As you know after reading my article on inflation your best friend in an inflationary environment is something that is NOT linked directly to the currency in question, the US Dollar in this case.  Precious metals, etc certainly come into play here, but there are other less common things you can keep around to help out.  Obviously you’ll need to have food storage and water taken care of to be able to truly protect yourself.  But aside from that, what can you do?

The Obvious:  Buy Gold!

I’m guessing that the first thing that comes to mind when you think about protecting yourself from inflation or protecting yourself from the dollar collapsing is gold.  Buy gold!  It’s got intrinsic value, and your primer on currency said that’s one of the foundations of real value, Rudy!

Sure, that’s true.  And gold will always be worth something.  Right now gold is trading at about $1,052 per ounce.  Last year at this time gold was trading at just shy of $800 per ounce.  Go back five years and it was just over $400 per ounce.  Talk about appreciation!

There’s only one problem.  Gold is TOO valuable.  A one ounce bar, currently worth $1,052 as I write this, is pretty tiny.  It measures just shy of two inches long by one inch wide and is about 0.08 inches thick.  That’s pretty small.  And pretty darn valuable.

Do you really think that will be valuable for any sort of barter or trade if the dollar becomes worthless?  You can opt to use gold as a storage vehicle for larger amounts of money as long as you augment it with less ‘value dense’ commodities.  If you only have gold, you’re asking for trouble.

Rudy’s Warning: Unless you’re using it as a pure hedge against a devaluation of the dollar, make sure you take physical possession of the gold you buy.  If you buy virtual gold somewhere chances are you’ll never be able to get at it when you need it.  The same goes for silver and other precious metals as well.

The Next Best Thing:  Silver!

Silver is definitely less value dense than gold.  Silver is trading at about $17.42 per ounce right now.  This makes it a far better commodity to buy for every day commercial use than gold.  I would recommend that you skip the silver bars and ingots and buy bags of ‘junk silver’.  Junk silver is a term for coins that are worth more for the silver they contain than for their face value.  You can buy junk silver from coin shops, pawn shops, and dedicated retailers.

When buying junk silver you are looking for pre-1965 minted US coins (not pennies!) which contain 90 percent silver.  Coins minted after 1965 contain less, and I’ll talk about that in a minute.  If you’re buying 90% coins an easy rule of thumb is that any combination of coins that comes to $1.40 face value is 1 ounce (technically one troy ounce) worth of silver.  So right now, $1.40 face value of pre-1965 coins is worth $17.42.

The easiest way to buy junk silver is by the ‘$1000 Bag’ which is a bag containing $1,000 worth of pre ’65 coins by face value.  This bag contains 715 oz of silver and will be priced appropriately, and usually with a surcharge of sorts.  So you don’t have to count the actual face value of the coins, if the bag weighs at least 52 pounds, you’re getting your moneys worth.

You can also buy 40% silver, which is basically silver half dollars minted between 1965 and 1970.  These contain 40% silver.  I would personally avoid them, but if you feel inclined to buy some, go for it!  Note that you can also find these coins in circulation still, so if you ever run across fifty cent pieces, look at the mint date!  You never know when you’ll get lucky!

The Poor Man’s Hedge:  The US Nickel

This is something that is less commonly known about but has been advocated by a number of folks, including Jim Rawles at SurvivalBlog.  It revolves around the concept that the Nickel contains 75% copper and 25% nickel and is therefore still worth something.  At the moment the value of the metals in that coin is about $0.046.  It’s not hard to figure out that if the dollar continues it’s slide and/or metals continue to appreciate the lowly nickel will soon become worth more than it’s face value, just like the pre ’65 silver coinage.

This is more of a pure hedge than something you would plan to use in daily commerce.  Most people don’t know what to do with copper or nickel and wouldn’t know how to melt down the nickels into base metals anyhow.  That said it is likely that they will become valuable just like today’s junk silver is valuable and are thus a good long term hedge against inflation.

Rudy’s Tip: Coin debasing is what happens when the Fed changes the metallic composition in a coin to one that costs less.  Typically the core metal is replaced with zinc flashed with the original core metal.  This happened in 1983 with pennies which went from 95% copper to 97.5% zinc flashed with copper and are now only worth a fraction of face value.  History shows that non-debased coins gain investment value once the melt value exceeds about three times the face value.

As a side benefit, look at what happens in hyper inflation.  If you read my article about hyperinflation in Zimbabwe you will recall that over the course of the inflationary event thus far they have dropped a total of 25 zeros.  Do you think they reissued coins during that time?  Not on your life.  So under similar circumstances if the US Dollar is revalued by dropping digits your nickel would be worth the exact same face value.  For example if the Fed dropped three digits, that Nickel would now be worth $50 pre-collapse dollars.  Not bad.

Where do I get this stuff?

Well, nickels are easy.  Go to the bank and buy rolls of them.  Read Rawles’ post for some more ideas but honestly I have just gone down to the bank and bought them by the roll.  I usually buy about $40 worth at a time.

Gold and Silver are a bit harder.  You can buy locally for sure, or there are online retailers.  For junk silver you can also find E-Bay to be a good source, though I like the guys at GovMint since they have smaller bags available and knock off $25 if you buy more than $150.  Google around for good sources around your area.  This stuff is heavy so it can make sense to buy locally instead of paying for insured shipping costs.  A drive is often worth considering if it’s not too far!

Wrapping Up

I personally stay away from gold.  Silver and the nickel make sense to me.  Think long and hard about what you need and make your decisions accordingly.  One last tip:  If you have money in retirement funds like most of us do, look at the option of diversifying out of the standard mutual fund choices and buying Silver ETF (Exchange Traded Funds) or similar investment vehicles.  It’s hard to get cash out of your retirement fund, but this can help you against a stock market disaster!

One final request … if you have any tips or thoughts on what I’ve written, please share them with the group in the comments below!

In the deflation article we established that deflation is an overall decline in price, or increase in the value of a given currency unit.  In other words, your dollar goes farther.  We also established that inflation is the opposite of that.  Pretty simple, right?  Your dollar buys less and less the higher inflation goes.

We generally measure inflationary rates according to one or more price indexes.  The one everyone is familiar with is the Consumer Price Index, also called the Cost of Living Index.  Other indices are useful as well when measuring inflation in narrow parts of the economy but we’ll use the CPI for the purpose of this article.  The annual inflation rate is simply the annualized percentage change in the CPI as measured by the federal government.

Inflation is bad, isn’t it?

Not inherently.  Just like deflation, inflation is not good or bad in and of itself.  In fact most economists believe that low steady rates of inflation are a good thing for an economy.  The key is that the inflation rate should stay below the growth rate of the economy at large, or the Gross Domestic Product as we call it here in the United States.  Mild inflation is also key to getting out of a depression or recession.  Mild being the key word there.

On the flip side, inflation can do some bad things.  If inflation begins to rise too high there is a natural response by consumers to spend their money on tangible durable goods before that money is devalued too much.  If you recall in the deflation article we talked about supply and demand and how it drives prices.  If consumers begin buying durable goods, prices go up as demand goes up and that has a circular effect I’m sure you can all see.

Another negative side effect of inflation is something called Cost Push Inflation.  It’s basically the concept that as consumer prices rise, employees demand more and more cost of living increases to keep up.  This is particularly negative with collective bargaining agreements like union contracts and the like which are tied to the CPI.  It can trigger a wage spiral which has the further effect of increasing the inflation rate as businesses raise prices to compensate for higher employment expense, leading to higher wages, ad inifintum.

What happens to debt in an inflationary period?

That depends on the type of debt.  A fixed interest loan, such as a standard mortgage or a contractual loan will become cheaper to pay off.  A variable interest loan will stay about the same in compensated value, but there is a real danger to variable interest rates.  The interest rate will ALWAYS rise faster and farther than your wages will.  Always.

Rudy’s Tip: Inflation adjusted interest rates on fixed interest loans are called ‘real’ rates.  It’s defined as the nominal rate minus the inflationary rate.  So if your fixed interest rate is 8% and inflation is 3% your effective rate is 5%.  If inflation jumps to 8% then you’re essentially paying no interest.  Beyond that and the bank is essentially paying you for the loan.  Funky!

What causes inflation?

Well, if you’re an economist this is where you start talking about the Quantity Theory of Money, the Velocity of Money, Currency Debasement, and other interesting things.  Since we’re in a fiat money economy we’ll limit our discussion to that.  There are really two things that matter in the long run.  The money supply and economic output.  If the supply of money increases too quickly compared to the economy at large that inevitably leads to price inflation based on the law of supply and demand.

Interest rates also play a part here as higher interest rates lead to lower inflation rates and vice versa.  This is why you see a reduction of the federal funds rate in an attempt to kick start the economy.  The theory here is that if money is cheaper to borrow more people will take advantage of that leading to more economic growth and thus higher inflationary pressure.

Great Ceasar’s Ghost!

A random final bit of information here.  I talked about currency debasement in the last section.  Debasement in its purest form is when you take a commodity currency (like a gold coin) and melt it down, then recasting the coin with a lower commodity content.  Most historians believe that debasement was one of the leading causes of the fall of the Roman Empire.  The Roman silver  denarius was 95 percent silver when introduced.  Over a one hundred year period it was debased so far that it only contained 0.5% silver.  Yowza.

Couldn’t happen here, right, since we’re in a fiat system?  Nope.  Debasement basically takes a unit of currency and reduces it’s value.  What do you think the Fed printing presses running overtime does to our currency values?

Wrapping Up

That’s it for inflation!  Conceptually pretty simple, especially after reading the deflation article I wrote.  Next we talk about Inflation Gone Wild.  Also known as Hyperinflation or Something That Keeps Rudy Up At Night.  Stay tuned!