CINCINNATI BUSINESS COURIER
November 7-13,1988
Investments
By Charles D. Vaughan
Best hedge against inflation – Study history
WANNA BET?
That’s the time honored way to settle disputes in our society. Some of these bets are socalled “sucker bets.” You may recall Sky Masterson, hero of Damon Runyon’s musical “Guys and Dolls,” declining such a bet with a warning from his father not to bet against any guy who proposed that a fish would jump out of a fountain and squirt water in his ear. Fair warning; you may get a wet ear. I’ll bet you can’t answer a few simple questions about inflation.
1.) Historically, in the United States, is a 4 percent annual compound inflation rate “reasonably low?”
2.) What’s the highest one year inflation rate in the history of our land?
3.) What’s the highest one year U.S. inflation rate since the Civil War?
4.) What country had the all time highest hyperinflation rate?
5.) During what period were there more worldwide hyperinflations than any other in history?
Give yourself 20 points for each correct answer. That means those you got right before you read the rest of this article:
1.) Are you kidding? Since 1720, the average annual compound inflation rate in this land has been about 1.25 percent. Over a long time a 4 percent rate would be catastrophic. For example in 100 years it would mean a 50-fold increase in prices compared with the 27-fold rise between 1720 and 1985.
2.) The highest one year rate in our land was 396 percent in 1776 which gave rise to the expression “not worth a Continental” as the currency was then known. After the Revolutionary War, the currency was completely reformed causing the largest one year drop in inflation of 97 percent.
3.) The highest rate that has occurred since the Revolution was during the Civil War with the rate reaching 30.75 percent in 1861. For most countries the highest rates have occurred during wartime. But, the second highest rate for the United States was in 1979 when prices rose 13.3 percent followed by a 12.4 percent rate the next year.
4.) A hyperinflation is a sizable, uncollected rise in the price level. Most people are aware of the German inflation of 1921-1923 when prices rose 50-billionfold in 28 months. Most of us have seen pictures of people with a wheelbarrow going to buy a loaf of bread. Well, this was peanuts compared with the post World War II, hyperinflation in Hungary. In the single year 1946 prices rose four octrillion to one (an octrillion is one (1) followed by 27 zeros). Printing was a good business to be in.
5.) Throughout history there have been relatively few instances of hyperinflation. Since the 1970s a number of Lesser Developed Countries have accepted a constant high rate of inflation as a fact of life. There are as many hyperinflations going on right now as there have been in all previous recorded history. This should make a dramatic statement to those who believe that only wars or strong economic growth create inflation.
Scoring is simple. If you got a 20, you are better than average. If you got a 40, you beat me before I did this column. If you got 60 or more, you either cheated or you wrote the book I just read.
Study of historic price level inflation has very meaningful implications for all of us today. One of the reasons that inflation rates have been relatively low during most of the period covered by international records was probably that currencies were backed by precious metals. Wartime inflations were followed by violent deflations as currencies got back in line. For better or worse, there is no “anchor” as gold used to be to keep us from drifting.
Modern economic policies permit governments to persistently spend more than they collect in taxes and many countries have mortgaged their productivity beyond any reasonable expectation of repayment. It is not unreasonable now to believe that a 3 percent to 4 percent base level of Inflation is OK. But, it also is not outlandish to think that some period of rapid inflation is possible again in the next decade or two.
Study of historical data suggests that common stocks, contrary to popular belief, have not been an effective hedge against rapid inflation. Investors who do not learn to use proven inflation hedge strategies are betting against the odds.