Hazlitt on inflation

What You Should Know About Inflation By Henry Hazlitt

Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody's cost of living, imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals.

But it is never "inevitable." We can always stop it overnight, if we have the sincere will to do so.

Inflation in ancient Rome

Quantitative easing in ancient Rome
It would seem clear that the major single cause of the inflation was the drastic increase in the money supply owing to the devaluation or debasement of the coinage. In the late republic and early empire, the standard Roman coin was the silver denarius; the value of that coin had gradually been reduced until, in the years before Diocletian, emperors were issuing tin-plated copper coins that were still called by the name "denarius." Gresham's law, of course, became operative; silver and gold coins were naturally hoarded and were no longer found in circulation.

During the fifty-year interval ending with the rule of Claudius Victorinus in A.D. 268, the silver content of the Roman coin fell to one five-thousandth of its original level. With the monetary system in total disarray, the trade that had been hallmark of the empire was reduced to barter, and economic activity was stymied.

Fiat Money Inflation in Revolutionary France, by Andrew Dickson

Fiat Money Inflation in France, by Andrew Dickson


It progressed according to a law in social physics which we may call the "law of accelerating issue and depreciation." It was comparatively easy to refrain from the first issue; it was exceedingly difficult to refrain from the second; to refrain from the third and those following was practically impossible.

It brought, as we have seen, commerce and manufactures, the mercantile interest, the agricultural interest, to ruin. It brought on these the same destruction which would come to a Hollander opening the dykes of the sea to irrigate his garden in a dry summer.

It ended in the complete financial, moral and political prostration of France-a prostration from which only a Napoleon could raise it.

So, even France in eighteenth century had its version of Paul Krugman, Ben Bernanke and quantitative easing.
It is needless too say that fiat currency inflation did not work. But it so interesting how people get seduced by this idea.

Gold and oil higher

Gold Prices Rise On Inflation Worries, Higher Oil

"The price of gold climbed higher on Thursday as encouraging economic data raise the prospects of inflation. Higher oil prices and the dollar's decline against the euro also boosted the precious metal's hedge value."

My investment plan for this business cycle

Every inflation cycle is different.

Following is my plan for this business cycle.

In the initial stage of inflation -
1. Refinance to a 30 year fixed rate loan at a rate below 5%
2. Buy some of following assets - precious metals, emerging market equities and currencies, Asia, commodities, natural resource companies, some too big to fail banks, healthy American industrial companies, and some junk bonds and prime rate funds. Keep some cash. Subscribe to Barrons.

Intermediate stage of inflation -
After the fed raises interest rates for the first time, become a momentum trader. Subscribe to a momentum trading newspaper like Investor's Business Daily and cancel Barrons. Trade with tight stop losses.

Terminal stage of inflation-
After the fed raises rates by at least 2%, start preparing for deflation and reversal of dollar carry trade. Take profits of assets acquired in the initial stage of inflation. Raise cash. If treasuries are above 5%, start nibbling them. Even if treasuries remain in a secular bear market longer than the business cycle, they will provide a risk free arbitrage due to existing mortgage. Subscribe to Barrons again.

Remember also that markets work through deception.

What is your plan? Please share in the comments section.

Lets do an experiment

Lets stand in one corner of the room and continuously pour water on the floor. Now, ask your friend to stand in the opposite corner with a measuring stick. Let him measure the water level. As water has not reached the other corner yet, let us pretend that the water level will never rise. Who are we fooling? And yet, the federal reserve wants us to believe that it can continue to pour money into the system and inflation will not rise.

Three stages of inflation

Every inflation eventually leads to a deflation. There are three stages of inflation.

The initial stage of inflation overlaps with the previous deflation.
People are unsure about their investments and some think that deflation will continue. Value investors perform best in the initial stage of inflation. People who take cheap loans also win. Credit starts to flow to sectors where fundamentals are the best. Every inflationary cycle is different.

In the intermediate stage of inflation, credit continues to flow to sectors where credit is already flowing. The reason is that it is easiest to pay off the debt with a profit if more debt is taken after you have taken debt and more people buy the same assets that you bought. Momentum traders perform best in the intermediate stage of inflation. Technical analysts are mostly momentum traders. When people talk about inflation proofing their portfolio, they usually refer to only the intermediate stage where they see constantly rising prices. That is a mistake because inflation has a full cycle with profit opportunities in each stage.

In the terminal stage of inflation, every talks about investing. People who missed the boom of last few years want to jump in. There are new acronyms. Very soon inflation will be over and deflation will follow. There will be tightness of money.
Cash will soon be king. Risk averse people who hold cash and government bonds win. When deflation takes hold, some bold and prudent short sellers have a party time.

Unfortunately, it is hard to know which stage of the inflation cycle we are in exactly. But we only need to be approximate and more right than wrong to make money in the longer run.