If you own hard assets, you are protected from inflation and not hurt by deflation. Hard assets are anything other than U.S. dollars paper currency: home, car, clothes, furniture, commodities, jewelry, and so on.
But you have to pay your bills. Indeed, much of the trouble in financial crises stems from lack of liquidity, not lack of net worth. The whole idea of the world’s central banks, including our own Federal Reserve Bank, is to provide liquidity to basically healthy banks and other financial companies. They are not supposed to help bankrupt organizations.
The same is true outside of the Federal Reserve Bank’s world. Small businesspeople and individuals need to not only have a positive net worth, but also be able to pay their bills every day so they are not suddenly forced to try to sell hard assets like their house and jewelry under distress at fire-sale prices.
You can have a significant positive net worth in the form of home equity and 401(k) but see it suddenly evaporate if the values of real estate and the stock market drop—as they did in 2008. As long as you can pay your bills each week, the temporary drop in home or stock values does not hurt you. But if you, for whatever reason, are short of liquid assets and therefore not able to pay your bills, your net worth can be wiped out by the need to sell illiquid assets to come up with bill-paying money.
But if you keep a lot of dollar-denominated assets—cash, bank accounts, certificates of deposit, bonds—you are taking great risk. Hyperinflation, which comes from printing too much money, wipes out the value of dollars—literally!
The solution to hyperinflation is always the same: replacement of the currency with another new currency. Like I said, the dollar becomes worthless during hyperinflation.
One of the most famous episodes of hyperinflation in the 20th century was the Weimar Republic in Germany in 1922-3. Those who owned German marks lost everything. Annuities, university endowments that held government bonds, bank accounts—all were rendered worthless—not worth less, worthless. People who had “saved for a rainy day” turned out to be hyperchumps in hyperinflation.
The German government replaced the mark with new currencies multiple times. The public rejected all of them. Then the introduced the Rentenmark which was secured by German real estate: farms, homes, businesses. “Renten” means security in German. When they finally introduced a currency that was backed by something other than government fiat, the hyperinflation ended.
Germans whose net worth was in the form of hard assets like a farm, home, or business before hyperinflation hit came out okay. Hard assets generally retain their purchasing power through both deflation and hyperinflation.
So you gotta pay your bills. But if we have hyperinflation, you do not want to own dollars or dollar-denominated assets like bank account, certificates of deposit, or bonds.
What to do?
You need some cash and bank account dollars. For one thing, there is no certainty that we will get hyperinflation. We could get a depression, otherwise known as deflation. Deflation is generally the opposite of inflation. In deflation, cash is golden. Its purchasing power increases.
But there is still the danger of hyperinflation. How do you maintain liquidity—the ability to pay this week’s bills—during hyperinflation?
What are liquid hard assets?
Items that are not dollars, but can be converted to dollars relatively quickly and retain their purchasing power until you convert them to pay your bills.
For example, “junk silver” should fit the bill. Many advisors have long recommended $10,000 face value of “junk silver” for each person in your household.
“Junk silver” is pre-1965 U.S. dimes, quarters, and half dollars. They were pulled out of circulation in 1965. As I write this, they are worth about 13 times their face value.
What makes them so good for paying some bills?
• Everyone can tell what they really are just by looking at them. They do not need an assayer or expert to appraise them.
• Their current denominations are convenient for routine shopping: 10¢ x 13 = $1.30; 25¢ x 13 = $3.25; and 50¢ x 13 = $6.50. Gold coins would work better for paying larger bills like mortgage payments.
• Old silver coins do not spoil like food or rust like iron and steel.
• They do not take up much space in your home or safe deposit box.
At present, you would have to take them to a coin dealer to convert them to cash. But if hyperinflation lasted very long, I expect most merchants and consumers would want to capture the coin dealer’s profit margin for themselves. I expect large retailers like Wal-Mart and Safeway would accept “junk silver” at its current market value which they could ascertain from the Internet in a nanosecond (e.g., www.coinflation.com).
Remember, you would only be using “junk silver” to buy stuff during hyperinflation. Why not just use current dollars? Because the prices of the things you want to buy, like food, will be going up extremely fast. In Weimar Republic Germany, the inflation rate hit 30,000% per month! At that rate, a McDonald’s value meal (plain small cheeseburger with no Coke or fries) costs $1 on the first of this month, $300 on the first of next month; and $90,000 on the first of the following month.
I mean that literally.
What good is, say, a 1964 U.S. dime in that context?
On the first of this month, it would be worth $1.30; on the first of next month, $390; and on the first of the following month, $117,000. You might even be able afford a child’s Coke in addition to the cheeseburger two months into the hyperinflation.
• coins that are worth their face value or more if melted down: nickels, pennies, gold coins, silver coins, platinum coins—not current dimes, quarters, or other coins
• the most popular metal and wood building materials and tools like 2 x 4s, copper tubing, brand name tools, aluminum ladders
• your business inventory if you are a retail merchant
• agricultural products if you have a farm or garden
• popular brand name children’s clothing and women’s accessories
• popular brand name gadgets like calculators, iPods, iPads, cameras, and so on (beware of obsolescence)
• consumer consumables in their original unopened packages like soap, shampoo, razors, canned or bottled food, vitamins and over-the-counter medicines, computer paper, toner cartridges
• condoms, fishing equipment, ammunition, batteries, forever stamps, Coleman lanterns, diapers
Basically, you want
• popular items that sell in high volumes during normal times
• basic rather than luxury items
• items where there will be no argument about its quality or whether it is a counterfeit
• value that is not so great you would have to sell it in pieces to use it to buy the sorts of things you will want to buy (e.g. a nice car could only be used to buy a very expensive item)
In the interest of full disclosure, I do not recommend precious metals including “junk silver.” I just use it here to illustrate the principle of liquid hard assets. One reason I oppose precious metals at present is the tax law. If you bought a 1964 dime for $1.30, then used it to buy a $90,000 cheeseburger, the McDonald’s is required to submit a Form 1099B (for barter or bullion—in this case, the dime would be both) with the IRS. That would reveal you had a capital gain of $117,000 - $1.30 = $116,998.70. Capital gains are usually taxed at 15%, but not precious metals, art, or collectibles. Those are taxed at 28%. So you would owe $116,998.70 x 28% = $32,759.64 in taxes. Don’t feel too bad though. The minimum wage at that point would probably be $7.25 x 300 x 300 = $652,500 an hour.
One suspects that the tax law would be changed during hyperinflation, but as it currently stands, capital gains are not indexed.
What I recommend are commodities that are not currently selling for much more than their historical average price in terms of 2010 dollars and that you can consume yourself. For example, it makes more sense to buy a case of Campbell’s Chicken Noodle Soup at Costco for—I’m guessing—$12. Then, when one $1 can is worth $1 x 300 x 300 = $90,000, eat it. Your stomach will not send a 1099B to the IRS. That makes far more sense to me than buying a 1964 dime now for $1.30, selling it for $117,000, paying the capital gains tax of $32,759.64 and trying to find an $84,240.36 can of supermarket off-brand chicken noodle soup to buy with what’s left.
Another reason I oppose current purchase of precious metals is that they are overpriced in relation to their historical average price in 2010 dollars. A case of Campbell’s soup at Costco is also a commodity. Inflation does not distinguish between commodities. They should all go up the same percentage when inflation occurs. But I do not believe the soup is currently selling for a premium the way gold and silver are. The problem with using precious metals to hedge against inflation now is that they have already been bid up to bubble value status in anticipation of inflation. The inflation protection largely went away as the price rose above historical real (adjusted for inflation) value. See my article on the disadvantages of gold as a inflation hedge.
Foreign currency is not a hard asset. All currency on planet earth today is fiat money, that is, none is backed by gold or anything else.
However, there are foreign governments and there are foreign governments. Some are rushing to throw themselves off a financial cliff like the U.S. and the PIIGS in Europe. But others, like Australia and New Zealand are not.
My point here is that liquid hard assets are not the only form of liquidity in hyperinflation. Good foreign currencies are also liquid, uninflated assets. However, hyperinflation usually is accompanied by capital controls and a typical capital control prohibits possession, spending, accepting, importing, or exporting foreign currency. Typically, during hyperinflation, the hyperinflating government orders all citizens to turn their gold and foreign currency ino the federal government and pays you less than market value for it.
See the following articles for more details:
Whenever I write or speak about hyperinflation or depression, people say, “You’re forecasting apocalypse! None of your advice will matter because people will be starving and invading the homes of anyone who has anything to steal it.”
Bullshit! I just wrote a 330-page book about this and spent years researching it. That did not happen during hyperinflation or depression in the past including the recent past in other countries. I did find there was an up tick of corruption and crimes like robbery, but that happens in both booms like the subprime lending bubble and busts like depressions and crimes. Memories of the Depression involve images of soup kitchen lines, men selling apples on the street, children picking up coal along the train tracks (as my mom remembers doing), and Wall Street executives jumping out of windows (which did not happen), but not armed robberies, which happened a little, but not enough to be considered a characteristic of the time.
To the apocalypse-now crowd, I didn’t predict apocalyspe. You did.
I diligently researched the history of financial crises around the world during the last 2,000 years. You didn’t. Calm down. If you want to go into the financial crisis forecasting business, do your damned homework.
For more information on How to Protect your Life Savings from Hyperinflation & Depression, 2nd Edition.
John T. Reed