How should we respond to fears of inflation?

April 23, 2010

Fear of inflation is one of the leading topics among clients currently.

Key Points

Fear of inflation is one of the leading topics among clients at the moment. One doctor client asked whether he should split his investments into commodity-based countries that could provide a cushion against inflation.

Is that true? Do we really have to worry about an "inflation monster" that resembles the Cookie Monster but that devours savings instead of edible treats?

Not so fast. With more than 20 percent extra capacity, we seem to be far from a supply problem. From a monetary standpoint, if the Federal Reserve were to tighten the money supply gradually, as it says it is planning to do, it is possible we could sidestep material inflation.

Nor would commodity price increases alone create an inflation problem. Fairly recently, we went from less than $30 a barrel of oil to $140 without setting off a broad-based inflationary spiral.

WHAT WILL HAPPEN?

What do I believe will happen? First of all, I don't think higher inflation is imminent. Moreover, prospects for inflation will be strongly influenced by how fast we grow.

If the negativists are correct about having sluggish or no growth, then it is possible that inflation may not happen over the foreseeable future. I prefer waiting to see how things shape up. Perhaps the Fed will tighten the money supply when it should.

In addition, I want to see how President Obama's healthcare reform program and the related ideas for saving money longer-term lead to a different conclusion than a practical one that raises taxes to finance the extra outlays needed. Spiraling medical costs in general, soon to be taking up $1 out of every $4 or $5 of U.S. output, is my biggest concern.

If forced to make a prediction now, I would look for the rate of inflation to turn up, one year-or more likely two years-from now, but I predict it will be temporary and not the extended problem some people predict. My assumption is that the country will deal with medical-related outlays realistically once the heat is on, within a few years, as it has done with other difficult situations throughout its history.

When that time comes, I will place money into Vanguard Inflation-Protected Securities (VIPSX) and PIMCO Real Return D (PRRDX) mutual funds, both of which are inflation-indexed bond funds with strong relative records, thereby providing a hedge against inflation.

I also would consider a position in the T. Rowe Price New Era (PRNEX) equity fund, which has a concentration in commodities that also could provide some inflation relief. The traditional hedge, real estate, is under a cloud now, but in a few years it could be particularly useful if we have a sharp upturn in inflation.

The author is president of Altfest Personal Wealth Management, a financial and investment advisory firm in New York City; an associate professor of finance at Pace University; and a Medical Economics consultant. The ideas expressed in this column are his alone and do not represent the views of Medical Economics. If you have a comment or a topic you’d like to see covered here, please e-mail medec@advanstar.com
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