The Fed got it right

Many sensationalist authors, pundits and experts would have us believe the world is ending when it comes to the U.S. money supply. They want to push their agenda forward, scaring regular people in the process.

JUSTIFIED

Federal Reserve Chairman Ben Bernanke did the right thing by throwing money at the recession. He studied the Great Depression and how to avoid it. It really could have been worse.

During the financial crisis, credit was drying up. People stopped spending and started saving. Incomes shrank. Everything was contracting. Something needed to be done.

For a simplistic example, how do we keep a deflating balloon from going flat? We inflate it with more air. In this case, during the Great Recession, the government inflated a shrinking economy by printing money.

Does that mean this added “air” will pop the balloon? Probably not, because it was already losing steam. If the government continues to print very large amounts of unnecessary new cash, however, that could lead to a “pop”.

We do have to live with the consequences.

DANGERS OF HYPERINFLATION

The danger everyone fears is that the U.S. dollar will become worthless. An extreme example is Germany after World War I. The country promised to pay reparations and did so by printing mass amounts of money. This caused a loaf of bread to go from 163 German marks to 1.5 million marks in less than two years. This rise made people literally use wheelbarrows to carry money.

This scenario seems unlikely for America. In 2008, according to St LouisFed.org, the M2 money supply went from $7.5 trillion to $10.4 trillion this year. That’s a big jump but not hyperinflationary.

Another danger is causing assets bubbles. We witnessed a big one with gold. Everyone was buying it and moving the price up to record levels. Now we’ve seen a small drop in gold’s price. This decline should continue, harming those who invested at the top or invested too much into the metal.

THE USUAL SUSPECTS

What’s an investor to do about potential inflation? As I’ve mentioned in past articles, there are solutions. A few basic ones are to invest in TIPs. These bonds add the rate of inflation to their return. You can also invest in stocks, real estate and commodities. Another possibility is the use of currency funds. These mutual funds invest in foreign money like Chinese yuan or Swiss francs.

Most of these ideas are aggressive options that need to be thoroughly researched, used in moderation and diversified through mutual funds.