Beating Inflation

Back when I was originally considering early retirement in the 2000’s, I though I could pull it off with 300k to 500k. When I most recently started saving, my target was 1.2MM. Now that I am married, my target has crept up again to 1.2MM to 1.5MM. Part of this is lifestyle creep. My expenses in general have continued to go up, but a big part of that is that a dollar doesn’t buy what it used to.

The US inflation rate for 2021 is around 2.24%. If my investments are making less than that, then I am essentially losing money as the value of the dollar declines. In terms of savings, I would actually be moving backwards.

Quantitative Easing

One of the things that happened between my initial retirement plan and now is Quantitate Easing. This first happened in response to the 2008 Financial Crisis, where the Federal Reserve purchased bonds, mortgages, etc with money they made up to increase the money supply, and stimulate the economy. They continued this program through 2014 as the economy struggled to recover.

The Federal Reserve then began to do this again in 2020, in response to the Coronavirus pandemic, and has committed to purchasing $80 billion a month in treasuries and $40 a month in mortgage backed securities until further notice. The Fed’s balance sheet has gone from 4 to 7 trillion since 2019.

Needless to say this policy can have an economic impact whether it be on interest rates, creating asset bubbles, or just overall inflation. I would suggest that the impact on interest rates and the creation of asset bubbles has been particularly noticeable over the past couple of months.

Quantitate Easing has driven interest rates down allowing for me refinance my mortgage, which a year ago I thought was already a pretty low rate into something even lower, allowing me to save hundreds more per month towards retirement. This also though has the effect of driving down the interest rates on my savings and bond funds.

Savings Accounts

Right now I am only using my savings account for money that I know I don’t need in the next 30 days, that goes to checking, but might need at some point in the next couple of months, and don’t want to liquidate investments and pay the taxes on that. Keeping money in an account that pays .01% just doesn’t makes sense. If the current inflation rate is 2.24%, then I would still be losing 2.23% each year on this.

Sure, I could move it to an online savings account, but the math doesn’t get much better there. For instance, Marcus, the online consumer division of Goldman Sacks is currently paying .5% on their savings accounts. Ok, so now I am only losing 1.74% on my investments. Although I admit, some investments do lose money, I don’t want to go investing in things that I know are going go down just by simple math. By keeping my money with a savings account with my bank, however, it is instantly available, even if I do lose a couple of pennies in interest a month.

Stocks

One area of my retirement plan that has been helped by Quantitate Easing is my stock portfolio. Generally, stock prices have continued to go up, despite the fact that company earnings have been pretty bad lately due to the pandemic. Some of this might be in anticipation of the company’s recovering post COVID, but the S&P 500 has been at records for months now, how much of a recovery can there be? It seems that a large part of the current stock market valuations can be blamed on simply being so much cash out there from QE which is now trying to find a home. Additionally, with interest rates where they are, the cost of capital is low for people to buy more stocks on margin, driving the prices up further.

Fiat Backed Cryptocurrency

Fiat backed cryptocurrency, such as USDT (Tether), and USDC (Circle) are similar to Non Fiat Backed Cryptocurrency, such as Dogecoin, Bitcoin, Ethereum, and run on similar technologies, except in theory one dollar in USDT or USDC is backed by one dollar held at Tether Limited or in the case of UDSC by Circle Corporation. Additionally, there are other Fiat Backed cryptocurrencies out there, as well as Fiat Backed cryptos out there based on currencies other than the US dollar, but those two, USDC and USDT are the largest.

On their own they have the same issues with US dollars declining in value. After all, if the value of a dollar is declining by 2.24% per year, then the value of a USDT coin is declining by the same amount, as the value of USDT is tied to the value of a dollar. However, I can stake the USDT or USDC and earn interest, currently of around 10% via Compound. Gemini currently has a similar program that let you earn 7.4%. So 7.4% minus the 2.24% inflation rate still gives me a return of over 5%. Hence, done correctly, Fiat Backed Cryptocurrency, if done correctly, could be a way to beat inflation.

That being said, using Fiat Backed Crypto to hedge against inflation comes with risks of its own. For one, you lose the FDIC insurance that would go with say, putting your money in Citibank. Also, since USDC and USDT run on the Ethereum network, high gas fees can eat away at your earnings if I start moving my USDT around a lot. Additionally, there are questions about the soundness of USDT specifically, with the New York Attorney Generals office questioning their claim of having each USDT backed by 1 dollar.

Non Fiat Cryptocurrency

As much as stocks have gone up during the pandemic, Bitcoin has gone up even more. Bitcoin did initially fall with the March 2020 stock crash into the $4000 range, but has since shot up to around $50,000, over a 1000% return in just under a year. This is beats the inflation rate of 2.24% by quite a bit.

A couple things might be in play here in regards to Quantitate Easing. One, is the same excess cash that is currently sloshing around the sock market is making its way to the cryptocurrency market as well, driving up the cost of Bitcoin. Another factor in play is that the supply of Bitcoin is limited by its algorithm.

There will only ever be 21 million Bitcoins ever produced, about 18 million of which exist currently. This doesn’t account for the coins that have been lost due to lost wallets, or accidentally getting sent to wrong addresses, and thus becoming essentially unusable. People are seeing this scarcity as a way to keep ahead of inflation.

Over the past few weeks, it hasn’t just been people getting on the Bitcoin bandwagon, corporations such as Microstrategy and, Tesla, have also added bitcoin to their balance sheets. Additionally Paypal is adding ways to not only buy Bitcoin, but to use it as a funding source for transactions. All of this has increased the demand for Bitcoin, while the price remains limited by its algorithm.

One of the arguments that is used against non fiat backed cryptocurrencies such as Bitcoin is that there is nothing backing it. You are essentially relaying on someone else wanting to purchase your Bitcoin at some point in the future, ideally for something of value equal or greater than you paid for it. There is no guarantee of this value however. The same can be said for fiat currency such as the US dollar, however, the value of the US dollar has been in decline, currently at a rate of about 2.4% per year because of the previously mentioned inflation.

Demand for US dollars however continues to hold up, despite the Federal Reserves recent money printing habit because the dollar is the world’s default currency. When we import items from China, we can generally pay them in dollars, and generally pay them in US dollars, backed by the full faith and credit of the US Government, whatever that means. Essentially one dollar is always going to be worth one dollar, no matter how many dollars the Federal Reserve decides to print out of thin air.

However, there is no guarantee that this will continue to be the case. What would happen if the world decides they now want to be paid in their local currency, or in Bitcoin, or in some other currency nobody is using yet?

Where does it all go

So back to inflation. As I have mentioned several times now it is currently running at 2.24%, in spite of the Federal Reserves efforts to create a lot more dollars. Over the past few months, this has exasperated the wealth gap here in the United States, with the additional currency going to banks, corporations, and those lucky enough to have most of their assets tied to the stock market and other rising assets. For now, wealth is just sitting there, otherwise we would be seeing a lot more inflation. Those not lucky enough have seen their net worth decline, not only by the economic issues created by the pandemic, but by the declining value of what wealth they do have in US dollars.

Diversification

There is, sadly, not a single solution to my retirement savings beating inflation. Each possible way of doing this comes with its own risks. Has the stock market become an asset bubble at risk of popping? Is there a bubble in the Cryptocurrency market, can Bitcoin maintain its current value? Needless to say, investment involves risks. Perhaps the only risk free way to invest is to put everything in a savings account, and watch your wealth decline to inflation, hard pass.

Since there is no magic bullet, the solution is to try a bit of everything.

Disclaimer: Investing involves risks, and nothing in this post should be construed as financial advice. Risk of investments includes the loss of principal, which I can’t assume liability for. Please consult with an actual financial advisor for advice.