Investing and inflation

 The U.S. Bureau of Labor Statistics, which calculates the Consumer Price Index that measures inflation, maintains a detailed and comprehensive website - www.bls.gov/cpi/home.htm.* See www.pbs.org/newshour/bb/economy/july-dec97/inflation_12-16.html for a lively discussion of the inflation is dead scenario. In 1996, the government appointed a group of economists, the Boskin Commission, to examine the accuracy of the official inflation rate. The estimate was that inflation was overstated. Often inflation was overstated by as much as two percentage points each year. For the commission's report, see www.ssa.gov/history/reports/boskinrpt.html. Many investment experts now feel that stagflation, or falling prices, is more dangerous than inflation. Including bonds as a permanent component of your portfolio is the best way to limit this risk. (See note on Chapter 4.)*For more information on this practical pitfall, see “The Money Illusion” by Eldar Shaffir, Peter Diamond, and Amos Tversky, in Choices, Values and Frames, edited by Haniel Kahneman and Amos Tversky (Camit University Press, 2000), pp. 335-355.

*That year President Jimmy Carter delivered his famous 'Malage' speech, in which he warned of a 'crisis of confidence' that 'attacks the heart and soul of our national will' and which 'threatens to destroy the social and political fabric of America.'Stanley Fischer, Ratna Sahai, and Carlos A. Veitch, 'Modern Hyper and High Inflation,' National Bureau of Economic Research, Working Paper 89301, at www.nber.org/papers/w8930'The United States has actually gone through two periods of hyperinflation. During the American Revolution, prices nearly tripled each year between 1777 and 1779. During the Revolution, a pound of butter in Massachusetts cost $12 and flour reached $1,600 a barrel. During the Civil War, inflation hit annual rates of 29 percent (in the North) and nearly 200 percent (in the Confederacy). By about 1946, the inflation rate in the United States was 18.1 percent.'I am indebted to the critical but accurate insights of Laurence Siegel of the Ford Foundation. Conversely, in times of deflation (or persistently falling prices) it is more profitable to be a lender than to be a borrower. This is why most investors should hold at least a portion of their assets in bonds, which can act as insurance against falling prices.When inflation is negative, it is technically called 'deflation'. Falling prices may sound good at first, until you think of the Japanese example. Prices in Japan have been falling since 1989. The value of real estate and the stock market have been falling year after year. This is certainly nothing short of a constant torture for the world's second largest economy.* Ibbotson Associates, Stocks, Bonds, Bills, and Inflation, 2003 Handbook, (Ibbotson Associates Chicago, 2003), Table 2-8. The same pattern appears outside the United States, for example in Belgium, Italy, and Germany, where inflation was particularly high in the twentieth century. Elroy Dimson, Paul Marsh, and Mike Staunton explain that "inflation appears to have had a negative effect on both stock and bond markets."See Triumph of the Optimists: 101 Years of Global Investment Returns (Princeton University Press, 2002), p. 53

."Complete information on REITs can be found at www.nareit.com. However, sometimes this information may be out of date.For more information visit www.vanguard.com, www.cohenandsteers.com, www.columbiafunds.com, and www.fidelity.com. If you own a home, the advantages of investing in a REIT fund may be weak, since owning a home implies an ownership stake in your real estate.A good introduction to TIPS can be found at www.publicbt.treas.gov/of/ofinfin.htm.For a more detailed discussion, see www.federalreserve.gow/Pubs/feeds/2002/200232/200232pap pell, www.s-creating Publications/redrags/73,09-2002 htm, and www.bwater com/research benda atm.