I have to take a break from my normal posting to post what has occupied my brain this week. I know it’s probably not what most people think about in that space and time between going to bed and falling asleep, but here is result of this week’s insomnia which lasts for two to five minutes a night:
Inflation as it relates to currency means a dollar today will buy less than the same dollar tomorrow. If one expects inflation, where should one keep money to maintain purchasing power? In the past, people wanting to preserve purchasing power tried putting their money into things perceived to have intrinsic value. For example, gold has long been a constant. The desire people have for precious metals seems to be constant.
However, people have been putting their money into gold for years in anticipation of massive inflation. If one believes the price of precious metals is too high, is there a better option?
I think to answer this question one should first look at why gold and other precious metals have maintained their value relative to houses and food regardless of inflation. They maintain their value because their perceived value relative to other goods is unchanged regardless of how much the other goods cost. If an ounce of gold = 200 hamburgers which have doubled in price, then the price of gold has doubled. In a free market, the value of gold can be in dollars or hamburgers. None of this answers the “what to do if one expects inflation and believes the cost of the metals is higher than their intrinsic values.”
I note the stock prices have dropped this week as the U.S. plays brinkmanship games with whether or not to default. What I am unsure of is why? If there is a default, then the value of the U.S. currency, dollar, should go down. If the value of the dollar drops, everything bought with the dollar should cost more dollars meaning inflation. If one follows this line of thinking and believes inflation is a likely outcome, then one should be looking to maintain the purchasing power of money already held. If one believes metals have been bid up too high by those looking at standard currency hedges, why not look at the maker of hamburgers? I say hamburgers only because of the example. The point is we assign value to our currency by looking at what it can buy. If it costs 200 hamburgers for the ounce of gold, that trade won’t change with inflation. So wouldn’t the production of goods and services be the logical place to put money to preserve its purchasing power? Eventually, the price to earnings for stocks seem to come back in line. If a hamburger costs two times what it did last year and hamburgers are still selling, eventually the stock should be priced roughly two times what it was last year as income doubles. So as stocks stabilize, can I not then sell my stock maintaining the purchasing power I had before inflation?
If this is true, why has the stock market reacted so negatively to the possible default? I ask because I honestly don’t understand. I have long thought the market as a whole reacts very similar to how individuals act just with no sense of time. I like the saying, “The stock market can be irrational far longer than I can stay solvent.” I think of the market as a lot like my MS. There are things which can be done to slow or speed up its progression, but nobody as of yet has managed to predict its course from day to day. Maybe looking at the stock market as like a living organism dealing with problems from day to day is why I find it interesting…but maybe it’s just because macro economics is some thing I like thinking about. I am that geek.