The 10 Smartest Things Ever Said About Inflation

Inflation is defined as “a…rise in the general level of prices related to an increase in the volume of money and resulting loss of value in currency.” 

We have been living through a period of extremely low inflation but this won’t last forever, and even a low rate of inflation can significantly erode purchasing power over a retirement of several decades.  So to help you better understand inflation, and what you can do protect yourself against it, here are the 10 smartest things ever said about inflation:

(1)  Who is Responsible? “Government is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.”  – Ludwig Von Mises

The primary cause of inflation is governments printing too much money.  To be fair, most governments don’t print so much money that it becomes worthless (although it does happen) but governments frequently print enough money that it becomes worth less than it was previously. 

For a current example of a government printing so much money that it’s currency is well on its way to becoming worthless, here is an article from the Washington Post, dated November 27, 2016, about inflation in Venezuela.

(2) Shrinking Money: “Most people, as consumers, think of inflation as prices moving up…As investors, we think of inflation not as prices moving up but as the value of money shrinking.”  Ronald H. Muhlenkamp  

Inflation manifests itself in increased prices but its root cause is a decrease in the value of money caused by “too much money chasing too few goods.”  It is caused by governments increasing the supply of money not by businesses increasing prices.  This distinction is important because, as economist Percy Greaves explained, “Changing the definition changes the responsibility.”  Inflation is generally not caused by greedy businesses but by greedy governments.

(3)  Inflation is the Adversary: “All investors share one formidable and all too easily underestimated adversary: Inflation.  This adversary is particularly dangerous for individual investors – and most particularly dangerous for retired people.  Over the long run, inflation is the major problem for investors, not the attention-getting daily cyclical changes in securities prices that most people fret about.”  Charles D. Ellis  

We need to pay more attention to the long-term effects of inflation and less to the day-to-day dance of the markets. 

(4)  Inflation is a Hidden Tax: Inflation is a hidden income tax that a government places on its people through fiscal and monetary policy.  Inflation distorts investment results.  Nominal returns may look great on paper, but real returns are what counts.  If an investment earned 5 percent one year, and that year inflation was also 5 percent, then the “real” rate of return was 0 percent.  Actually, it is less than 0 percent because the IRS taxes the full 5 percent nominal gain regardless of the inflation rate, which in effect is a government income tax on a government inflation tax.  In the above example, a 30 percent tax on a nominal return of 5 percent leaves you with 3.5 percent, and a real return of negative 1.5 percent.  Richard Ferri

Always measure investments by their “real” (after inflation) returns, not their nominal returns, and don’t forget to consider the effect of taxes.  Only by considering the corrosive effects of inflation can you determine if your investments are performing well or not. 

(5)  Even Low Inflation Rates Can be Dangerous:  I believe that the relatively low inflation rates we have experienced in the last quarter century might actually be just as dangerous as the hyperinflation I grew up with in Latin America.  This is because low numbers can be easily ignored.  Yet over long horizons they can be just as deadly…”  Moshe Milevsky

Is Milevsky exaggerating?  Maybe a little, but consider that at only 3 percent inflation (which our government considers “normal”) the purchasing power of your money will be cut in half in 24 years.  Since many people’s retirements last longer than this you can easily lose more than half the purchasing power of your income during retirement, which could turn a comfortable retirement into one of near poverty.    

Like the proverbial frog in the pot of slowly heating water the fact that you barely notice the shrinking purchasing power of your retirement income doesn’t make the damage any less painful in the end.  With high inflation we know we need to take steps to fight against it, but with low inflation we are often lulled into a false sense of security.   

(6) Humor is a Great Teacher: “Americans are getting stronger.  Twenty years ago, it took two people to carry ten dollars’ worth of groceries.  Today a five-year-old can do it.”  –  Henny Youngman

Sam Ewing adds, “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.” 

Funny, yes, but also a vivid reminder of what inflation can do to purchasing power over time.

 (7)  A Picture is Worth a Thousand Words: [The figure below] “shows three postage stamps: 1968, 1978, and 2007 – 6 cents, 13 cents, and 41 cents.  Each stamp has the same value.  Each stamp is a first-class postage stamp in the United States.  Each stamp has a different price and a different date.  What changed between 1968 and 2007 wasn’t the value of the stamp; it was the value of the dollar.  Between 1968 and 1978 the dollar lost half its value.  So, to get the same value, you had to double the price of the stamp.  From 1978 to 2007 the dollar lost (more than) two-thirds of its value, so you had to triple the price of the stamp.”  – Ronald H. Muhlenkamp   


I love this powerful visual reminder of the effects of inflation over time.

(8)  You Can Run but You Can’t Hide: “Inflation might be seen as a wind that blows ill on those who try to hide from it.  People who keep investing in the economy and producing marketable goods will do well.”  George Gilder

Inflation is especially dangerous to risk-averse investors.  United States Government Treasury Bills (T-bills) are often referred to as a “risk free” investment.  Is this really true?  Consider the following example by James P. O’Shaughnessy:

“Had you been an extremely conservative investor and kept your portfolio in U.S. T-bills, your 1927 $10,000 would have grown to only $16,256 by the end of 2009, a real average compound return of just 0.59 percent.  In essence, you would not be much better off than you were in 1927, since your portfolio earned virtually nothing in 82 years.  T-bills appeal to conservative investors over the short-term because there is virtually no possibility of short-term loss.  Yet look at what inflation did to the hapless T-bill investor –the maximum decline of the inflation-adjusted T-bill portfolio was 49 percent [over a 5-year period], the result of holding cash in an inflationary environment.” 

The devastation that inflation causes to conservative investors over long periods of time led James Grant, editor of Grant’s Interest Rate Observer, to quip that T-bills’ promise of risk-free returns often turns into a delivery of “return free risks.”  Staying engaged in the economy, and taking at least a moderate amount of risk, even in retirement, is the best protection against inflation.   

(9)  Protection Against Inflation: “U.S Treasury Inflation-Protected Securities protect against inflation with certainty, while real estate holdings guard against inflation with reasonable assurance…domestic equities add to the inflation characteristics of a portfolio, but in the short run domestic equities prove notoriously unreliable as inflation hedges.”  David F. Swensen

Investing superstar David F. Swensen offers three tools to protect yourself from the effects of inflation.  Some combination of these three tools should be included in all retirement portfolios:

  • U.S. Treasury Inflation Protected Securities (TIPS): TIPS are a special type of U.S. government security first introduced in 1997. TIPS protect investors against inflation by adjusting the principle amount of an investment based on the Consumer Price Index (CPI) and then paying a set rate of interest on the adjusted principle amount.  For example, if you invested $1,000 in TIPS and the CPI rose 2% the first year after your investment, the principle amount would be adjusted to $1,020, and the agreed to interest rate would be paid on the adjusted principle. During periods of deflation the principle would be adjusted downward.  As an inflation hedge, Swensen recommends investing half of your bond allocation in TIPS. 
  • Real Estate: During periods of inflation the value of real estate usually rises at least as fast as the general rate of inflation. If you don’t want to be a landlord Real Estate Investment Trusts (REITs), a type of company that invests in real estate, are a great investment option.  REITs are widely available to investors through mutual funds and ETFs and offer a similar hedge against inflation as owning actual real estate.    
  • Domestic Stocks: Over long periods of time stocks have always rewarded investors with returns greater than inflation. However, over short time periods stocks can’t even be relied on to provide positive nominal returns, much less protect you from inflation.

(10)  Delay Social Security: “One alternative to TIPS is an inflation adjusted annuity, and an elegant and extremely effective way of accomplishing this is by ‘buying’ the 8% annual increase in Social Security payments received for each year of delaying their starting date.  The ‘payment’ for this ‘annuity’ is the money spent on living expenses before the recipient’s 70th birthday, when the maximal benefit kicks in.”  William Bernstein

Since Social Security is adjusted annually for inflation a bigger monthly check from the government means increased protection against inflation.  Unfortunately, getting a bigger Social Security check involves patience, and most of us are either unable or unwilling to wait.  Although it might be difficult to wait the inflation protection offered by delaying Social Security makes this a strategy you should employ if at all possible, even if it means spending down other retirement savings in the meantime. 

There you have it; the ten smartest things ever said about inflation.  These quotes should provide you a better understanding of the cause of inflation, its effect on the purchasing power of your money over time, and most importantly, what you can do protect yourself from it. 

Review these quotes about inflation, examine your own situation, and make one or two moves to prepare for a future which will almost surely include periods of inflation much higher than what we have seen in the recent past.  Now is the time to prepare.

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