The hands behind currency valuation

Currency valuations affect a lot of things and are themselves influenced by still more variables. The strength of a nations' labor force in terms of skill, marketability, productivity and economic growth builds confidence in a currency. The Yuan Renminbi or RMB is an example of an emerging global currency that is increasingly being used as a reserve currency by other nations according to CNN International.

Image source: Fran Hogan

Government fiscal policy, like central bank monetary policy also plays a role in the valuation of currency. Sometimes this is done to the detriment of an economy per Hedge Fund Manager David Einhorn in a New York Times Op-Ed.  More specifically, Einhorn states our government's use of cash basis accounting understates the actual financial obligations taken on by an increasingly unsustainable cash-flow. Moreover, it is the money made from the hands of a nation's people that fiscal decision makers are themselves handling. 

• Federal Reserve: $9.545 trillion in checking, saving and M.M.F.s
• Issues in Political Economy: Equity rises increase currency strength
• Commodity prices rise with dollar depreciation per the FAO
• Countries de-value currency to boost exports per The Economist
• 33-50 percent of post Civil War currency was counterfeit per FBSF
• The $ symbol is believed to originate from the Spanish Dollar

Monetary policy also plays an important role in currency valuation. Since central banks can change money supply, they can also change the value of money by increasing or decreasing the amount of money in an economy. Altering money supply enhances economic performance at best and is an economy eroding cancer at worst. When the value of money erodes or loses purchasing power, inflation protection helps preserve net worth and becomes useful in long-term financial planning. The valuation of different currencies represent various nations' economies and competition between those economies.  

$1000 Invested In 1971 at 5 percent is worth less today according to the U.S. Treasury

For $1000 to have the same intrinsic worth as it did in 1971 it would now have to equal $5,517.00 according to the U.S. Bureau of Labor Statistics. Now suppose someone put $1000.00 into a Treasury Bond in 1971 at a 5 percent interest rate and also pays income tax of 28 percent after redemption. That $1000.00 bond would now be worth $5,470.89 according to the U.S. Treasury. 

Th problem is that is even less than the amount of money required to maintain the value from 1971, $46.11 less to be exact. Conclusion, anything lower than 5 percent is insufficient to build suitable retirement due to inflation. It is for this reason, specific investments such as Treasury Inflation Protection Securities or TIPS are bought to provide inflation protection.

Inflation in the U.S.

Inflation has existed in the United States for every decade since the 1910's except the 1930's. During the 1970's after the U.S. completely removed the gold standard from backing currency, inflation rose rapidly. What this means is the price and cost of products and services generally rises in an ongoing manner causing downward pressure on the purchasing power of the dollar over time. When someone says they were able to buy something for a fraction of the cost 40 years ago they are indirectly indicating inflationary forces exist over time.

Inflation can be good and bad in the sense the presence of inflation may be an indicator of a prosperous economy seeking to gain greater profits within various sectors, or in the case of a less favorable inflation, demand for products exceed supply. Since inflation is a variable within the nexus of economic relationships, it is perhaps best not to perceive it as the only indicator of an economy's success or failure, but instead as a metric that points to economic behavior in relation to other economic circumstances, the total of which may be beneficial or not. This article will discuss the meaning of inflation in terms of how it is measured, historical inflation trends within the United States, causes and remedies of inflation.

Inflation metrics

Inflation metrics measure inflation within specific areas of the economy and consequently can be quite deceptive if not assessed in terms of other inflation metrics and the economy at large. For example the consumer price index (CPI) is measured in two ways, one way includes all items in the cost of living while the excludes energy and food costs which comprise a great deal of consumer spending. The differences between the two are quite significant especially in light of the surge in energy prices experienced during periods where energy costs have risen such as the 1970's and 2000's. A few of the other economic inflation indexes are provided below.

• Consumer Price Index (CPI) and Implicit Price Deflator (IPD): Measures consumer product costs

• Producer Price Index (PPI): Measures industrial production costs

• Employment Cost Indicator (ECI): A metric that follows the cost of labor

• Personal Consumption Expenditures Price Index (PCEPI): Another measure of consumer costs

• International Price Program (IPP): Used to assess prices of international goods

U.S. inflation statistics and facts

• U.S. consumer price inflation from 1913-2006 has averaged 3.43% per year.(5)

• The U.S. Producer Price Index experienced very large rises between 1950-2000.(7)

• 1975-1999, professional and technical salaries increased an average of 5.4%(6) 

• Service occupations salaries rose an average of 5%/year between 1975-1999. (6)

• Average PCEPI i.e. Personal consumption Expenditures Price Index between1983-2000 was 3.8% for services and 1.1% for goods. (4)

Causes of inflation

Inflation is a fairly common phenomenon throughout the World and is generally not favored by consumers but is sometimes favorable to businesses that are able to take advantage of inflationary movements in revenue generation. In general however inflation spells increasing costs and lower purchasing power per dollar. Several factors contribute to the occurrence of inflation, specifically those listed below.

• Demand for goods and services exceeds supply pushing prices up

• Production costs rise causing prices of goods to also rise

• Excess profiteering caused by semi-exclusive i.e. oligopolistic corporate pricing power

• Passing on industry specific costs i.e. high demand, and higher production costs 

• Money supply rises increasing wealth thereby causing prices to rise

Remedies for inflation

Inflation above a certain percentage is considered hazardous to an economy because it can negatively impact economic growth and prosperity where as lower levels of inflation around the 2% range tend to be manageable and exist side by side with economic growth. Consequently, the United States Federal Reserve keeps a close watch on inflationary data and attempts to periodically adjust money supply so as to avoid inflation and assist economic growth. By tightening money supply with higher borrowing cost, inflation is slowed but so to can economic growth be slowed, and the reverse can be the case when borrowing costs are lowered.

On the consumer end, inflation protection  helps ameliorate the rising cost of goods and services and preserves the value of investment capital. Inflation can also be remedied and dealt with in various different ways at the economic level. Some methods treat the problem of the inflation with countermeasures, whereas other measures such as the U.S. Federal Reserve monetary policy attempt to cure and/or limit the negative effects of inflation from the front end. A few remedies and methods that are used in dealing with inflation are provided as follows.

• Inflation adjusted incomes

• Inflation protected investments

• Fiscal and Monetary policy

• Business regulation

• International trade agreements

• Foreign Banking Alliances

In summary, inflation is a common and well known economic reality that has existed at various levels throughout most of the last century. Inflation is measured using broad based economic metrics that focus on main areas of cost and price pressure such as consumer spending and industrial production. Inflation is also tempered and regulated by the U.S. Federal Reserve, legislative fiscal policies, international trade and banking agreements, and business regulation. 

Consumers can also protect themselves form inflation by investing in inflation protected securities and asking for inflation adjusted pay raises. Understanding the effects of inflation, its causes and ways to deal with it can assist businesses, economists and consumers in adjusting for and appropriately dealing with fiscal and monetary outcomes typically associated with it.

Sources:

1. http://www.clevelandfed.org/research/inflation/us-inflation/cpi.cfm
2. http://www.mrsc.org/focuspub/ipd.aspx
3. http://www.econ.umn.edu/~smith097/articles/A%207.%20.pdf
4. http://www.allbusiness.com/marketing/market-research/917714-1.html
5. http://www.inflationdata.com/Inflation/Inflation_Rate/DecadeInflation.asp
6. http://www.bls.gov/dolfaq/bls_ques6.htm
7. http://twocents.blogs.com/weblog/long_wave/index.html
8. http://www.labormarketinfo.edd.ca.gov/article.asp?ARTICLEID=625&PAGEID=3&SUBID=112
9. http://www.bls.gov/ncs/ect/sp/ecbl0014.pdf

Investing in gold coins

Gold coins are an investment that can and do appreciate, depreciate or keep a steady value depending on when they are invested in and liquidated. Gold coins are a dynamic investment that have a reputation for being 'safe' and 'stable' because gold traditionally holds value, and gold is by virtue of its rarity, in short supply. In other words, there are some reasons to invest in gold coins, however there are also good reasons not to.

Gold coins experience price fluctuations as does the spot gold price, and they are subject to inflation that is the very thing some investors buy gold for in the first place. This is because gold offers inflation protection when its price rises due to the weakening of major currency such as the U.S. Dollar. Gold coins are also a more complex investment than they appear on the surface due to elaborate global economics, historical asset diversification, and market mechanisms. This article will discuss the dynamics of gold coin investing in terms of advantages and disadvantages.

Advantages of investing in gold coins

Global gold coin demand increased 40% from 137 tons to 191 tons between 2007 and 2008 as per the World Gold Council's gold statistics. Since demand is a driver of price when supply is limited, the increased demand in relation to price is positively correlated. In recent years, gold has appreciated in value a great deal. There is a lot of analysis and thought in to the reasons why this has happened. Among those reasons are those listed below:

Image source: Petr Kratochvil

Reasons to invest in gold coins

• Gold supply is limited
• Gold prices rise during and with inflation
• Traditionally gold is a safe asset
• Lower currency values mean higher gold prices
• Gold coins may have aesthetic and collector appeal
• Gold is forecasted to continue rising (2)

In addition to the reasons for buying gold coins are the types of gold coins on the market. This is an important aspect in gold coin purchasing as the type of coin can affect its value, liquidity, and availability. Some gold coins are only partially gold with other metals within the coin, other gold coins are almost 100% gold. Gold bullion coins are considered investment grade and are 99.9% gold and between 22-24Karats.(3) Being aware of the percentage and authenticity of gold within a gold coin is an important aspect in its valuation, as gold is valued by weight so a mixed gold coin trader may charge more or less for gold depending on their skill and objectives in assessing and valuing gold.

Types of gold coins

• Rare and historical gold coins
• Collectible gold coins
• Gold bullion coins
• Gold and base metal coins

Disadvantages of investing in gold coins

The disadvantages of investing in gold coins are reasons why investing in gold coins is not a simple decision if one is expecting a guaranteed large profit. The very fact that reasons exist not to invest in gold is a sign that gold is not necessarily as safe an investment as some investors may like to believe. These disadvantages of investing in gold are presented below and are not few and far between. Three of these points are elaborated upon to illustrates the complexity of gold investment.

Reasons not to buy gold coins:

• Gold coins are subject to premiums and taxes
• The global recession is ending
• Gold prices are not historically constant
• Gold is subject to inflation just like currency
• Gold is one of many valuable assets
• Control of gold supply affects prices
• Historical reasons for buying gold are invalid

The type of gold affects its worth

The type of investment in gold may not be as profitable as investment in other types of gold such as gold futures, gold exchange traded funds (ETF's), gold mining company stocks and non-coin gold bullion. This is because of dynamic business, economic and market variables that compete against other types of assets.

Gold is one of many valuable assets

Back in 1500 C.E., gold may have indeed been a good investment, however times do change and gold is no longer the only precious metal on the planet, nor is it only one of few assets to invest in. In the modern era, gold constitutes a mere fraction of global worth and investment choices. Additionally, gold is no longer used as a common currency so the gold has no common purchasing power. In other words, gas pumps, automated teller machines, internet shops and online brokerages don't except gold as currency so you can't use it.

Gold coins are subject to inflation:

The same logic that tells investors to buy gold coins can also be a reason not to buy gold coins. For example, inflation adjusted gold prices indicate the true value of gold reached a peak in 1980, this was a time when inflation was high, so naturally the price of gold became high.

To buy a lot of things gold has to be converted back to cash that has inflated. So, if an ounce of gold purchased in 1970 cost in the vicinity of $30 USD, however, those $30 USD adjusted for inflation would be worth $164.58 2008 U.S. dollars using an online inflation calculator. This means, $1000.00 estimated 2009 gold price per ounce/$164.58=6.07 X $30=$182.28. Thus gold has only increased $17.70 or 11% per inflation adjusted ounce within the last four decades.

Another competing investment such as 10 shares of International Business Machines (IBM) cost approximately $169.20 in 1970. Those same 10 shares would be are worth around $1,200.00 USD in the middle of September 2009 or $708.80 in 2008 inflation adjusted dollars. Adjusted for inflation using the same inflation calculator, those 10 shares of IBM would be worth $92.82 in 2008 dollars when the price per IBM share fluctuated between $83-$130 USD per share. of about $1200/$708.8=1.693 X $169.20=$286.456. Thus 10 shares of IBM have increased in value by about $117.256 or around 69.4% in inflation adjusted dollars.

Sources:

1. http://www.inflationdata.com/inflation/Inflation_Rate/Gold_Inflation.asp
2. http://libertyvalley.com/rough_projection_gold_and_silver_prices
3. http://www.taxfreegold.co.uk/22carator24carat.html
4. http://catalog.usmint.gov/
5. http://www.goldprice.org/

How to use inflation rates

Inflation is the change to spending power of one unit of a country's currency as measured by annual percentage adjustments. For example, $100.00 at a rate of 2.75% inflation will be worth $97.25 after one year of inflation. 

Inflation can have large affects on the value of money over time and for this reason financial planning with inflation protection in mind is a vital consideration when saving for retirement or calculating the costs of living and the value of one's savings at a future point in time. This article will illustrate the numerical influence of inflation, and provide tips for incorporating inflation in financial planning.

Inflation and time value of money

Knowing how to use inflation rates when planning finances is a key step in optimizing one's investments, cost management and financial needs over time. There are several ways to use inflation rates and incorporate those rates into financial planning. The first step involves identifying a reasonably accurate inflation rate for long-term financial calculations as only past inflation rates can actually be measured. One way to do this is forecasting inflation using a moving average calculation.

Once an inflation rate is identified, the next step is to find the time period for which inflation will be applied to. For example, 6 months would be a short-term inflation adjusted calculation whereas 25 years would be a long-term calculation. Generally, the impact of inflation will be lower for shorter time periods than longer ones. Thirdly, after finding the inflation rate and time period, a financial value and/or set of cash flows may be incorporated into the calculation so that one has something that is being affected by inflation. The following is an example of an inflation-adjusted calculation.

• Manual inflation calculation method:

Inflation rate: 2.5% Time period: 10 years Current Value: $10,000

Year 1: $10,000 multiplied by 2.5%=$250.00, $10,000-$250.00=$9,750.00

Year 2: $9,750.00 multiplied by 2.5%=$243.75, $9,750.00-$243.75=$9,506.25

Year 3: $9,506.25 multiplied by 2.5%=$237.66, $9,506,.25-$237.66=$9,268.59

This process continues until 10 years of inflation are applied. While the inflation dollar value becomes lower with each passing year, so to does the value of the initial amount of money. Eventually, after 10 years of inflation, what was once worth $10,000.00 becomes $7,763.29 or close to 25% less than the original worth of the money.

Incorporating inflation into financial planning

As the previous section illustrates, inflation can have a dramatic influence on the value of money over a relatively short period of time. Prudent financial planning will take into account the cost of inflation when obtaining savings and investment yields and even cost management. There are several ways to incorporate inflation rates into financial planning. For example, some investments are automatically adjusted for inflation. For investments that aren't obtaining a yield higher than inflation and then adjusting the future value of the money for inflation ideally adjust for inflation. The following is a list of ways to incorporate inflation rates into financial planning.

• Invest in inflation-adjusted securities
• Obtain a yield on savings and investments greater than the cost of inflation
• Talk to a financial adviser about inflation when developing a financial plan
• Adjust long-term expenses and equity such as mortgages for inflation
• Calculate cost of living in retirement with inflation in mind

Calculating and using inflation rates when financial planning doesn't have to be overly complicated but does have the affect of making non-inflation retirement plans look like an illusory value in reality. To calculate inflation a number of methods can be used including the technique above. Additional methods include online inflation calculators that are easy to use. All one needs to do using this method is enter the values accurately and let the computer program do the rest.

Summary

Using inflation rates in financial planning is sometimes overlooked, but is actually quite important as the value of money is significantly affected by inflation over time. Inflation can be thought of as a hidden cost that can greatly lower the value of money saved for retirement. It is quite important to be aware of the concept of inflation and how to incorporate inflation into one's financial planning whether it be long term budgeting, investing, expense management or retirement saving.

Inflation can be calculated in a number of ways such as either manually or via calculator. Inflation adjusted calculations can complicate financial planning but is somewhat a necessary evil to factor in. The key variables when using inflation are time, present value, and inflation rate. Obtaining accurate inflation rates may be difficult for long term financial planning but can be estimated using moving average or average inflation values for one's country of residence.

Financial affects of currency wars on investments

Currency wars can lead to investment inflation, and a kind of translucent wealth that is only made visible by the illusion of value. In other words, currency wars can stimulate economic activity, and investment value, if only in the short-term, and at a cost that can impact the overall wealth of consumers.

To illustrate further, currency wars are contests to outbid international competitors to improve sales of a nations products and services. Just like storefront price wars, countries in price wars attempt to keep the valuation of their currency below their competitor in order to boost economic activity.

China, Japan and the United States are all believed to be showing signs of a currency showdown as 2011 approaches. Currency showdowns, price war and competitive devaluation essentially refer to the same thing. The tools of currency wars are quantitative easing and money supply; both make it easier for banks to borrow and lend money by either increasing money supply or decreasing the cost of borrowing money. Currency wars occur when economies are seeking to either maximize growth or supplement weak growth. The affect on financial markets is increased liquidity by investment banks that may see leverage opportunities amidst lower market prices.

In October 2010, the Bank of Japan, a central bank that carries out monetary policy, advanced its quantitative easing plan by reducing its interbank lending rate to zero percent, a move similar to that of the U.S. Federal Reserve Bank. Between December 2008 and October 2010, the Federal Funds Rate was held at a quarter percent. The one month London Interbank Offered Rate (LIBOR) is similar to the Fed Funds Rate and has also been quite low for almost as long i.e. below .53 percent since January, 2009.

When interest rates decline, it can also affect currency valuation in the foreign exchange market. For example, the price of the United States Dollar rose against the Japanese Yen may rise when the Bank of Japan lowered its interest rate to zero. This, at least temporarily, made it more expensive to purchase U.S. goods and services but made U.S. consumers a little wealthier in terms of international spending power.

The problem with currency war is the financial and economic damage that has an increased risk of being created by excess liquidity. For example, if U.S. monetary policy produces too much money, the cost of living can actually rise for Americans during a time where wage pressure is high. Loose monetary policy can also cause central banks to buy gold and other assets to hedge their currency asset holdings. For example, the Wall Street Journal reported emerging markets were buying gold in 2011 to diversify their portfolio reserves.

This can make it more difficult to save and invest in the long-term unless proper measures of inflation protection are taken both in terms of individual household wealth and national economics. Large amounts of currency liquidity can also reduce businesses spending power when the majority of their profits are earned domestically. Another possible fiscal bi-product of this lower spending power, is further erosion competitive positioning of U.S. corporations, share prices and the industrial sectors they compete in.

In addition to potentially negative affects of price wars on investments via a decline in competitive positioning and market share of domestic companies, quantitative easing can reduce confidence in the national currency.

When international confidence in a currency wanes, economic power declines because things like Foreign Direct Investment (FDI) and financing of government debt instruments such as U.S. Treasury Notes declines. For the U.S. the possibility of not remaining the international reserve currency can also increase leading to dampening of economic control prospects both nationally and internationally.

In the United States, liquidity measures are the remedy for an economy that needs growth stimulus; exports also help. In China, a low Yuan-Renminbi has helped its exports and it has been reluctant to increase the value of its currency to maintain growth encouraged by these exports. For the U.S. this means the risk of being priced out of export markets increases thereby indirectly jeopardizing its workforce through lower product and service demand.

The affects of currency wars can be felt by individuals, investors, businesses and economies world wide depending on the size and scale of the currency showdown. If national trade and account deficit values do not decline despite quantitative easing measures it either means national deficit spending rises despite an increase in earnings, or that earnings have declined further in proportion to spending.

This is a sign a currency war is not achieving its desired affect. The second fiscal quarter of 2010 yielded a U.S. Account Deficit of $123.3 billion according to the Bureau of Economic Analysis (BEA). Currency wars can also under price valuable goods and services thereby undermining the very economies they attempt to leverage.

Sources: (Date of record, October 20, 2010)

1. http://bit.ly/aOhawU (Bureau of economic analysis)
2. http://bit.ly/9IGV1u (Federal Reserve Bank)
3. http://yhoo.it/afbBGh (Yahoo Finance)
4. http://bit.ly/d356KF (WSJ Prime Rate)

Inflation bonds 101

When an investor, financial institution, mutual fund or foreign Government seeks inflation protection, it is a good idea enter into one or more of several financial vehicles designed to protect financial interests and worth. One such financial instrument is the inflation bond.

• What is an Inflation Bond: An inflation bond protects against inflation by offering an interest over and above a periodically adjusted inflation rate.

• Where you can find Inflation Bonds: U.S. Government inflation bonds can be bought directly from the department of the treasury, bureau of public debt. (http://www.publicdebt.treas.gov/) and foreign inflation bonds such as the Canadian Real Return Bond can be purchased through brokerage firms.

• Benefits of Inflation Bonds: Inflation bonds can do more than protect against inflation. Inflation bonds can also help one diversify an investment portfolio against adverse economic and market conditions. Additionally, since interest is not paid until maturity or redemption, inflation bonds can be utilized as an untaxed retirement savings vehicle. When they expire and/or are redeemed the owner may benefit from being in a lower tax bracket than at the time of purchase.

• Costs of Inflation Bonds: Government Inflation Bonds come in a number of different denominations and generally the amount one pays for them is the face value of that denomination. Corporate inflation bonds can be purchased either through a broker or directly form a company.

Tips on buying inflation bonds

When buying inflation bonds there are several things worth thinking about as in many forms of investing. Essentially those things revolve around finding the best deal with the least amount of risk. Some of the factors to consider are as follows:

• Bond Grade: Investment grade is an important indicator of the financial credibility of the institution(s) issuing the bond. The closer the rating is to AAA, the more accountable the issuer is.

• Secured Versus Unsecured: Collateralized bonds may not always be what they are cracked up to be. For example, secured AAA bonds backed by mortgage securities can decline in credibility if the housing market experiences a downturn. Unsecured bonds or 'debentures' rely on credit alone making the grade even more important.

• Real Rate of Return: The real rate of return is the actual amount of interest after inflation is deducted. Not all inflation bonds offer the same real rate of return. Shopping around can assist in finding the best rate.

• Rate Adjustments: Government I-bonds typically readjust interest rates every 6 months. It is a good idea to investigate how corporations readjust for inflation before purchasing their bonds.

• Foreign Inflation Hedge: If one lives in a country where inflation is high, investing in U.S. I-Bonds, Treasury Inflation Protected Securities (TIPS) and/or Corporate Inflation bonds may be a wise choice to protect ones income from losing value. Additionally, such investments can earn money in lieu of a less secure foreign savings vehicle.

Inflation Bonds are an attractive choice for both individuals and institutions wishing to protect, secure, diversify and stabilize investment capital and/or investment portfolios. While the returns on these types of bonds are not always as high as some other possible choices of investment, they do provide a consistent source of capital growth. Such capital growth can also be tax deferred in the case of I-Bonds, and interest gained from TIPS is both state and locally tax free.

Best funds for inflation protection

In the World of investing the practice of hedging is used to combat inflationary pressures. This is done in order to protect one's investments from adverse circumstances arising in particular industries and sectors, economic down turns and inflation. In the case of inflation, hedging involves investing in funds that traditionally perform well and/or better than most other funds during periods of high inflation.

To illustrate the affect of inflation on wealth, in the United States a period of high inflation was the 1970's during the first oil crisis period. During these times the value of the dollar declined against stronger foreign currencies and the spending power of one's income declines. This can often go hand in hand with rising cost of goods such as gasoline, and consumer staples further deteriorating one's spending power.

Financial institutions and Governments are well aware of inflation and take great measures to avoid it because of its negative affect on economic performance. For investors this is good news because it allows them to utilize these financial vehicles to hedge their own investments against inflation. A few of these investment vehicles are the following:

• U.S. Treasury Inflation Protected Securities (TIPS)
• British Inflation-linked Gilts (ILG's)
• Canadian Real Return Bonds (RRB's)
• Australian Capital Indexed Bonds
• Gold and other Metal Exchange Traded Funds (ETF's)
• High Grade Inflation Protected Corporate Bonds (IPI's)
• High Yield Domestic and International Certificates of Deposit

U.S. Treasury Inflation Protected Securities (TIPS)

TIPS are a U.S. Government backed financial instrument first instituted in 1997 and that is periodically adjusted for inflation. For example, if inflation in time period A is 2% the TIPS return on investment will incorporate this into the total yield. If however, in period B the inflation rises to 3% the yield in the TIPS will also rise. In addition to this inflation protected yield is a 'real yield' of around 3.3%. So no matter what inflation is, the TIPS 'real yield' on top of inflation should be steady. A similar method is used in ILG's and RRB's.

High grade inflation protected corporate bonds (IPIs)

Corporations like the Government, issue Bonds to raise money for their project capitalization operations. These Bonds are rated as high as AAA and as low as D. Most bonds in the A range are considered secure investments and since the return is fixed, volatility during times of inflation can be a hedge against one's more risky investments. IPI's are corporate bonds that are inflation adjusted allowing for a fixed yield when inflation rises. IPI's are very similar to TIPS except for the fact they are corporate rather than Government backed.

Gold and metal exchange traded funds

Gold and Metals have traditionally held their value well during periods of high inflation and in some case deflation. This is due to the international confidence in Gold as an alternate form of exchange. Unlike money the supply of Gold cannot be drastically reduced or increased allowing its value to remain more fixed.

During periods of high inflation, confidence in this more secure form of exchange rises, sometimes leading to a steady an/or rising price. The same is true for some other precious metals such as platinum. Gold can be purchased through mutual funds and other securities specializing in this type of commodity.

High yield certificates of deposit

Since investors can lock into a fixed interest rate on Certificates of Deposit this can be advantageous if timed correctly. That is to say, the yield on CD's changes periodically and since one locks into a yield that is the yield one is stuck with if the CD yield rises. Nevertheless, CD's are a stable and fixed form of interest that can be a stabilizing factor in a turbulent economic cycle. Moreover, some countries offer attractive fixed and variable rates on bonds, New Zealand and Australia being two current examples with CD rates in excess of 5%.

Australian inflation protected bonds (RBAs)

In seeking to diversify and protect an investment portfolio, and ideal decision may be to invest in an international financial instrument priced in a currency with low inflation , that yields high interest and offers inflation protection. Australian inflation protected bonds may be suitable for this purpose with a 2009 inflation rate of 2.5% and yields above inflation.

Protecting against inflation is a realistic concern in the investment World and among financial institutions. While there are more financial vehicles for protecting against inflation than listed above some of these other methods like SWAPS are more designed for financial institutions and not the individual investor. One can become increasingly sophisticated with how one protects against inflation but the key principle behind Hedge investing is balancing higher volatility and even outperforming those investments during inflation with more stable and secure returns such as those provided in this article.

Sources:

1. http://money.cnn.com/2007/01/16/commentary/sivy/sivy.moneymag/index.htm
2. http://tinyurl.com/6ybljpl
3. http://www.finpipe.com/tips.htm
4. http://personal.fidelity.com/products/fixedincome/bondratings.shtml
5. http://www.bankrate.com/brm/news/investing/20031021a2.asp