I admire Ron Paul. He’s one of few modern Congresspersons to fearlessly stand up to Washington corruption and megalomania. His book The Revolution was a courageous diatribe against ever growing federal government power, American military imperialism, and problems with private money issuance by the Federal Reserve. However, he, like many well-intentioned pundits and leaders of our day, is overly concerned about inflation.
Inflation has been a populist issue for a very, very long time, and low inflation rates seem to be something to celebrate, even though the people most disapproving of inflation – the middle class – are the ones most likely to benefit from it.
Inflation is the general rise in prices caused by increasing the money supply faster than productivity. Contrary to popular perception, money must be printed to keep up with economic expansion; otherwise, the same number of dollars would compete for a growing set of goods and services, causing prices to drop. The resulting deflation is the culprit in most recessions and depressions as well as high unemployment.
Conversely, prices increase when money is printed too fast – that is, faster than the rate of general productivity. But when prices go up, so do prices for labor, because the excess of dollars is now competing for both goods and services. So, for example, when prices rise by 3% but an employee receives a 3% cost of living increase, the result is a wash. The primary effects of inflation are that dollars become less valuable and, consequently, they become easier to get. Who should worry about inflation? The answer is clear: people who have net wealth in dollars.
For instance, a person who has $100,000 in cash in the bank and no debt will discover that her money will buy fewer goods and services next year than they do this year. However, if the same person also has a $500,000 home mortgage, then while her cash will buy less next year, her mortgage will be correspondingly easier to pay, hence decreasing her real debt burden. In essence, she has net dollar debt, not net dollar wealth, for a total of $400,000, that becomes less burdensome year after year as it inflates away. That’s why people who’ve been paying their mortgage for 20 years typically have small mortgage payments: the real cost of their debt has been decreasing while salaries ratchet up (at least) with inflation.
Further, inflation is a significant cause of the increase in home prices, the other significant factor being that land is in limited supply. Yes, we’ve seen insane volatility in home prices in the past three decades, especially in the most recent housing correction, but people who have held their homes for more than twenty years have, on average, seen increases in value between 3% and 6% per year, thanks largely to inflation. For those homes that are mortgaged, the owner enjoys growing equity and decreasing debt burden.
If you have net debt – i.e., you owe more dollars than you have in the bank – then stop worrying about inflation. Seriously. You are not a victim. (This doesn’t mean you should rush out and borrow money, as interest rates generally account for inflation.) If, on the other hand, you have net wealth in dollars, then the only way to reduce your exposure to inflation is to sell your dollars. In other words: buy something of value. Preferably, invest in something that you personally value, but if you seek a store of wealth for long-term savings, almost anything is better than cash.
Unfortunately, investing in something you value requires you to actively introspect and discover what you subjectively value. That’s hard. People generally invest in things they think other people value because they trust groupthink and don’t want to put in the effort of actually figuring out what has value. But groupthink causes fads and fads fade. For example, we can blame the recent real estate crash on loose lending standards and a thousand other causes, but let’s face it: buying an extra condo or two was the in thing in the mid-2000s. Most of the time, people were buying additional properties because they thought they could resell them for a profit, not because they, personally, valued them. If people had bought only what they had intended to keep and enjoy long-term, the real estate crash would been softened or perhaps even prevented.
The same is true of the average stock market investment. Most people, including many experts, buy securities (or funds made up of lots of different securities) because they hope to resell them later at a profit, not because they value the stock ownership per se. In general, the only thing a stock buys is a vote, a dividend, both, or sometimes neither. If you own a non-dividend-paying stock and don’t vote at the company’s shareholder meetings, sell it. Immediately. Buy something you will value instead.
So, what do you value? Real estate? Precious metals? Businesses? Fine art? It’s not an easy question, but well worth answering. After all, if you own what you value, then who cares whether prices are rising or falling? Inflation be damned.