The government’s own consumer price index is showing that year-over-year price inflation is running at 7% (December 2021). This is the highest Americans have seen in nearly 4 decades.
It is starting to resemble the 1970s when price inflation hit double digits. Here is the problem though. In the 1970s, interest rates also went to double digits. Today, they are near zero.
The 1970s economy was not a great time. Still, if you wanted to save money and not lose purchasing power, you could at least find some kind of savings account, money market fund, or bond that would pay a high interest rate to minimize your lost purchasing power.
Take a look at interest rates today. As of January 14, 2022, the 1-month yield stood at 0.05%. The 30-year yield stood at 2.12%. All of the rates in between those periods were somewhere in between.
But you probably aren’t going to buy a 30-year bond paying just over 2% in order to protect yourself against 7% annual price inflation. The biggest joke is that you would actually have to pay taxes on the gains from that 2% annual interest.
Maybe you are saving to buy a house in a year. You can buy a 1-year treasury bill paying about half of a percent. But if you lose 7% in purchasing power, then you will lose about 6.5% on net.
This is why the current environment of higher price inflation and ultra-low interest rates is so disastrous. This is why there are speculative bubbles everywhere. People are forced to speculate just to have a chance to maintain the purchasing power of the money that they want to save.
Depending on how you measure it, real interest rates are currently close to negative 7 percent. The real interest rate is calculated by taking the current interest rate minus the price inflation rate.
If I go to my bank, I cannot get a savings account or money market fund paying more than a small fraction of a percent. If you search, maybe you can find a financial institution paying 1 or 2 percent. The fact remains that real interest rates are deep in negative territory.
Money Management with Inflation
If you have a mortgage rate of 4% right now and it doesn’t make sense to refinance, then it may make sense to pay down the mortgage with extra money laying around. It seems nonsensical to pay down a 4% rate when your money is depreciating at 7%. But you have to ask yourself: What are the alternatives?
You can buy a bond paying 1 or 2 percent at best. You can put it in a savings account at near zero interest. Or you can speculate in the stock market, cryptocurrencies, or whatever you want to gamble on. In this context, it all of a sudden doesn’t seem that stupid to pay down the debt.
It’s interesting that gold and silver have historically been considered the best hedges against higher inflation, yet the precious metals are about the only thing not part of the Everything Bubble.
Perhaps this makes gold and silver a really good buy right now. Or maybe it just means it makes everything else a really good sell right now.
From a personal standpoint, you really have to look at your own situation and your risk tolerance. And sometimes losing a little bit of purchasing power in the short term makes more sense than taking on heavier risk where you could lose even more.
From an overall economic standpoint, the current situation is very bad for wealth generation. The high inflation with the low interest rates really encourages people to take on debt and to not save. The low interest rates are sending a signal that there are already plenty of savings in the economy. But that is not the case because the low interest rates are artificially low. This is what happens when the Federal Reserve buys up debt.
This will not go on forever. Something will break, but that is not to say that things won’t get worse. At some point, interest rates will start to catch up with price inflation, or price inflation will start to come down.
This is why we are in a speculative bubble. It is a creation of the government and the Federal Reserve spending money, running up debt, and creating money out of thin air. It is damaging to our living standards.
Just about everything is a speculation now. Staying in cash is, in itself, a speculation. The best you can do is to diversify and to stay up to date on what is happening. The current situation with high negative real interest rates won’t last forever. Don’t be on the wrong side when something changes.