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Are You Preparing for Financial Armageddon?

Here's a simple question we can answer in a few minute's time: Is the Federal Reserve's injection of hundreds of billions into the U.S. economy the only thing that stands between us and crippling deflation? Or is all that money dooming us to hyper-inflation that will someday have us looking back wistfully on $20 bread loaves while we swing clubs at each other, trying to corner the market on squirrel bits?

It's not how much money, it's how often it's spent
While I enjoy playing amateur doomsday economist as much as the next guy, I have to say that I think the inflation arm-wavers have got it all wrong. They point to scary charts showing a vast explosion in money provided by the Fed, for example, and jump to the conclusion that this will inevitably lead to major inflation. For a while, during that late 2008 commodity bubble, I thought that might happen, too. I was waving my arms. (It was less cool then.) But unfortunately, as the months wore on, some pesky evidence got in the way of my opinion.

Prices for all kinds of goods and services stagnated, and even started falling. It was fairly obvious that the spike in money supply wasn't stoking inflation because for that to happen, the money in question needs to be cycled through the economy. It needs to be spent, and the more often that happens, the more likely you'll see inflation.

Since we're not seeing much of that, it seems to me that the economic theories on the velocity of money can explain what we're seeing. Simply put, it's not the amount of money that matters for inflation; it's the amount of money and how often it is used during a given period of time. During this epic credit crunch, the resulting consumer spending pullback, the rise of unemployment and savings, and those dropping prices suggest a pullback in the velocity of money. More money -- even a lot more -- just may not matter if it's not chasing a fixed supply of goods and services.

Planning for inflation anyway
While I'm not in the inflation alarmist camp, I still acknowledge that the end result of all this stimulus could be inflation down the road. And inflation can make life tough for investors. Where do you look for returns if the costs of all goods and services are going up?

In late 2008, the answer for many seemed simple: commodities. Oil. Metals. Minerals. Doesn't matter what happens to inflation if you own these, right? Because if industry needs them, industry pays the going rate, no matter where it goes.

At least that was the logic of some out there, and although it made little more sense than the excuses for the real estate bubble ("They aren't making any more land."), the results were extraordinary. Oil, gas, and other raw materials and commodities saw huge run-ups in late 2008. Remember $140 dollar oil barrels? Remember the predictions for $200 oil that seemed rational at the time? Remember the gold bugs doing their victory strut as that odd, yellow metal attracted financial survivalists while the rest of the financial world collapsed?

A lot of money piled into commodities, and people who bet on the raw materials themselves -- especially at the height of that bubble -- got walloped as badly as any internet-bubble investor or home flipper once the recession took hold. Turned out that what was supporting those prices wasn't real demand, but perceptions about massive future demand, and after those hopes evaporated, asset prices did, too.

I'll take stocks, thanks
Let's not be too snarky about it. Predicting where commodity prices are going is a game that will eventually up-end the smartest people in the room. That's why I don't engage in it.

When I look for inflation hedges, I keep it simple, and I keep looking at stocks. Owning individual companies -- especially those that have iron-clad brands or other wide moats -- can be a perfect inflation hedge because these firms are able to raise their prices as needed over the long term.

As Charlie Munger put it: "I remember the $0.05 hamburger and a $0.40-per-hour minimum wage, so I've seen a tremendous amount of inflation in my lifetime. Did it ruin the investment climate? I think not."

Although I think McDonald's (NYSE: MCD  ) and Yum! Brands (NYSE: YUM  ) are good choices in such an environment, burgers and pizzas aren't the only places to find price-protected stock returns. It costs a lot more than a quarter to squeeze the Charmin these days, and more than a few cents per change to wrap the baby in the latest Pampers. That ability to raise prices along with inflation has helped Procter & Gamble (NYSE: PG  ) and Kimberly Clark (NYSE: KMB  ) make shareholders happy for decades. If smokes and booze are more your bag than baby tissue, do a long-term price check on the cigarettes sold by Altria (NYSE: MO  ) or Fortune Brands (NYSE: FO  ) . You simply cannot get your smoke on, or get your buzz on, for a buck anymore, but the fortunes at these companies have hardly suffered as a result because they can raise prices along with inflation.

Foolish final thought
Whatever you think of the inflation situation, it pays to have your options explored. While I look to solid brands and other companies that have the ability to raise their prices as necessary. I also look to strong companies that serve the energy, commodities, and materials businesses, that may benefit from a more inflationary future. One of these is Dynamic Materials (Nasdaq: BOOM  ) , a company with a wide moat that serves businesses in the energy and materials sectors. It doubled shortly after we bought it for our real-money portfolio at Motley Fool Hidden Gems. The stock is still down from when I originally tapped it (just before the commodity bubble popped) but for many of our members, it's been a stellar performer off of its lows -- where we told our members it was a screaming buy. And we think it has great prospects even from today's prices.

At Hidden Gems, we're taking advantage of today's volatile markets by putting a quarter of a million dollars into our favorite small caps. In addition to Dynamic Materials, we recently recommended -- and purchased -- a company that would probably please both the inflation-hedging commodity and materials crowd. It's a small company with decades-long, established relationships, supplying vital materials to some of those big name brands I mentioned above. It's paying off its debt thanks to big increase in free cash flow, but, because of the uncertain economy, the Street is still afraid. Smells like opportunity to us, which is why we bought shares on Wednesday.

If you'd like to see how we're preparing a small-cap portfolio for the future, inflation or no, a risk-free trial is on me. Simply click here to get started.

Seth Jayson is co-advisor of Motley Fool Hidden Gems. At the time of publication, he had no position in any company mentioned here. Kimberly Clark and Procter & Gamble are Income Investor recommendations. Dynamic Materials is a Hidden Gems recommendation. Fortune Brands is a Stock Advisor pick. The Fool owns shares of Dynamic Materials and Procter & Gamble. The Fool has a disclosure policy.

Read/Post Comments (17) | Recommend This Article (75)

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 July 24, 2009, at 9:56 PM, xetn wrote:

    Perhaps you would be interested in a history of money and the FED:

  • Report this Comment On July 25, 2009, at 10:37 AM, braunnyman wrote:

    So is Bernanke insisting we keep rates low to spawn a false boom, to lead then into a depression?

  • Report this Comment On July 25, 2009, at 1:48 PM, braunnyman wrote:

    in reference to the video posting

  • Report this Comment On July 26, 2009, at 8:31 AM, JeanDavid wrote:

    If it is not the money, but the flow of money, then I think we are in trouble. The unemployed and underemployed do not contribute to the flow of money.

    Likewise the trillions of debt and other government obligations really will have to be paid for sometime. To do that, taxes will have to be raised a lot, and it makes little sense to raise the taxes on the poor, and the rich will not stand for it. So we either default on it, or inflate our way out. An alternative to that would be to raise production of goods that are needed, but we exported so much of that already that I doubt we will ever get it back.

  • Report this Comment On July 26, 2009, at 12:59 PM, VegasMartin wrote:

    I think it's almost silly to be Bearish on stocks at this point. One of the reasons stocks have done so well since their March lows is because investors woke up and realized that equities are a much safer investment than the dollar. With the dollar at a new low, you have to preserve purchasing power and the best way to do that is by getting into stocks that are selling at "50% off."

  • Report this Comment On July 26, 2009, at 6:18 PM, crawlfish wrote:

    Despite the stock market meltdown twice this decade stocks are the best place to invest your money. Even though companies have concrete assets the real wealth is in their employees human capital. Money and materials are now easily moved around the globe. The thing that is the restraining factor is people who with out the money and materials are worthless. Good management and workers will create wealth. The best sign of a good potential investment is can the company recruit and keep top talent. Unlike a lot of my historical illiterate associates I know from history how adaptable our government system is. I don't think Obama and a democratic congress can or will irreversible damage our country. Our system always self corrects it self and we have many times in our history been in a lot worst hole than what we are in today.

  • Report this Comment On July 27, 2009, at 8:04 AM, TMFBent wrote:

    "One of the reasons stocks have done so well since their March lows is because investors woke up and realized that equities are a much safer investment than the dollar."

    Not to mention that yields on "safety" (treasuries) were so low as to virtually guarantee a gradual destruction of the investment's buying power, even under tame forward inflation scenarios.


  • Report this Comment On July 27, 2009, at 8:07 AM, TMFBent wrote:

    "If it is not the money, but the flow of money, then I think we are in trouble. The unemployed and underemployed do not contribute to the flow of money."

    Precisely why Bernanke and Co. are operating as they are. Moreover, they have many tools to soak up excess, but very few to prime the pumps.

    "Likewise the trillions of debt and other government obligations really will have to be paid for sometime. To do that, taxes will have to be raised a lot..."

    I don't know if I agree with that. If you do the math on the potential tax gains from even moderate economic growth, it's enormous. Bruce Greenwald explained this to us here at Fool HQ a few months back, and his arguments were pretty compelling.

    I believe he lays them out in his new book, here (

  • Report this Comment On July 27, 2009, at 8:21 AM, TMFBent wrote:

    Another viewpoint from someone via email. I'll protect his identity by calling him: Agent Cobra-Strike.

    Dear Seth,

    We are experiencing inflation, just not in the things you might expect. It is in the things we import. The vital things. Not the Chinese crap that is tied to our dollar. In 2002 oil was $20/bbl and gold was $375/oz. Do you think we will revisit those numbers? On the other hand, if you plot oil or gold against the euro over that time period...almost no increase. The dollar is sinking, as it must, against any more stable, and freely floating currency, given the irresonsible fiscal policy of our country. We keep talking about the cost of our wars in Iraq and Afghanistan, the trillions in financial bailouts. Has anybody presented you with a bill? Have your taxes gone up? No. We have charged these expenses to our children while at the same time cutting the budgets for their education. Do you really think a nation of hamburger flippers is going to be able to pay these staggering sums back?

    Eventually America will default on its debt or print so many dollars that the end result will be the same. I'd buy some gold if I were you.


    Agent Cobra-Strike

  • Report this Comment On July 27, 2009, at 8:38 AM, brwn8484 wrote:

    Lets see... I am sick of Bloggers telling me that inflation is tame and prices are dropping. Here is the reality of the last two weeks:

    1. The CRB Commodities Index +7.5%

    2. Oil +15%

    3. Copper +14%

    4. Gold +5%

    5. SP500 +11%

    6. 10-year US Treasury yields 3.71%

    On top of that Oil and Gas have increased year over year every year. Where do you people get your your statistics?

  • Report this Comment On July 27, 2009, at 9:10 AM, TMFBent wrote:

    I get mine here:

    And I usually look at a wide variety of consumer products, and also concentrate on year over year or seasonally-adjusted numbers, because, let's be honest, doing otherwise opens you up to charges of cherry picking to prove a point.

  • Report this Comment On July 27, 2009, at 3:54 PM, Intlinvstr4life wrote:

    1) Gold: a soft, mediocre conducting, heavy metal. What really supports its value these days anyway? And don't say, "because it's shiny."

    2) Oil (or current energy producing commodities): if you are really asking for tangible inflation, let's all speculate on oil again and see how quickly prices rise.

  • Report this Comment On July 28, 2009, at 8:14 AM, TMFBent wrote:

    1) Gold is really a strange thing. There are lots of folks out there investing in it as a kind of failsafe against financial armageddon, yet what they're buying are paper certificates of some sort, wholly unstuitable for the clubs 'n' grunts world of the future. I know people who have gold in case of emergency, but it's gold stuff, and it's in a safe or deposit box. If you really believe in a financial apocalypse, that may be a better bet, though I'd still fill the shelter with ammo and dried beans, myself.

    2) That oil bubble was crazy. I was fooled by it, but have now learned the important lesson that oil (and other commodity) prices don't move in the short term based at all on real consumption, but on perceived consumption. Seems self-evident in retrospect, but it wasn't obvious at the time, at least not to me and lots of other folks spending too much on it.

  • Report this Comment On July 30, 2009, at 1:43 AM, john2000k wrote:

    The Fed was created back in 1913, as far as I understand, in order to bring stability to our currency and our markets. The Fed has done neither.

    During the tenure of the Fed, nearly a century, we have lost approximately 96% of the value of our nation's currency. The Fed has done an absolutely horrible job of protecting our currency.

    You say that people are "jumping to the conclusion" that there will be inevitable inflation. Tell me, what else should people expect from the Fed, inevitably, when inflation is all that they have given us in nearly 100 years?

    Inflation is the nature of the Fed's business.

  • Report this Comment On July 30, 2009, at 3:31 AM, jrj90620 wrote:

    Let's see.The U.S. Dollar is down about 98% from the beginning of the Fed in 1913.This happened mostly during years when the U.S. was in an uptrend.Since the U.S. Titanic hit an iceberg around 1970 we have been in decline and the currency,which is really the common stock of the country,has been in faster decline.With the U.S. decline accelerating faster in the last few years you can expect a faster decline in the currency.All this nonsense about needing a stong economy and strong consumer demand to cause inflation is crazy.Zimbabwe isn't suffering massive inflation(really massive currency devaluation) because of a strong economy.I just read that Bernanke's personal assets have declined 33% in the last year.I would have figured an economic illiterate fool like Bernanke would have lost even more.

  • Report this Comment On July 30, 2009, at 4:25 PM, Intlinvstr4life wrote:

    Bent: Don't forget the water and chili-powder. Raw dried beans? – cringe

    The Fed has about as much power to devaluate a currency as they have power to control inflation and recessions (i.e. effectively none). I would submit that “devaluation” over the long term has 2-root causes.

    First, the present quality of life for the public in general is unimaginably-better than what it was in the early 20th century. Think about it: how much would it cost now-a-days to assume a life (or, a life expectancy for that matter) of 1913? Strip away the costs necessary to improve health, housing, food & water, and transportation and you are left with very cheap, very questionable forms of what we currently enjoy.

    Secondly, the desires of the few to horde and control should not be underestimated. One commentator mentioned Zimbabwe. Zimbabwe doesn’t have a fed. Neither does it have a functional free market system, or a publicly controlled political environment. Rather it has what some would call a bribe-ladder economy. Basically, if you want something it will cost a little extra at here and there, here and there, until the end result literally costs thousands more because of several hundred “here’s” and “there’s” implicit in any Zimbabwe supply chain.

    But don’t assume that we here in the US are immune from the same malady. We see similar hording and attempts to control in the form of market bubbles – catalyzed by a few trying to gain an edge.

    Housing is the easiest scenario to relate to. Once housing demand began to out pace supply, largely on account of people wanting to play the housing market game, prices began to get out of sync with the rest of the economy. This lead to a rise in costs for housing related goods and services, because there was significantly more activity and money to be made in that sector. However, now that the bubble has burst (from an average home price perspective), are we seeing a similar bursts in the costs for housing related goods and services? Well, not really – I was at Home Depot this weekend and I only saw prices going up. And voile real signs of inflation for Joes like you and me, real signs of devaluation.

    Of course I would just like to see what the government or the fed thinks it can do to control all this. We as the public, I think, should point the finger inwards and consider the consiquences of flagrant investing before we start finding political scape-goats.

    Great stuff here Fools. Keep up the good columns and posts.

  • Report this Comment On July 31, 2009, at 1:47 PM, TMFBent wrote:

    "Of course I would just like to see what the government or the fed thinks it can do to control all this. We as the public, I think, should point the finger inwards and consider the consiquences of flagrant investing before we start finding political scape-goats. "

    But... that would be uncomfortable! He did it is so much easier on the psyche...


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