Wednesday, April 22, 2009

The Hyperinflation Scam

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.

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