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Is Inflation Just Around the Corner?
Posted by: Roadmap2Retire (IP Logged)
Date: February 11, 2014 10:18AM

Inflation is a tricky beast to control. The central bankers around the world do not want it rampaging and destroying the masses in its path. They want to rein it in and control it without killing it. Ever since the financial crisis of 2008-2009, the US Fed has slashed the interest rates and has been on a bond buying spree. The central bankers of the developed economies have followed suit with slashing their interest rates, whilst keeping an eye on the inflation rate. Cutting the interest rate was supposed to be a temporary measure to spur the economies and inflation for now, remains dormant. On the contrary, the International Monetary Fund (IMF) recently warned of deflationary risks. Deflation would be the biggest nightmare for the economies - something that occurred during the Great Depression of 1930s, a repeat of which Ben Bernanke wanted to avoid by any measure while he was the Fed chair.

The Fed decided to cut the interest rates for an extended period of time (at the risk of rising inflation, even though it hasn't happened so far) and the bond buying route, which has resulted in additional trillions of dollars of deficit to the US national debt. The insurmountable debt may seem daunting, but there are some tweaks that are at their disposal. Recently, the the government has changed the way inflation is calculated - which leaves out essential parts such as food and energy costs; and the government has also changed the way the GDP is calculated to make the economy look better than it really is.

How does the central bank and the government dig itself out of these problems? Normally, governments have three tools to fix their books: (a) Taxation - which is an unpopular option and raising taxes could result in political suicide, (b) Borrowing - by issuing bonds and (c) Devaluation of currency - which results in inflation.

The debt can be more manageable by devaluing currency, the US$, since all the debt is issued in local currency. This is great for the debt issuer, i.e. the US, and hurts the debt holders. But how can they spur it on and inflate their way out of this problem? One way to spice up the economy and the spending is to raise the wages, more importantly the floor - the minimum wage. As wages rise, more money in the economic system should results in inflation. If wages are rising, fixed amount of debt can be paid off more easily using cheaper dollars. Normally, its the other way round - where wages rise due to inflation. But we could be witnessing the government trying to approach the problem the other way round. The media is abuzz (see the Google Trends chart below) with wage increase talk over the last few months across N. America.

In the US, a number of states including Kentucky, Connecticut, NY, NJ, California have started debating about increasing the minimum wage, if not already started passing the bills. Some of the states have proposed raising the minimum to $10.10 per hour. In Canada, Ontario recently announced raising its minimum wage to $11.00 per hour. Quebec has followed that with increasing its minimum wage to $10.35 per hour. More money in everyone's pocket should result in more spending to spur the economy and we could finally start seeing some of the inflation that the central bankers want to see.

As an investor, you want to strategically position yourself to, not only protect yourself but take advantage of these shifts. There are many ways to protect your portfolio against inflation such as - inflation-indexed bonds, owning commodities, real estate etc. A more detailed account of this can be found on my earlier post - How to Fight Inflation.

Are your investments positioned to protect you from inflation? My full list of holdings can be found here.

Acknowledgement: A special thanks to Bryan from Fast Weekly for reviewing and providing feedback for this article before publishing.

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