When we talk about price inflation, it is common to sympathize with consumers.  After all, we are all consumers (buyers of goods and services), unless you live a really secluded life somewhere.

When you go to the store or the gas station and see prices have gone up, it means less money in your pocket (or bank account).  It means that, ultimately, you will have less to spend on other things.  With so many people struggling to get by, it is right of us to sympathize with the average consumer.

However, consumers aren’t the only ones who have issues with price inflation, particularly higher rates of price inflation.  Companies and business owners have to deal with inflation, not only in determining what prices to charge, but also in planning for the future.

It is already a challenge to be a business owner.  You have to guess at what consumers want and are willing to pay, and then you have to execute in doing it.  You also have to deal with government taxes and regulations.  When you add inflation into the mix, it just makes making a consistent profit that much more difficult.  This is especially true for business owners who have significant input costs.

If you own a furniture store, you have to either build the furniture or buy the furniture from someone else before selling it.  Most people don’t build their own, but even here there are input costs, as you need the materials to build.  Whether you are ordering your goods from China or from across town, it adds a great deal of uncertainty not knowing what you are going to pay for your inventory next month.

Also, if costs start to increase significantly, you don’t know if it is temporary (or transitory in Fed speak) or if they will continue to go higher.  You have to decide how much you want to raise your selling prices, if at all.  Just because you, as a business owner, are experiencing higher costs, it doesn’t mean your customers will necessarily pay higher prices.

Even if you are a business owner without a lot of input costs, inflation can still cause havoc.  Think of a massage therapist.  There still might be some input costs, and the person may feel the need to raise prices as a consumer, just to keep up.  But again, there is no guarantee that people will be willing to pay more for a massage, even if the price is the same in real terms.  If they are paying more for gas and groceries, it might be the monthly massage that gets cut out of the budget.

Again, there is already a great deal of uncertainty about what your customers want and what they are willing to pay.  When you add rising prices to the mix, it really becomes something of a guessing game.

Retirees and Future Consumers

People who are already retired are in a difficult position with rising prices, especially if they live on a fixed income.  Even a fixed income that adjusts for inflation may not actually keep up with the higher cost of living.  The cost-of-living adjustments often understate the actual increase in price inflation, and the adjustments can often lag behind.

This is why it is important to have a well-diversified portfolio that is properly hedged for significant inflation.  While stocks can provide some hedge over the long term, there can be periods of high inflation where stocks do not necessarily perform well.

There is also another class of people who have to deal with the issue of inflation, and that is future retirees.  You could also count these people as consumers, but they are future consumers.  They are trying to figure out how much they will need to save and invest in order to retire with the living standard they desire.

It is already difficult to plan for retirement.  Just like being a business owner, it takes some amount of guessing.  You don’t know how much money you will be earning from now until retirement.  You don’t know what unexpected expenses you may incur.  Most of all, you have no idea how much of a return you will make on your investments.

Now add price inflation into the mix.  When you started planning for retirement at age 25 (hopefully), you thought maybe you would need a million dollars, plus any pensions and Social Security.  Now, 20 years later, a million dollars isn’t looking like it’s going to be enough because prices have increased so much.  Now you think it might be closer to 2 million dollars.

But in another 20 years when you are retired, what if you need 4 million dollars?  Or what if prices have gone up five-fold in that time and you need 10 million dollars?  Are your investments going to get you there?

Even in a world where price inflation is 2% (the Fed’s supposed target), that still means that prices will double approximately every 36 years (using the Rule of 72).

This illustrates just how much damage the Federal Reserve does.  When you give the government or central bank a legal monopoly over a fiat currency where money can continually be created, then it is going to mess with everyone.  Money makes up at least half of nearly every transaction in our world.

Protecting Against Inflation

Monetary inflation redistributes wealth, and it causes a massive misallocation of resources.  There are many different groups that get impacted, but nearly everyone suffers with a standard of living that is lower than what it should be.  It is doubly difficult for those trying to plan a retirement and for those who own and operate a business.

There isn’t a lot you can do, but you can at least try to protect the purchasing power of the wealth that you have already accumulated.  This is why I recommend the permanent portfolio, or something similar in nature.

I have heard criticisms of the portfolio from both sides.  Those who are terrified of inflation say you shouldn’t have 25% in bonds and 25% in stocks because these will just lose purchasing power.

There’s another side that says you are crazy if you put 25% in gold and gold-related investments.  This makes me think that the portfolio is just about right.

If we experience a period of really high price inflation, then gold will likely do much better than the inflation rate, thus making up for any losses in purchasing power from the bonds and cash.  I’ll also point out that with cash (really, cash equivalents like a money market fund), you will likely start to get a higher interest rate, even though it will lag behind the inflation rate.

On the flip side, having a lot more than 25% gold without bonds and cash can leave you vulnerable to recessions and market crashes.  We aren’t likely going to see decades where prices keep rising at an astronomical rate.  The artificial business cycle will likely play itself out, which will include periods of recession and disinflation.

The permanent portfolio is not perfect, but nothing is in this uncertain world.  It is the best thing I’ve found that will protect against all of the major economic environments, while also providing long-term growth.