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Thursday, January 21, 2010

Inflation Monster

This article appeared in The New York Time over the weekend, and it was written by Harvard Economist. Greg Mankiw. The first sentence of the article asks "Is galloping inflation around the corner?" and that does a great job introducing what the article is about. The risk of future inflation is something I have posted about before, and it is something we discuss with all of our clients.

As the economy recovers, the Federal Reserve will be engaged in a very delicate balancing act of trying to avoid high inflation while keeping the recovery from losing steam, all in the face of large government budget deficits. I don't know how it will turn out, but I do know that high inflation wreaks havoc on personal retirement plans, as it is difficult for retirement incomes to keep pace with rapidly rising prices. That is why during retirement it is not advisable to put all of your assets in "safe" investments like cash and bonds, because those assets will not produce returns greater than inflation when the inflation monster does indeed arrive.

Here is the last paragraph of Professor Mankiw's article:

"Investors snapping up 30-year Treasury bonds paying less than 5 percent are betting that the Fed will keep these inflation risks in check. They are probably right. But because current monetary and fiscal policy is so far outside the bounds of historical norms, it’s hard for anyone to be sure. A decade from now, we may look back at today’s bond market as the irrational exuberance of this era."