Inflation is coming

Given the incredible surge in U.S. government debt, I cannot see how our wise managers will be successful in maintaining any control over inflation in the years to come. That was the topic on my mind as I went to bed last night, and as someone without a defined benefit pension plan to look forward to, I was considering what my investment strategy should be to capitalize on the inevitable inflation.

This morning, I read Greg Mankiw's "Economic View" article in the New York Times, "It May be Time for the Fed to Go Negative". I find it disheartening to see anyone advocate what amounts to the devaluation of the U.S. dollar, but I believe Dr. Mankiw's point is simply that before a recession can end, real wages have to find their proper place (i.e., they have to decline to where they would have been without a credit supply induced bubble in prices). There are two ways to accomplish this: 1) we all take pay cuts, or 2) devalue the dollar. The second is psychologically, and therefore politically, easier to accomplish, and we're on that course anyway. Dr. Mankiw is just airing an idea that could speed up the process. I think the metaphor of ripping off the Band-Aide applies here. It's better in the long run if prices find their equilibrium quickly. Government policies (unwise management) seem to be trying to artificially support prices instead of driving us to proper prices. In other words, current policies seem to favor a protracted, yet shallower recession over a quick, but deeper one.

About half way through the article, it became obvious that the appropriate response at the individual level was to take a position against the U.S. Dollar. As I'm currently doing research in Swiss banking, I'm thinking that the Swiss Franc might be a good place to take shelter. The intent of the Federal Reserve, of course, is to wisely manage inflation such that individuals spend or otherwise invest their money so as to spur the economy. However, it may not be the U.S economy that gets spurred if investors see better inflation control in other economies. In time, "flight to quality" will surely cease to mean US treasury securities, and therefore the US dollar will suffer in the long run.

How is it that the cause of our problems, the oversupply of credit, can also be the solution? What form of logic are intellectuals applying to reach this conclusion? The answer most likely lies in the short- versus the long-term view. Easy credit in the short term will, hopefully, get us out of the recession, then we can tighten the money supply to stop inflation after we are out of the woods.

We keep demonstrating, however, that we are incapable of wisely managing (manipulating) the credit supply. Maybe it's time we let market forces work their magic, even if it is painful in the short term. In the mean time, start thinking about your personal plan to cope with inflation. It's coming.

- WM