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Inflation, the Destroyer of FIRE

A Quick Preamble

This post is dark. FIRE posts tend to be super upbeat and confident, but this is not one of those posts. High inflation or hyperinflation is a massively destructive force, and you need to know about it.

In engineering, you’re taught to look at all risks. If a risk is remote, but its consequences are catastrophic, you still hedge against it with your design.

Do I think we’re going to see a period of hyperinflation? Possibly but probably not. I do, however, believe that you need to be educated on inflation because that monkey is already out of the tree. It’s a disservice to you if I just fill your head with the upside without warning of the downside. I don’t care about your feelings; I care about your financial health.

Inflation, the Destroyer of FIRE

The principles of FIRE are well-established. Increase your income. Decrease your expenditures. Save and invest as much of your income as possible. Carry no debt. Control your spending habits. What if I told you that there’s an economic scenario where all these behaviors hurt you instead of helping you? This scenario is called high inflation or hyperinflation. Read on to find out more about hyperinflation and what to do about it if and when it happens!

Your Emergency Fund is Not Good Enough

If you’re reading this, there’s a good chance that you’ve got an emergency fund stashed away. Good. This is ideal under the vast majority of economic situations.

Let’s say you have $10,000 squirreled away for a rainy day. You have it in a safe low-risk account like a savings account or a CD. Your focus, in most circumstances, is that dollar amount: $10,000. In a hyperinflationary scenario, that is precisely the wrong thing to focus on!

We’re spoiled by a relatively stable currency right now. This is a continuation of a decades-long run of tightly controlled inflation. The result of this environment is that we’re trained to focus on the absolute amount of money we have. However, what we genuinely care about is purchasing power.

Let’s use a contemporary example: Venezuela. Currently, inflation in Venezuela is up approximately 1,000,000%!

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A Venezuelan man weighing Bolivars to purchase groceries.

Imagine you are the man in the photo above. A few years ago, that significant bundle of cash (almost 3 kilograms worth!) meant something. Now? It buys you a chicken.

How do you keep your purchasing power from evaporating?

Never Pay Off Your Debt!

The wise leaders of the FIRE community are almost unanimous in telling you to pay off your debt. I agree with this advice, with one caveat.

Related: IHR

Related: Invest or Pay off Debt: Feature at Rockstar Finance!

Related: Should You Pay Off All Your Debt?

Usually, this is fantastic advice. But during hyperinflation, don’t touch your debt!

As hyperinflation takes hold, wages typically follow suit. If you’re making $50,000 today, you may be making $100,000 in a month’s time. Again, this ties back to your purchasing power. If you need to exchange 5% of your purchasing power to pay off your debt today, you’ll still need to pay 5% of your purchasing power to pay off that debt later (if inflation and wages perfectly align). However, that debt you racked up before? It’s static!

Floating rate debt could kind of keep up with the hyperinflation rate, but typically it follows the offending government’s false and underreported interest rate increases. Fixed rate debt though? The people you owe money to are getting creamed!

Instead of trading 5% of your purchasing power to pay off that debt, you now only need to exchange 2.5% of your purchasing power. Under hyperinflation, your best bet is to pay only the minimum monthly payment and let the debt ride from month to month. In another month, it may take only .5% of your purchasing power to pay off your debt, so why would you ever be incentivized to pay off your debt? In a year or two, you might be able to pay off all your debt with a small fraction of one paycheck!

Buy All the Things

If your currency is getting inflated to oblivion, the price of items can change from month-to-month or even hour-to-hour. In a dynamic where prices are continually rising, the population has a mad scramble to buy food, toiletries, and the other essential items for life before the prices go up by multiples. Grocery stores get cleaned out. The shelves are barren.

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The purchasing power of most people gets annihilated because their salaries don’t increase or they increase at the much lower official inflation rate. Additionally, many jobs are lost. People either stop working when their pay no longer provides enough to feed their families or their employer goes out of business if it can’t keep up with the costs of inflation.

This is happening in Venezuela now and the average person there has already lost 20 pounds and is starving. People are mugging neighbors for fruit from their fruit trees and women are prostituting themselves to survive.

Are you better off controlling your spending?

When Your Earnings are Burning

As I mentioned above, wages rarely keep a lock-step with inflation. There is an accordion effect in play, and salaries usually struggle to catch up.

Here’s one FIRE principle that still holds: earn more money. Specifically, increase your purchasing power.

However, how you can do this is upended. Are you going to go to your boss and ask for a raise every week because of inflation? Is he/she going to be able to give you one, even if they want to?

How are you going to maintain or even increase your purchasing power?

 

Geoarbitrage? Think Again.

To further compound the issue (no pun intended hur hur), the governments of countries with hyperinflation NEVER accurately track inflation. It’s not in their best interest to. The Venezuelan government’s inflation statistic does not read 1,000,000%. Acknowledging reality only serves to dig them into a bigger hole, though by this point, the entire world knows what’s going on in that country.

When I studied in Buenos Aires, there were two distinct exchange rates: the official government exchange rate and the black (or “blue”) market exchange rate. If you changed your dollars over to pesos in the airport, you received a set number of pesos. If you exchanged your dollars on the blue market (literally just a dude standing on a street corner), you’d get almost twice as many pesos for your dollars. If you want to use geoarbitrage to meet your FIRE goals, exchange rates are vitally important to you!

Related: Geoarbitrage: Turbocharge Your Early Retirement

How do you keep exchange rates from running away from you?

The MSOLife Inflation Gameplan

By this point, you’re scared of inflation. Good. But I haven’t provided you with any answers yet. What do you do?

Here are my hedges for inflation. If not a complete answer, they are a good partial answer.

Purchasing Power

You need to be able to maintain purchasing power. What keeps track with inflation or even surpasses it? Commodities. Add to your commodity allocation in your stock portfolio by buying companies that primarily deal with commodities. Commodity companies are typically leveraged plays on commodity prices because most of them have some debt and their entire business operations revolve around the price of commodities.

Additionally, think about buying and storing some commodities directly. This could be some shelf-stable food and other supplies like toilet paper and laundry detergent. Also, there’s one commodity that is compact but holds a large amount of purchasing power. I have a lot of it, and it costs me around 1% of its value to insure it every year. I’ll let you figure that one out.

Own A House

If you don’t own your own home and instead rent, here’s one more reason to buy a house: if you purchase it with fixed-rate debt, you’re locking in a substantial portion of your expenses. If you rent, you can guarantee your rent price will increase every year under hyperinflation. That’s if rental contracts don’t get thrown out and rent is hiked up more frequently than that.

Invest in Real Estate

A while ago I wrote a post about the common myth that real estate is a good hedge for inflation.

While that’s true, it’s mostly only true with a specific subset of real estate: multi-family. Don’t buy single family homes. Buy units with three, four, five, or more individual units. You, as the owner, can pass on the cost of inflation to tenants. The more units you have, the more turnover you’ll have in tenants and the more opportunities you’ll have to raise the rent.

Related: Is Real Estate A Good Hedge for Inflation? Meh.

I know rising rents are a contentious issue. Some may even say it’s immoral to raise rents. This empty-headed sophistry is unproductive. Is the solution to class disparity to make EVERYONE poor? No. As they say, you do you. Take care of yourself and your family first. You’re no good to anyone if you become a liability. You took on the risk of investing in real estate, and you should be the beneficiary of the reward.

Become Self-Sufficient

I was trained by the Army to be keenly aware of risks and to make plans to offset them. The same is true of my engineering educational background. Over the last few years, I’ve prepared for the worst. I don’t think I’ll ever need to use any of this preparation, but it’s there if I do.

Related: You Have An Emergency Fund…Do You Have An Emergency Bag?

Recently, the Moose clan bought a house. In this house, I have emergency food supplies to last us for an entire month. If shelves go empty, we’ll be ok for a while. Additionally, we have a large apple tree in our backyard that yields approximately 200 apples every year.

Over the next couple of years, I will plant various other fruit trees that can handle the frigid New England winters. During the spring through fall seasons, we’ll also be growing many of our vegetables, herbs, and spices.

If the worst-case scenario hits, we’ll be self-sufficient in no small degree. If nothing happens and business continues as usual…guess what? Our grocery bill declined dramatically. We can keep more of our earnings and invest them. I don’t see much of a downside with growing your food if you can.

We also do all yard work and housework ourselves. I don’t pay people to do anything for me, even shine my shoes, unless it’s something I can’t do myself and I can’t easily learn how to do.

We have a 22-kilowatt standby generator to power the entire house. If energy prices suddenly shoot up, I have two 100 gallon propane tanks filled to the brim. This gives us more than a week of power at our disposal whenever we need it. Undoubtedly, propane prices will also increase. However, I have 200 gallons of propane stored and at the very least gave my family some optionality.

If everything indeed goes to shit, I can survive off the land, without a house, for at least a few months. I know because I’ve done it. I’m lucky because the Army taught me these skills when I received some training in guerrilla warfare. If you don’t camp or already know some of these essentials, at least learn how to make a fire and a temporary shelter. Embrace the suck and you might have some fun doing it as well.

Related: A Summer with the Army Special Forces

Related: Embrace the Suck

 

Conclusion

Do I think we’re in for extreme times? Hopefully not. Probably not. But it’s a non-zero percent chance. In that kind of scenario, unless you’re truly set up properly, you can put early retirement plans on hold. If you’re already retired and haven’t prepared, you may be in for a nasty surprise.

What are the odds of hyperinflation happening in the United States within the next few years? I’m torn on this. I see all the reasons why it should happen. I also see good reasons why it won’t. Let’s say I give it a 5% chance of occurring.

Sorry for being a downer, but I give a shit about you. Here’s an upbeat post to help get you back into a positive mindset!

Related: 6 Stoic Quotes to Succeed in 2018

 

 

 

 

2 Comments

  1. melaniepartnersinfirecom November 9, 2018
    • Moose November 9, 2018