Buy Into Inflation Fears at Your Peril

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In the past weeks, I've digested as much inflation paranoia as I can stomach. Far from double-digit debasement of the dollar, current data suggests a coming period of relatively moderate inflation, highlighted only by pockets of significant price increases. Nervous investors who reshuffle their portfolios to brace for an impact that may not come could pay the price for their panic.

Breaking down the inflation equation
In the broadest sense, inflation results from too much money chasing too few goods. On its own, an increase in the money supply -- which has most definitely occurred -- won't cause a widespread spike in prices. True inflation also requires the "chasing goods" factor: vibrant economic activity, fed by robust employment and a healthy lending environment. Needless to say, I don't think we'll be seeing that anytime soon.

Of course, you don’t have to believe me on any of this. Nobel-prize-winning economist Paul Krugman recently explained why runaway inflation looks more like fearmongering and politicking than sound analysis. Addressing concerns about the expanded money supply, Krugman wrote:

[The Fed] has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices. But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them … So the Fed isn’t really printing money after all.

OK, fine, but surely the recent Fed actions must be inflationary at some point -- right? Not necessarily, Krugman argued:

The Bank of Japan, faced with economic difficulties not too different from those we face today, purchased debt on a huge scale between 1997 and 2003. What happened to consumer prices? They fell.

Finally, there is the nagging question of whether the U.S., unable to sell enough Treasuries, will ultimately be forced to meet its debt obligations by printing money, devaluing the dollar in the process. This outcome seems plausible when one considers forecasts that U.S. debt will soon exceed 100% of GDP.

Here, Krugman points out that Belgium, Canada, and Japan have all faced similar fiscal binds in recent decades, but none of these governments resorted to debt monetization.

Admittedly, the above statistics do not inspire giddy optimism. But history also indicates that there is little cause for panic. Investors currently moving their portfolios into inflation-proof bomb shelters could be disappointed when the shrapnel doesn’t start to fly.

Inflation or not, oil's a buy
Of course, the past doesn't always dictate the future, and investor perception can damage your portfolio's value just as much as the actual facts. So it does make sense to take moderate steps to guard against inflation-related market movements.

You could seek shelter in gold, through the popular SPDR Gold Shares (NYSE: GLD  ) ETF, but this is mostly a bet on market sentiment. Instead, consider an investment that offers inflation protection and benefits from utilitarian fundamentals: oil.

According to the International Energy Agency, recent project delays and cutbacks in the oil industry will cost us 2 million barrels per day in future production, and roughly 4.2 million barrels per day of future capacity has been pushed back 18 months or more. These constraints strengthen oil's fundamentals, even before you consider the additional ballast provided by an economic recovery.

For the time being, the price of crude seems to have gotten ahead of itself, but investors can use a pullback to pick up shares of the integrated majors such as BP (NYSE: BP  ) , Conoco Phillips (NYSE: COP  ) , Total SA (NYSE: TOT  ) , and ExxonMobil (NYSE:  XOM  ) . All but Exxon offer dividend yields of roughly 4% or better. For investors with greater risk tolerance, consider oil-sands players Canadian Natural Resources (NYSE: CNQ  ) and Suncor (NYSE: SU  ) , whose large North America asset bases offer safety from the greedy hands of dictatorial governments.

Converting your dollars into shares of oil-related companies won't necessarily protect you from market volatility, but it should provide profits over the long term, whether your portfolio must overcome massive inflation, or muddle through a period that is both less dramatic and far more plausible. 

Other Foolish views on inflation:

Total SA is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Mike Pienciak does not hold shares in any company mentioned. The Fool's value is justifiably inflated by its hydrocarbon-based disclosure policy.

Read/Post Comments (24) | Recommend This Article (20)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 03, 2009, at 4:28 PM, Maurice2 wrote:


    True inflation also requires the "chasing goods" factor: vibrant economic activity, fed by robust employment and a healthy lending environment.

    Was this the case in Zimbabwe or the Weimar Republic? How do you account for that contradiction?

  • Report this Comment On June 03, 2009, at 4:30 PM, automaticaev wrote:

    the weimar republic had that because everyone else was like pay me and so they were like sure no problem. If everyone wasnt against them then it wouldve been more similar to whats going on now.

  • Report this Comment On June 03, 2009, at 4:33 PM, theHedgehog wrote:

    "For the time being, the price of crude seems to have gotten ahead of itself, but investors can use a pullback to pick up shares of the integrated majors such as (list of oil companies etc)"

    Or, you could buy all of them by buying shares of IGE.

  • Report this Comment On June 03, 2009, at 4:53 PM, MyNameIsTaken wrote:

    Paul Krugman is a self proclaimed liberal, so take that in to account before you accept what he is saying as fact.

  • Report this Comment On June 03, 2009, at 7:01 PM, chopchop0 wrote:

    It's hard to take Krugman seriously, given his extreme bias towards the growth of government and the welfare state. He's a hack NYT columnist at best.

  • Report this Comment On June 03, 2009, at 7:13 PM, Maurice2 wrote:

    "the weimar republic had that because everyone else was like pay me and so they were like sure no problem. If everyone wasnt against them then it wouldve been more similar to whats going on now."

    Yeah. My point is inflation can happen if people doubt the value of the dollar. It's not dependent on economic growth. So the premise of the article is bogus.

    If the Fed wants to inflate, they can (and they will, to decrease the debt burden).

  • Report this Comment On June 03, 2009, at 7:29 PM, masterN17 wrote:

    Bernanke has stated Fed will not print currency to meet debt obligations and that lawmakers need to reduce the budget deficit. Take from that what you will.

  • Report this Comment On June 03, 2009, at 7:38 PM, StopLaughing wrote:

    It does not matter if you are a Keynesian or a Monetarist, if oil prices increase, that causes inflation as it raises the cost of producing and transporting everything else. It is the reverse of Supply Side Econ.

    Obama (like Bush before him) has a policy of costly oil. That policy alone is inflationary not to mention a host of others. As long as we are dependent on costly foreign oil, the $ will be weak due to the trade deficit. A weak $ is inflationary as long a we are importing costly oil.

    Inflationary spiral (dizzy dog chasing tail).

    Alternative energy is too costly, slow and inefficient to make much difference in the short run.

  • Report this Comment On June 03, 2009, at 8:05 PM, colgringo wrote:

    I agree with StopLaughing. Anyone, who can read a graph, knows that the dollar always moves opposite to oil. When the price of oil climbs, the dollar falls.

  • Report this Comment On June 03, 2009, at 10:07 PM, XMFGlide wrote:

    Thanks for reading everyone.

    Maurice2: the "chasing goods" factor is meant to be understood in the context of a "normal" economic environment in which the government is not monetizing its debt, i.e., printing fresh money to meets its debt obligations. Debt monetization is what happened in Weimar; it got so bad that people wanted to be paid in the morning so that they could buy dinner groceries before the prices rose in the evening. The movement of money through the economy, in that case, was not a reflection of production but a disdain for holding currency in favor of goods.

    Furthermore, yes, inflation can happen if people doubt the value of the dollar and Treasury auctions fail. Krugman's point is that we have no modern example of such an event. Japan's debt is at 170% of GDP, and its government bond market is still kicking. Canada has been above 100% of GDP; France and Germany are projected to approach debt at 80%-100% of GDP. Sure, it is possible that the future will play differently, which is why I recommend dollar-denominated oil.

    MyNameIsTaken: I am aware of Krugman's politics, which is why I intentionally quoted only those statements of his that are based exclusively on hard facts--facts that can be verified with IMF- or OECD- published data. In fact, the point of the Krugman article from which I quoted was to put emotions aside and look at the facts.

    chopchop0: "hack columnist"? What is your evidence?

  • Report this Comment On June 03, 2009, at 10:22 PM, eddietheinvestor wrote:

    It's hard to take the blog seriously when the primary source is Paul Krugman. It's funny when Krugman complains that the inflation argument has been politicized because that's what he does incessantly. Krugman hated all of Bush's policies because he hated Bush; now Krugman feels that Obama's policies can't possibly lead to inflation because he adores Obama. The argument would have more credibility coming from an economist whose views on economic policy don't depend on what party the president belongs to.

  • Report this Comment On June 03, 2009, at 10:34 PM, Hutch1227 wrote:

    We will see what happens over the next couple of years. The Fed is helping to force a massive bubble in Treasuries. It makes sense that it must eventually burst. When that happens, there should be either major deflation or inflation depending on the response at that point. An interesting experiment, attempted during very "interesting times". I will try to find a safe distance from which to observe

  • Report this Comment On June 03, 2009, at 10:35 PM, Southie1967 wrote:

    Don't forget "regulations" - restrictions on supply and demand must be added to your equation plus, possible protectionism. All three = inflation. How much, now that is the speculative part.

    Krugman has as much credibility as AIG.

  • Report this Comment On June 03, 2009, at 11:38 PM, paultaut wrote:

    Inflation is only one of the reasons to Invest In Gold. Another and More important reason is that Gold has been classified as an Investment Asset Class by the Major investment Housese.

    "Every Portfolio should have some exposure to Gold". This reclassification from the Rabid Gold bugs to a legitimate investment will do more for Gold than any currently perceived inflation/deflation scenario.

  • Report this Comment On June 04, 2009, at 12:12 AM, chopchop0 wrote:


    If you need more evidence of his journalism, you can really get a feel for his populist/socialist bias in this piece, particularly the last few paragraphs (it's a long read):

  • Report this Comment On June 04, 2009, at 9:26 AM, jonathan0766 wrote:

    The statement that "true" inflation requires a vibrant economy, robust employment, and healthy lending is completely, shockingly ignorant of all historical fact and reality. The author desperately needs schooled in history.

    The 1970s alone disprove the entire assertion. The 1970s had none of those positive economic effects and the "true" inflation was more than happy to go to work.

    Heck, check the value of the dollar since 1939, it has lost 94% of its purchasing power. Can you say... massive inflation?

  • Report this Comment On June 04, 2009, at 9:43 AM, jonathan0766 wrote:

    I'm sure this won't cause any inflation. Sure....

  • Report this Comment On June 04, 2009, at 10:18 AM, fritz75 wrote:

    Perhaps the worst article I have ever seen on motley fool. Using Paul Krugman as your source is like using Michelle Obama as your source to write about Barack Obama's handling of the economy. Shear stupidity. The man has nothing BUT an agenda!

  • Report this Comment On June 04, 2009, at 12:21 PM, Richard233 wrote:

    I don't know what the real inflation rate will be, but I

    do notice that certain items I have bought have risen

    in price.

    As an example. I used to buy these bags of cracker

    jacks. 99 cents for a long time, now they are $1.29.

    2 liter bottle of Diet coke soda. Was $1.29, now $1.79.

    Used to be on sale for 3 for $2, now its 4 for $5.

    Both of the above examples are of what I consider to

    be small luxuries. I'm sure an in depth investigation

    will show lots of things going up in cost. When the

    things I want to buy go up, I consider it inflation.

    Yes, electronics continue to drop in price, but that

    cycle has always existed and reflects the truth that

    manufacturing costs are much lower than the cost

    to make the goods and is used to recover the costs

    of development, advertising, and of course profit.

    Inflation is held in check, in part, by the lower

    demand, but it does not stop it completely as costs

    rise in costs to create/produce the goods. Eventually

    the price needs to rise to reflect these costs or

    production stops.

  • Report this Comment On June 04, 2009, at 4:34 PM, DKRIEB wrote:


    Get ready, we are in for massive runaway inflation. Gold (physical gold) should comprise a portion of your portfolio. The Obama administration is currently looking at various and creative ways to raise taxes such as taxing medical benefits, value added taxes (he loves Europe), a surprise move to place an excise tax on IRA withdrawals as well as exchange IRA's for some d\sort of government bond fund.

    People need to wake up, this idiot is a socialist and he as well as Michelle are angry about the wrongs that have placed on minorities. I am truly amazed at the sheep that voted for this phony and liar.

  • Report this Comment On June 04, 2009, at 4:38 PM, shanelevy wrote:

    "It's hard to take the blog seriously when the primary source is Paul Krugman..."

    Esterlin, it's hard to take you seriously when you ignore the facts. Krugman has been quite critical of several of obama's policies, so critical that the media characterized it as a showdown between geithner and krugman.

    Of course Krugman is a liberal, but he has never had qualms with opposing politicians in the democratic party. What I think you are really trying to say with your veiled and false remarks is that you inherently distrust liberals, which is your prerogative, but that is a purely political point that more importantly is irrelevant to the discussion at hand.

  • Report this Comment On June 04, 2009, at 7:07 PM, XMFGlide wrote:


    Unfortunately, I did not have space in this article to address all the nuances of inflation.

    What I assume that you're referencing is a supply shock, which can remain isolated to a particular good, or can subsequently push high prices throughout the economy. That's the type of event I am referring to in describing the current situation with oil, only I don’t see the global economy strengthening to the point that disastrously high oil prices lead to an 18% Fed rate -- at least not in the medium term.

    As for what's happened to the dollar over the past many decades (and this addresses Richard233's point as well), yes, that's probably the result of an overgrowth in the money supply in the same period, which has led to a steady rise in prices. But note that we haven't been mired in recession for all of the past many decades! In fact, recession has been more the exception than the norm. Finally, a steady rise in prices is different from much of the current inflation discussion, which focuses a coming massive spike in prices.


  • Report this Comment On June 05, 2009, at 11:42 AM, menefer wrote:

    This article could just as well be titled "Ignore Inflation Fears at Your Peril". I for one am betting on significant inflation. I'm basing this not on someone elses thoughts, but on practical observation. A steady rise in prices is inflation. The government has been understating the inflation rate for at least 10 years. Your home tripling in value is not a strong housing market but pure inflation. This has overstated growth and kept us out of an official recession when we should have recognized one much sooner. Inflation although painful for those who don't see it will be a necessary part of our return to reality.

  • Report this Comment On June 05, 2009, at 7:09 PM, ballfan01 wrote:

    Based on these blog comments, inflation is a foregone conclusion. Really? I'm not a fan of the current administration and don't know Paul Krugman from Adam. I do know, however, that when there is such a strong overwelming sentiment for something to happen(in this case inflation) it won't. As for gold. The only thing that gives gold value is its industrial use(which minor and is down), jewlery(where more people are selling for scrap than buying) and as a ponzi hedge against inflation. Miners and smelters are working 24/7 to take advantage of the inflated price of gold. As a result, there is more gold out there than ever before because, for the most part its just horded in different forms(coins, bullion, etc.) This proves that the greater fool theory is still alive and well.This ponzi hedge, has created a bubble in the price of gold. This bubble will surely burst just liike it did in the 70's.

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