Monday, March 09, 2009

Inflation is Coming! Inflation is Coming!

One of the biggest complaints about our current economic crisis is that it was so unexpected. Why couldn't economists predict it? If we had only had a little advance notice, we could have protected our life savings.

Well, the next stage of the crisis has been predicted and we should all be planning for how to deal with it: inflation. Not just inflation, but possibly hyper-inflation of the like we haven't seen since the early 80s. We can predict the possibility of inflation because of the size of the economic rebound that's coming. It will probably be exacerbated in the US and Canada by the poor implementation of the stimulus packages - particularly, by the delay in implementing them. In the short term we're all focused on the possibility of deflation, but once recovery kicks in inflation will be the problem. That may happen in spring 2010.

How can we deal with inflation?

Inflation erodes wealth, so savings and investments suffer unless they're protected by returns that are higher than the inflation rate. Locking in savings at today's rates is a bad idea. On the other hand, if you can lock in fixed rates when interest rates are high you can do very well. (This was a common success story in the 80s and 90s.) So there's some wisdom in staying liquid.

Inflation erodes the value of debt. Say you put $10,000 on your mortgage this year to pay it down; next year that might only be worth $9,000. On the other hand, interest rates rise due to inflation: mortgage rates got as high as 22% in the early 80s. So locking in mortgage rates is a good idea.

If you don't get cost of living increases in your salary, your real salary decreases. It's a good time to start strategizing on how to keep your salary from eroding.

Of course, inflation isn't going to hit immediately. It will probably take six months to a year before we start to see it, and our central banks may be able to head it off so that we don't get walloped by it at all.

It's going to be a bumpy ride, and new crap is going to be flung at us before it's over. We can't fully protect ourselves, but we can at least brace for the next shock. We should all be planning for how to survive three more years of horrible economic conditions: unemployment, inflation, moribund markets, rollercoaster interest rates, corporate collapses, and the fallout from crisis in government budgets at all levels. An extra concern for Canadians is that our experience in past recessions is that unemployment remained high for a couple of years after the US rebounded.


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