Inflation's hidden cost: forcing families to make riskier investments

Back when the dollar was sound, American families invested in simple – and safe – instruments like savings bonds. Now, thanks to Washington’s inflationary policies, they have to chase higher – and riskier – returns.

The American Institute for Economic Research (AIER) first published a book called “How to Invest Wisely” in 1947. Since then there have been vast changes in the United States and world economies, especially in the financial markets. One of the biggest changes has been the relentless erosion in the purchasing power of the dollar.

Six decades ago, the phrase “sound as a dollar” meant something. It didn’t have the ironic ring it has today. At that time, Americans believed that the dollar was “good as gold.” Most families’ wealth consisted of savings accounts, savings bonds, life insurance policies, and money tucked away in cookie jars and shoe boxes.

Today, even working-class and middle-class families typically are invested in the stock market. Some of the pension funds they will need when they retire may, in fact, be invested in high-risk stocks, mutual funds, real estate investment trusts (REITs) and even hedge funds.

Have Americans simply become riskier over the years? No. They’ve been forced to chase higher returns because inflationary policies of the federal government have undermined their traditional forms of investment.

Two generations ago, the investments of most Americans were safe and paid relatively low interest rates. Interest on passbook savings accounts, for example, was typically calculated on the minimum balance during the calendar quarter and was posted at the end of the quarter. This meant that any funds withdrawn or deposited during the quarter earned no interest.

Today, families have a wide variety of “fixed-dollar” options, including money market funds, upon which checks may be written, with interest accrued daily.

Much of what we now take for granted was made possible by advances in information technology. The increased speed and accuracy of data processing has facilitated complex financial transactions, even in small amounts, at greatly lowered costs. As a result, many more people now own stock and other financial assets.

In 1947, direct and indirect ownership of company stock was limited to a relatively small minority of the public. Brokerage commissions were fixed at high rates. Funded pension plans were in their infancy. And there were only a handful of mutual funds in operation: 98 in 1950, according to the Investment Company Institute.

Today there are more than 8,000 mutual funds – more than the total number of publicly traded US companies – and some 51.2 million US households, or 43.7 percent of the total, own shares of mutual funds or other US-registered investment companies, with a combined value in the neighborhood of $10 trillion.

While several factors are involved, these changes were fueled by the decline in the value of the dollar. Since AIER first published “How to Invest Wisely,” the dollar has lost nearly 90 percent of its value and there is no end in sight. To buy what $100 purchased in 1947, a family today would need $972. In the last 20 years alone, since 1990, the dollar’s value has fallen some 65 percent, a phenomenon that could accelerate as we come out of the recession and the effects of the government’s recent spending-spree sink in.

This has meant that everyone concerned with maintaining the family’s standard of living has been forced to accept risks that they often don’t understand and that their parents and grandparents would have avoided.

What most people call investing today is, in fact, speculation, based on the hope that we – or someone we’ve hired – can identify underpriced or overpriced assets. All too often this leads to chasing after financial fads.

Most experts agree that investing, like other disciplines, conforms to certain principles. Chief among these principles are the facts that long term financial returns are related to the risks involved; that market prices of financial assets reflect potential returns and risks; that it is folly to believe that anyone consistently can evaluate those returns and risks more accurately than the market itself; that financial assets can be classified into groups that behave more like one another than like other asset classes; and that broad diversification among asset classes can reduce risk.

Several academics have earned Nobel Prizes for the work behind these findings, which are variously called the “efficient market hypothesis,” the “capital asset pricing model,” and “modern portfolio theory,” among other names.

Even though the financial crisis of 2008-2009 has caused many to question these principles, they still remain valid guidelines to sound investing.

But as long as the government’s monetary and fiscal policies continue to erode the value of the dollar, Americans will have an incentive to accept risks that would be unnecessary if a dollar was still worth a dollar.

Lawrence S. Pratt is a senior fellow at the American Institute for Economic Research, Great Barrington, Mass., and editor of the 2010 edition of “How to Invest Wisely.”


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