answers.

[PiobStache]

If you're worried about fiat currency just move your money to a currency that isn't fiat...but good luck with that.

I'm going to just go ahead and be a jerk - that was a completely useless statement.

How so?  The majority of the OP is given over to his concerns of the US having a fiat currency (and an odd mention of the periodic table) and how this is not a viable long term situation.  My point is that if your concern is fiat currency you're in a pretty tough position as there's no getting away from it.

[GrumpyPenguin]

I don't think many people here have a lot of dollars just sitting in a bank account, at least compared to their net worth. Maybe you could say we are all hedging by default?

[Retire-Canada]

Maybe you could say we are all hedging by default?

I would say not by default...we are doing it pretty intentionally.

[RedmondStash]

I don't think many people here have a lot of dollars just sitting in a bank account, at least compared to their net worth. Maybe you could say we are all hedging by default?

This.

[EnjoyIt]

After 1971 when Nixon took the US Dollar off the gold standard, it because fiat currently, backed by nothing but the full faith and credit of the US government.  I guess it's also backed by men with guns and the threat of violence.   The Federal Reserve is actually not part of the government, despite it's name.  The Fed has a mission of 2% inflation per year.  I believe this is because of the fear of a deflationary economy and the possibility of a death spiral.  The situation where people wouldn't spend money based on the assumption that it would be worth more tomorrow.  Our current situation is that 2% annual inflation massively degrades savings that we have that are not indexed to inflation.  The purchasing power of the US Dollar has continued to decrease and the US government has continued to increase it's debt.

I just don't see how this system is sustainable!  Is it possible there will be a debt jubilee?  If not, does the dollar continue to lose value and should we be storing wealth in places that are indexed to inflation, and have minimal cash?  The obvious answer seems to be holding real estate investment properties that create monthly cash flow.  What else can we do?  Gold and Silver are periodic elements, there is a fixed amount (although we don't know exactly what that is) and have been valued for thousands of years.  There is some use in industry, although much more use for Silver than Gold from what I understand.  The silver price has also been artificially manipulated by JP Morgan.  People are attracted to gold, though it doesn't make sense, because it doesn't return a reward and if you buy it just to speculate on it's price, you actually pay a cost to store it.  Another option is Bitcoin, which I know isn't very popular on this forum.  I see the blockchain industry being bigger than the industrial revolution and the invention of the internet.  Time will tell I guess.

So how can we hedge against dollar devaluation?  I really do welcome any info contrary to what I believe and look forward to a discussion that I can learn more about why I might be wrong.  I have already read the blog post about "why bitcoin is stupid" and found some arguments there, but I'm not satisfied with dismissing this technology.  I don't intend this discussion to be entirely about blockchain, but welcome any and all topics on how to store wealth.

You have multiple topics to discuss and I will address them one by one:

1) Yes, the US economy just like every economy these days is fiat. Also, historically all fiat currencies have failed at some point.  Is this time different because of how the world operates today?  I hope so, but more than likely in some distant future the US dollar will likely fail or at the very least be converted to something else.  I do not think this will be in our lifetime though.  As it stands today, the US dollar is one of the best currencies to own so you might as well stick with it.  For the dollar to collapse, the US government must collapse first and I just don't see that happening despite the ridiculously large debt we own.  Personally I like to look to Europe as precedent since many European countries hold way more debt as a percentage of GDP and until they start falling under its weight I see no reason to worry.

2) I agree with you that gold is not really a great asset these days.  Though owning companies that produce a profit is.  The only thing that will stop all these companies from producing and making a profit long term is the collapse of all the nations they reside in. At that point you are far better off owning canned goods, ammo and a skill that other people want.  Sure we will have recessions and maybe another runaway inflation, but holding real estate and stocks you put yourself in a very good position to come out relatively unscathed if not even profitable since you are knowledgable enough to hold on tight instead of panic sell.

3) You brought up bitcoin and I simply must address it.  Although Blockchain tech is awesome and may very well be the future of information exchange, owning bitcoin does not get you shares into this technology.  You do not and will not get blockchain dividends and you do not own a piece of a patent getting royalties when someone elses uses it.  Just like gold, a bitcoin does not produce income and fluctuates based on the emotions of the people willing to buy and sell them. In fact, bitcoin is not even a currency these days.  To be a currency people need to use it to buy and sell goods and services.  Although the capability exists very few legal transactions occur via bitcoin.  The reason for it is because transaction costs are high.  Why buy a cup off coffee for $5 and pay a $0.75+ transaction fee because you used bitcoins?  Also, for a currency to be used, its value must be relatively stable and bitcoin is very very far from being stable.  Again you can't do a transaction where buying a car is 3 bitcoins today then 3.5 bitcoins 2 weeks from now and 2.5 bitcoins 6 months later.  Bitcoin is simply not a currency.  Bitcoin is really a collectible item used solely for speculation in the hopes that someone one day is willing to pay more for it than you have.  Nothing wrong with speculating, it is your money and do as you will with it, but do it with the understanding of exactly what you are purchasing and its goals.

[PDXTabs]

So how can we hedge against dollar devaluation? 

Equities are an excellent inflation hedge as is a 30yr low fixed rate mortgage.

Yes, my inflation hedge is equities, but fixed interest debt is also a good choice.

[genesismachine]

I just don't see how this system is sustainable!  Is it possible there will be a debt jubilee?  If not, does the dollar continue to lose value and should we be storing wealth in places that are indexed to inflation, and have minimal cash?  The obvious answer seems to be holding real estate investment properties that create monthly cash flow.  What else can we do?  Gold and Silver are periodic elements, there is a fixed amount (although we don't know exactly what that is) and have been valued for thousands of years.  There is some use in industry, although much more use for Silver than Gold from what I understand.  The silver price has also been artificially manipulated by JP Morgan.  People are attracted to gold, though it doesn't make sense, because it doesn't return a reward and if you buy it just to speculate on it's price, you actually pay a cost to store it.  Another option is Bitcoin, which I know isn't very popular on this forum.  I see the blockchain industry being bigger than the industrial revolution and the invention of the internet.  Time will tell I guess.

So how can we hedge against dollar devaluation?  I really do welcome any info contrary to what I believe and look forward to a discussion that I can learn more about why I might be wrong.  I have already read the blog post about "why bitcoin is stupid" and found some arguments there, but I'm not satisfied with dismissing this technology.  I don't intend this discussion to be entirely about blockchain, but welcome any and all topics on how to store wealth.

So let's break down ideas:
Stocks - Companies have a lot of debt now, and in many ways are in the same boat as the government. Inflation may not be a bad thing for them. Debt may remain constant while revenues increase if there is high inflation, which should prop up the stock price. This is not considering secondary effects of inflation.

Real Estate - During inflationary times, real estate is considered to be a good inflation hedge - except when it's not. If there is hyper-inflation, the government may be pressured by the renters to enact rent control. This is exactly what happened in post WWI Germany, and rent costs eventually ended up being less than 1% of household spending (yes, you read that right). So always remember rent control can be a factor. Those who were able to hold on were able to sell properties when rents were normalized, but many landlords lost everything in the meantime.

Metals/commodities - This is theoretically good, but there is always the risk that A) Demand drastically changes, or B) Supply drastically changes. For oil, electric cars *may* cause large drops in demand. For metals, very large very productive undiscovered mines may suddenly be discovered and cause huge increase in supply. Both types of events have happened many times before.

Bitcoin - Demand may increase while price goes down. This is a possibility. If there is a bitcoin ETF that tracks Bitcoin without requiring the ETF to hold the underlying asset (to truly be a derivative product), people may decide to buy that instead of Bitcoin. There are any number of ways that the details can be worked out on these types of derivatives. There is already evidence that ownership of these types of derivatives where they exist today exceeds demand for Bitcoin since the price of the derivatives exceed the price of Bitcoin itself. Also think, Bitcoin is completely traceable. So in a scenario where you would most want your Bitcoin, what is to prevent the government from locking down all the exchanges? Or confiscating all funds in the exchanges? The exchanges are all required to follow KYC laws, and it would not be difficult for governments to do this if it started to become big enough for them to notice. An untraceable cryptocurrency like Monero may be a better option than Bitcoin if you're convinced of taking this route.

Diversification of the above would probably be your best bet.

For rough numbers, the US debt is increasing at about 5% per year, and debt service accounts for ~20% of total government revenues. If interest rates went up to a very historically normal 6% (the average interest on the debt is ~2% today), they would account for ~60% of total revenues and the debt would increase at a rate of 15% per year assuming no other changes. So right now, 5% annual debt increases can be contained because we have ~2% inflation and ~2% growth, so it's only increasing by 'net' ~1% per year. But if we have 15% debt growth per year, then that's a different ballgame. Also keep in mind that 2/3 of debt is held by non-government entities like corporations, so government is only the tip of the debt iceberg.

If we have higher interest rates, there are only a few variables in this equation to make it balance out:
1 - Growth is going to be above 2%
2 - The fed will let inflation exceed 2%
3 - Government revenues are going increase
4 - Non-debt government spending is going to decrease
5 - Interest rates are going to go down

I'll leave it to you which you think might be most likely. Personally, I think #2 is the least painful lever for the government to pull and it is historically by far the most likely, but the truth is nobody can predict the future.