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Inflation is on the rise, how to protect your portfolio
With producer prices rising at the fastest pace in 27 years, Ben Bernanke, Chairman of the Federal Reserve Board, reported that “upside risks to the inflation outlook have intensified” in his testimony before the Senate Banking Committee.
Producer prices rose a seasonally adjusted 1.8% in June and soared 9.2% from a year ago, the biggest year-over-year increase since 1981, according to the Commerce Department. Equally startling, the U.S. Consumer Price Index rose 1.1% in June, the biggest monthly rise since June 1982. At the same time, the Purchasing Managers’ Index of prices paid by manufacturers shot up to the highest level since 1979, reflecting surging energy costs that may drive prices even higher.
Prices of goods imported into the United States jumped by 15.4% in the twelve months to April, according to the Bureau of Labor Statistics. That year-over-year jump was the biggest since the Index was first published in 1982.
Do you need even more evidence that inflation is upon us? The Commodity Research Bureau Continuing Commodity Index (The CRB Index) made an all-time new record this past week, so it’s clear that the bull market in commodities is alive and well. We are seeing unrelenting new demand for commodities from China, Brazil and India – economies which continue to surge ahead, demanding all types of commodities that are required to build everything from basic infrastructure to consumer products.
It’s no surprise that the dollar, which has been trading in a narrow band against the euro since April, fell to a new all-time low before recovering slightly. Traders were concerned about the fact that the dollar fell against the euro even though European economies show clear signs of faltering themselves. As U.S. financial problems have deepened in recent weeks, the dollar has fallen against the euro, the British pound, the Canadian dollar and the yen, and seems to be poised to weaken even more.
The latest fall in the dollar complicates the job of the Federal Reserve as it tries to bolster the economy at the same time that it fights inflation. One of the prescriptions for a week economy is lower interest rates, which would cause more damage to the dollar, something both the Fed and the Treasury Department want to avoid. A weak currency spurs on inflation, as imported goods become more expensive.
Central banks to the rescue? Since the credit crisis erupted almost a year ago, the Fed has been trying to lower interest rates – exactly the wrong thing to do if inflation is your principal concern. Not that the Fed has had much luck in lowering the all-important mortgage rates. At the same time that the Fed has cut rates by 325 basis points, private sector borrowing rates, especially mortgage rates, have risen to higher levels than when the crisis began – further undermining the main source of the economic problem, residential real estate.
What if the Fed does an abrupt about face and begins to raise interest rates to curtail inflation. Will that work? First of all, it will slam the brakes on the economy, which is exactly what the Fed doesn’t want to do. Moreover, the fact is that the central banks can influence the rate of inflation only at a long remove; nothing they can reasonably do will change it in the near term. Inflation is what we’ve got, and the Fed, through Bernanke, is telling us that recession is a bigger risk than inflation, so we can forget about the Fed raising rates.
Billionaire investor Warren Buffet is concerned about “stagflation” – a slowdown in the U.S. economy at the same time that inflation accelerates. He says that we’re in the middle of it right now, and that he thinks the “flation” part will heat up and the “stag” part will get worse.
As investors’ concerns about inflation become more acute, they increasingly turn to inflation hedges such as gold. However, some sophisticated investors realize that rare coins have, historically, been a much better hedge against inflation than gold has been – twice as good, in fact.
“The correlation of the return on coins with inflation over the last 29 years is well above that of other assets considered, and nearly two times that of gold; thus, the contention that gold is a better hedge against inflation than rare coins is not supported by the data.” (The Investment Performance of Rare U.S. Coins, by Raymond E. Lombra, Ph.D., an Independent Study of the Investment Performance of Rare U.S. Coins for the Period January 1979 through December 2007. This study updates and extends an earlier study, which was prepared for the Joint Committee on Taxation of the U.S. House and Senate.)
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