Global Inflation Protection Investment Strategies

By M. Isi Eromosele

The debt situation currently facing the U.S. is not unique. Historically, other countries have followed two paths to deal with an overwhelming debt burden: suffer the distasteful consequences of default or monetize their debt and pay it off with devalued money.

Both paths are painful for investors. Either way, the value of the dollar erodes, and investors are left to grapple with the inflationary consequences. Recent policies suggest increased inflation may be just around the corner.

Inflation Drivers
The monetization of debt refers to using inflation (which reduces the value of each dollar) to pay off a country’s national debt. As such, inflation leads to many problems for investors holding investments in cash or investments denominated in dollars.
Theoretically, under normal circumstances, a country would want to keep its money supply under control, which should keep inflation under control.
One measure of money supply is the monetary base. The monetary base is highly liquid money that consists of coins and paper currency circulating in the public or in banks and commercial banks' reserves with the Central Bank of a nation.

The monetary base is also called “high-powered money,” because a given increase in the monetary base can cause an even larger expansion in the supply of money, an effect often referred to as the money multiplier. An increase of one billion currency units in the monetary base will typically result in an increase of many more billions in the money supply, as banks use leverage to supply credit to their customers.

In the United States, the growth in the monetary base usually indicates the Federal Reserve has printed an unprecedented number of new dollars.

Growth in the money supply is a function of the multiplier effect, which picks up as banks begin to lend money. Right now, bankers are insisting that low interest rates do not allow enough profit to justify the risk of loans. But artificially low interest rates will end, as the Federal government needs to sell ever more Treasury bonds to fund deficit spending.

They’ll need to increase interest rates on those Treasury bonds to make them attractive enough to sell. Higher interest rates will accelerate the multiplier effect as banks again find the risk/return relationship satisfactory to allow them to initiate more loans. More bank loans increases velocity. With the large numbers of dollars already in circulation, increased velocity will cause the money supply to grow rapidly.

Inflation will have a dramatic affect on investors, acting as an insidious tax, particularly for individuals living on a fixed income and for bond investors. They will lose purchasing power as inflation increases.

Protecting Your Investment Portfolio From Inflation
Real assets that are less liquid, such as real estate, timber, gold and silver coins and art, are appropriate for some investors, but these investments take time to locate and require careful research. Investors should buy these types of assets if they can afford to hold them indefinitely. They will likely lose money on these types of asset if they are forced to sell.

For most individual investors, this less-liquid strategy is not an option, since they lack the specialized knowledge, wealth, and/or time to accumulate those assets. Therefore, liquid inflation hedges are more appropriate. The rise of ETFs enables investors to quickly and easily access investments to help protect a portfolio from inflation and a falling dollar, while providing liquidity, transparency and low cost.
ETFs with important inflation-protecting properties include:

·        Inflation-protected bonds: These provide investors with income and some protection against inflation.

·        Non-dollar denominated bonds: Owning bonds denominated in currencies other than the dollar offers a hedge against declines in the value of the dollar. They can provide income and also add diversification.

·        Currencies: The idea of currency carry trading is to borrow funds in a currency with low interest expense and invest the funds in a currency paying high interest. The difference between the interest income and interest expense is the investor’s return.

·        Master Limited Partnerships: MLPs own domestic infrastructure assets that are used in the gathering, processing, transportation, storage, refining and distribution of energy-related assets like gas and oil pipelines.

·        Alternative energy: As inflation increases and the value of the dollar decreases, energy prices quoted in dollars increase dramatically. This increases interest in, and the value of alternative energy.

Advisors and their investors can effectively and easily purchase these investments and hold a diversified portfolio of inflation-protected securities that are inexpensive, liquid and fully transparent.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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