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Anyone lining up historical facts and then peering into the future can reasonably guess that inflation will define the economy for the coming generation. Under these circumstances, some investment shifts can make some sense, but first a look at the fundamentals.

Congress has three choices. They can raise taxes. They can cut programs and spending. Or, they can allow inflation to effectively reduce the value of the dollars that we owe to our own citizens and foreign governments that have bought U.S. Treasury bonds. The inconvenient truth about taking the inflation route is that no politician needs to take responsibility for a specific tax increase or spending cut. Inflation just creeps like fog onto the economic scene, allowing a "my hands are clean" approach to dealing with the problem. Meanwhile, just as the fog slows down sea traffic here at my Maine coast vacation site, inflation caused by rising interest rates slows down the economy like throwing out an anchor.

We're talking "stagflation" which is inflation coupled with a struggling economy.

It doesn't take much cynicism to conclude that inflation will be the path of minimum regret for Congress in the years ahead. The economic prognosticators at the highly-respected Institute of Trend Research have predicted inflation ramping up to 8 percent within three years.

When it comes to investing in an inflationary environment, housing comes immediately to mind. This was confirmed in a personal discussion with a Bay Area homebuilder hit especially hard by the housing implosion.
He said, "Inflation has always been great for the housing industry."

With the housing market having hit bottom, coupled with the fact that we have historically low, fixed-mortgage rates, an investment in housing can make great sense today. Vacation homes with views or on the water, and residences in urban areas, tend to benefit the most from long-term inflationary conditions.

With respect to fixed-income investments, bond mutual funds with longer average maturities will always be trying to catch up with inflation. Capital values of existing bonds in the fund will drop until they begin to approach maturity. If the majority of the bonds in the fund are several years away from maturity, the entire mutual fund's value will be depressed for awhile.

A short-term bond fund, by comparison, has bonds that mature in two or three years on average, and this is too short a time period for much drop in value. Another approach is to invest in individual bonds themselves instead of investing through a mutual fund. This enables you to control the maturity of each bond and hold them to maturity if they drop in value in the interim.

The stock market, during an inflationary period, tends to "whipsaw" investors. On the one hand, rising interest rates are bad for corporations that are paying for borrowed money. Interest rates, in general, are the single most important determinant of corporate profits. Meanwhile, companies typically own assets that can increase in dollar value and they can raise prices during an inflationary period. Buy-and-hold investors who are dollar-cost averaging, investing steadily, are served well in a whipsawing market. Those trying to time the market, without exception, will miss opportunity as the market climbs on its "wall of worry."

We went through this in the '70s, of course, but back then we didn't have any money. This time it's different, and we have to think about what inflation might mean to us.

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