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sagitarius84 (44.26)

The Hyperinflation Scam



April 22, 2009 – Comments (8) | RELATED TICKERS: GLD , USO , JNJ

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There is a lot of skepticism about the plans of the Federal Government and the FED to defrost the credit markets through its many stimulus plans. One of the biggest fears for some investors is that pumping too much money in the system would lead to hyperinflation and a complete devaluation of the US dollar against hard assets such as gold, oil, land and others, which would eventually lead to everyone living in caves hunting for food. There are even several ETF tracking Gold (GLD, IAU) and Crude Oil (USO, OIL).

I disagree with those fears. First of all I do expect average inflation of 3% annually for the next 3-4 decades to continue. The best way to hedge against that is to buy common stocks, which are not just pieces of paper, but rights to ownership of real businesses which would be able to pass any price increases on to their consumers. At the same time these businesses would share a portion of their profits with shareholders, by paying out dividends. Over the past 80 years dividend growth in the Dow Jones Industrials Index has more than compensated for the eroding forces of inflation. Dividend Growth for the 1920-2005 period was 4.9%, which was almost 2% higher than the 3% average inflation rate. The best ETF to track Dow Jones Index is Dow Jones Diamonds (DIA).

Over the past few decades the wealth of US households has been primarily comprised of Real Estate, stocks and fixed income. The real estate has been the primary residence of families; stock ownership was through owning mutual funds or owning stocks directly, while the fixed income portion consisted of deposits, bonds and cash on hand. As the value of stocks and real estate rose steadily, consumers felt richer and spent more, which in turn stimulated the economy. The past 2 years however have brought low stock prices, and declining real estate values.

According to some estimates, the total amount of stock market losses is estimated at 8 trillion dollars. No wonder many investors simply throw away their quarterly brokerage statements these days – their passive investments have plunged significantly in value.
On the other hand, the housing bubble has eroded a total of 6 trillion in homeowners equity in the US.

To summarize:

Money lost in the stock market: $8 trillion dollars according to World Exchanges

Money lost in real Estate: 6 trillion dollars according to Safe Haven

Total: $14 trillion dollars

Government Bailouts: 8.5 billion according to this article

Source: Government bailout hits $8.5 trillion

At the end of 2008, Americans' net worth fell $11.2 trillion, or 18 percent from 2007, to $51.5 trillion according to the Federal Reserve; which makes people less secure about their net worth situation. Investors have most of their wealth invested in real estate and stocks. When stock and real estate markets are booming, people feel wealthier, and tend to spend more. If homeowners wanted to redecorate their house or take a cruise around the world, they could easily sell their appreciated stocks or take a HELOC against their home equity. If they lost billions of their networth however, on aggregate they would be less likely to spend it all since they would have less assets to post as collateral in order to get the credit to live the nice life.

Thus in order to make people feel wealthier again, the government is spending several trillion in bailouts in order to lessen the negative wealth effects on the economy. As fewer consumers take out loans in order to spend on anything from decorating your house to going to that cruise to the Bahamas, and the ripple effects of this is felt throughout the economy there is less money to be loaned. Someone has to step in to provide a buffer against further declines in spending, and the government’s recent plans are a decisive action to prevent the worst from happening.

Thus I disagree that the government bailout would lead to hyperinflation, such as the one we saw in Germany in the 1920s, Zimbabwe or in Eastern Europe in the early 1990s. If the private sector’s participation in the economy decreases, and the government’s participation increases and offsets the decline in the private sector, the net effect for the economy is zero. Another difference between US and the other hyperinflation situations is that the US dollar is a currency that virtually all countries in the world accept in their foreign trading. Not only that but the US dollar is the primary reserve currency for many large foreign central banks such as the Chinese, Russian and Japanese banks. These banks hold their US dollar reserves in US Treasury Securities. They don’t have another alternative for their reserves. If they sold all their dollars their currencies would be much more unstable and the countries would suffer a huge drop of confidence in their economies. Furthermore during economic crises most foreign individuals tend to purchase dollars. For example during the Asian financial crisis (1997-1998), Russians, Indonesians and others were converting their savings mostly into US dollars, not gold or silver.

Thus I believe that the best way to protect your wealth is to purchase shares in consumer staples companies, whose products we use on a daily basis. I am a fan of Procter and Gamble (PG), Clorox (CLX), Colgate Palmolive (CL) and Johnson & Johnson (JNJ), which have not only been able to pass inflationary pressures onto consumers but are relatively recession immune as well. For a larger list of the best dividend stocks for the long run, check out this post.

Procter & Gamble (PG) makes detergents, soaps, toiletries, foods, paper, & industrial products. Brands include: Always, Head & Shoulders, Olay, Pantene, Wella, Actonel,
Dawn, Downy, Tide, Bounty, Charmin, Pampers, Folgers, Iams, Pringles, Gillette, MACH3, Braun and Duracell. The Cincinnati, OH company has increased dividends for 52 consecutive years and currently yields 3.30%. Check out my analysis of P&G (PG).

Johnson & Johnson (JNJ) is the owner of some well knows brands such as SPLENDA, TYLENOL, SUDAFED, ZYRTEC, MOTRIN IB, and PEPCID AC. The New Brunswick, NJ company engages in the research and development, manufacture, and sale of various products in the health care field worldwide. If you are concerned about the US dollar depreciating, look no further – 49% of JNJ’s 2008 sales came from abroad. Johnson and Johnson (JNJ) has increased dividends for 46 consecutive years and currently yields 3.60%. Check out my analysis of JNJ.

Colgate Palmolive (CL) manufactures and markets consumer products worldwide. It operates in two segments, Oral, Personal, and Home Care; and Pet Nutrition. The New York, NY based company
has rewarded stockholders with a rising dividend income stream for 46 consecutive years. This dividend champion currently yields 2.90%. I am considering initiating a position in CL on dips below $53.

Clorox (CLX) manufactures and markets a range of consumer products such as Clorox, Formula 409, Glad, K C Masterpiece, Ever Clean. The Oakland, CA company has a 31 year uninterrupted streak of dividend increases. The stock currently yields 3.40. Check out my analysis of Clorox.

Full Disclosure: Long PG, JNJ and CLX.

Relevant Articles:
- Dow 370,000
- Why dividends matter?- Procter & Gamble (PG) Dividend Stock Analysis- The Dividend Edge

8 Comments – Post Your Own

#1) On April 22, 2009 at 9:07 AM, sagitarius84 (44.26) wrote:

Do you think Gold would go past 1000 or is it going down to 300? What about oil?

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#2) On April 22, 2009 at 9:29 AM, Entrepreneur58 (38.06) wrote:

<<<"If the private sector’s participation in the economy decreases, and the government’s participation increases and offsets the decline in the private sector, the net effect for the economy is zero.">>>

Wow, talk about a scam!  If this statement was true, the economy could never fall apart.  No country ever in the history of the world would have a recession because the government could simply step in and spend money to make up for the lost demand.  The Japanese tried that for almost 20 years and it didn't work. 

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#3) On April 22, 2009 at 10:08 AM, checklist34 (98.65) wrote:

nice post, good thoughts.  I for one don't know the answer to the question of inflation but to assume that hyperinflation is a given is not realistic. 

I think a good case that deflation is the greater risk could be made.  And, i think inflation is some time away if we do see a significant dose of it.

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#4) On April 22, 2009 at 10:19 AM, outoffocus (23.91) wrote:

I disagree with those fears. First of all I do expect average inflation of 3% annually for the next 3-4 decades to continue.

You lost me with that statement right there.  Of course inflation was only 3-4% when the products and services that experienced double digit price increases were excluded from the inflation calculation (housing, energy, education, food).  Most of the "deflation" we are experiencing is merely a correction of the ridiculous inflation we had over the past 10 years (I guarantee you its WAY over 3-4%).  In other words, its a good thing.  Yet the government wants to prevent this correction from happening and I think they will be quite successful.

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#5) On April 22, 2009 at 10:20 AM, kaskoosek (30.22) wrote:

If public sector takes a larger share of the economy, this means that the stocks you own are worth much less, because stocks would represent a smaller share of GDP.

This article is too simplistic, it does not take into consideration the sesmic shift in the macro economy. 

I would have no problem in owning a multinational stocks like PM, but a retail company in the US does not interest me that much.







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#6) On April 22, 2009 at 10:36 AM, ralphmachio (< 20) wrote:

I have a tough time seeing gold going under 300$ I could see it getting to around 6 and change, maybe as low as 450, but when it comes back, it will be with a vengence. I could see it going easily passed 2000. Even more interesting is silver. Being a time of crisis, the charts of the last 50 years don't do it justice. Check the silver /gold 200 year chart, and imagine if people THOUGHT we were going to revert to the barter system- it doesn't even nearly have to actually happen.

I was just talking to a silver smelter who melts down large bars, brings em to gun shows, and sells em for 25% above spot. There's a nice end of the world market, which we will be laughing at in a couple of months, but will come back strong, I believe in the fall.

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#7) On April 23, 2009 at 9:52 AM, dcstrade (48.50) wrote:

Just a few points to argue:  China and Russia are trying to find a new reserve for the Yuan, and I'm sure they will be successful one way or another, possibly through investment in industrial metals and a basket of foreign currencies.  I wouldn't count on the US dollar being the stable "primary" reserve for Russia and China for too long.  Also, consider the Weimar Republic began with serious deflation that was urgently fought with money printing.  Your thoughts are organized and clear.  I agree that without numbers, it is difficult to argue anything, but this is not quite enough to convince me to discount the possibility of hyperinflation.

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#8) On April 24, 2009 at 1:50 AM, divedivedive (< 20) wrote:

I think the mistake here is assuming Hyperinflation is just inflation out of control. I think inflation is caused by too much money chasing too few goods. Hyperinflation is a loss of faith in a currency or a run on the currency. I think it is possible that the Fed could keep pumping out dollars to fight off deflation until China and others say uncle and dump treasuries. The dollar would drop like a rock. Deflation to hyperinflation overnight.

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