It's 2012 and it's payday. You're tired, but after work you drag yourself straight to the grocery store to load up on a couple weeks worth of provisions for your family. You're shocked at tonight's high prices, but you know they'll be even higher by morning. You used to keep some money in the bank for a rainy day, but now you've learned to spend it all as soon as you get it, before it loses buying power.

On the other hand, the huge salary raises you keep getting have made it pretty easy to pay off the old credit card balances you were carrying, and even your student loans from college. Those loan balances used to seem big, but with your wages going up so fast, the amounts you owed just sort of melted away to almost nothing compared to your hefty new income.

Welcome to the strange upside down world of runaway inflation. It may be here sooner than you think.

Washington's out of control frenzy of government spending, ballooning national debt, and reckless expansion of our money supply have many economists and financial policy experts forecasting a surge in prices. Inflation. Possibly severe inflation. Maybe even the dreaded hyperinflation, where prices rise so fast money becomes almost useless and people are forced to resort to primitive barter.

In the Bible, James was confronting a different aspect of economic injustice, but his words paint a vivid picture of the potential effects of inflation as well: Look here, you rich people: Weep and groan with anguish because of all the terrible troubles ahead of you. Your wealth is rotting away, and your fine clothes are moth-eaten rags. Your gold and silver have become worthless. James 5:1-3(NLT).

In the United States, we haven't faced serious inflation for more than a generation. If that changes and inflation really does heat up, many Americans will have no idea how to plan, how to adjust. So here are seven simple financial insights for successfully coping with inflation:

1) Inflation Makes Your Money Shrink. When prices rise faster than interest rates, the buying power of your money in the bank goes down every day. If you wait long enough, money in the bank becomes nearly worthless. And money in your pocket loses buying power even faster. During inflation, you're better off not to hold much of your wealth in money. Inflation also shrinks the value of claims payable in money, such as life insurance and legal settlements.

2) Inflation Makes Your Assets Grow. When inflation takes off, the value of things takes off with it. To keep up with inflation, the more of your wealth you keep in the form of noncash assets (everything from gold to land to food to commodities) the better off you are. Business profits and certain stocks (and even certain inflation-indexed bonds) can also rise in value and rate-of-return right along with rising inflation, so ask your qualified financial advisor about adding appropriate "inflation hedges" to your investment portfolio.

3) Inflation Makes Your Fixed-Income Shrink. If you're retired on a fixed pension or relying on some other source of fixed income, inflation erodes the value of your income stream. Your income remains the same, but it buys less every month. During our last outbreak of high inflation, back in the 1970's, many older folks on fixed incomes found it increasingly tough to afford even basic necessities, like food and utility bills.

4) Inflation Makes Your Wages Grow. If you're in the workforce, you'll probably be able to keep up with inflation. Wages in most sectors of the economy usually follow along with prices as they spiral higher.

5) Inflation Makes Your Old Debts Shrink. During inflation, prices and wages rise relative to existing debts. As your wages rise, your old debts become smaller and smaller compared to your overall income. If inflation gets high enough, your old debts could practically disappear! Oddly enough, paying back your old lower-interest loans (student loans, car loans, mortgages, credit lines, equity loans) gets easier and easier the worse inflation gets!

6) Inflation Makes Your New Debts Grow. Most lenders aren't stupid (well, at least not that stupid), so they don't want to lend you money today that will be worth less (in terms of buying power) by the time you pay it back tomorrow. So they charge interest on money they lend, in the hope that what you pay them ends up being worth more in buying power than what they originally lent you. And if inflation kicks in, the only way for lenders to come out ahead is to start charging higher interest rates. Higher than the expected rate of inflation. So if inflation is high, you can be sure new loans will cost you more too, in the form of even higher interest rates.

7) Inflation Makes Governments Crazy. When prices start to rise, people get angry and confused. When people get angry and confused, politicians feel the need to "do something." When the problem is inflation, the "something" politicians typically do is make a law against rising prices. It sounds ridiculous, but this is what they do. President Nixon tried it in the 1970's (his so-called wage-price-freeze) and other governments around the world have tried it too. It never works. It's like slamming a lid on a pot of boiling water, but leaving the heat turned up. The pressure builds under the lid and eventually it explodes off, and the water keeps boiling. I have no good advice on how to cope with inflation-inspired government craziness, other than don't be surprised when it happens. Politicians have a hard time grasping that laws of economics are infinitely more powerful than laws of government. Just know that the stronger your financial foundation is today, the more prepared you will be to deal with whatever comes tomorrow.

November 30, 2009

Stephen L. Bloom, J.D., teaches economics and personal finance at Messiah College. He is a consultant at the United Methodist Stewardship Foundation of Central Pennsylvania and an estate planning and transactional attorney at the Pennsylvania law firm of Irwin & McKnight, P.C.  A frequent media guest and speaker, he is author of The Believer's Guide to Legal Issues (2008, Living Ink Books).