----M.H., by e-mail from Dallas
A. Many readers have sent in variations on this question, including one (E.B. in Dallas) who sent copies of colorful and pretty--- but worthless--- currencies. Most people don't want to think about runaway inflation. Virtually everyone has real difficulty with what might be called a "measured response." It's altogether too easy to go to extremes.
So let's consider the problem in three stages, recognizing that we may never go beyond stage one:
• Stage one is a decline in the dollar that stays in a range that requires material adjustment but not radical change. It entails the kind of inflation pressures we experienced in the late 70's.
• Stage two will occur when we lose our position as consumer of last resort. The dollar would be deposed as the world's reserve currency. A significant reduction in our standard of living would follow, as happened with Great Britain when the Pound was unseated as reserve currency.
• The third stage would occur when there is wholesale weaseling from government on promised benefits such as Social Security and Medicare. This will create institutional chaos and circumstances worse than the Great Depression. Without major changes, this could easily happen to our children.
We're in the first stage today. This requires that we practice real asset diversification. That means favoring Treasury inflation protected notes over conventional coupon securities. It means owning shares in an unhedged international bond fund or certificates of deposit in other currencies like those offered by Everbank (www.everbank.com) as well as domestic fixed income funds. It means investing in energy companies, particularly those with domestic reserves.
It also means having real international equity diversification, probably through the ownership of small international companies and basic industry shares in developing countries--- remember, the biggest international companies often get more of their earnings in the United States than major American companies, e.g. Sony and Coca Cola.
If you are young and securely employed (almost mutually exclusive today) this is also a good time to maximize your home mortgage--- but NOT maximize the size and cost of your home. You can repay the debt in dollars that are worth less than the dollars you borrow. Otherwise, this is a good time to eliminate short-term debt, regardless of your age. All these steps will spread your risk and reduce your vulnerability to our currency. They will not make you rich.
The second stage will begin when, and if, the dollar loses its position as the global reserve currency. When that happens we'll be forced to eliminate our trade deficit and increase our savings rate. Foreigners won't be saving for us. This will bring high interest rates, high inflation, and a significant reduction in our standard of living. The best protection is having needed work skills, little or no debt, flexibility, and a willingness to buy fewer services. Note that none of this involves investing. We could be in this stage before the next Presidential election. In stages one and two gold will be a good "investment" because it will gain relative value.
The third stage will begin when our government is down to two ugly choices, printing money or defaulting on promised benefits, particularly the massive promises of Medicare. This is the runaway inflation that concerns some readers.
Impossible, you say?
We've already done it. It could happen again. When our first currency, the Continental, became worthless after the Revolutionary War, it led to the only armed insurrection against government in our history, Shea's Rebellion in Massachusetts. Many gold enthusiasts expect such runaway inflation.
What the gold bugs don't consider is that when paper money is worthless and gold has value, we won't have an exchange economy anymore. If that happens, a 357 Magnum revolver will be worth its weight in gold. Today, however, you can buy a good gun for the price of one ounce of gold.
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