“Ask Robert” February 2011 - Answer

“Ask Robert” February 2011 - Answer

Thanks again to everyone for posting their questions. This month's batch was particularly good and insightful.

This month's question comes from alphawolff, who asks:

Is there any chance the government could pull something out of their hat at the last minute that would stop the devaluation of currency, and we really could enter a recovery stage? I know where we are headed, with deflation and hyperinflation, but I want to make sure I can stay liquid enough to hedge my bet just in case something changes.

This to me is a great question because it exhibits what I'm talking about when it comes to being financially intelligent and shows an understanding that it's not the market conditions that make you rich but rather your knowledge and how you apply it in a given market that makes you rich.

As I've preached for decades, a financially intelligent person can make money in a boom or a bust market by adjusting their strategy, staying on top of the financial news, investing in their financial education, and applying their knowledge accordingly.

My answer to this particular question is yes and no. There is always a chance that the Fed will change course and prop up the dollar.

Here's how it could work. Were inflation to ramp up, the Fed could quickly hike interest rates. We saw something like this in the 1980s when then Fed Chairman, Paul Volcker, hiked interest rates into the teens to bring inflation down from 13.5 percent in 1981 to 3.2 percent in 1983. Additionally, the Fed would have to cancel its current $600 billion quantitative easing program, and put some real verbal and policy muscle behind the dollar.

A move like this would put world confidence back in the dollar, something that is faltering quickly, which would cause the value of the dollar to rise relative to other currencies. The result would be deflation as the rising dollar would then have more purchasing power and higher interest rates would discourage investment. In a scenario like that, savers would be winners as long as the policies were in place and effective because dollars would go up in value.

In such a scenario, my strategy would remain the same, though the execution of it would change. I would still as always invest for cash flow, finding and purchasing deals as they came available and provided the return I'm looking for. However, I would probably shift some my liquid assets like gold, silver and oil, the assets I use to buy my income producing assets, to dollars. The reason I would do this is because like gold, silver, and oil, the dollar is now a commodity. If the government really wanted to push its value, it would rise relative to other commodities and you would probably see liquid assets like precious metals, oil, and food go down in price as the dollar gained in purchasing power.

Now, let me stress that I think this scenario is highly unlikely—if not nearly impossible.

What makes this current financial crisis unique is that while we're seeing inflation in some core products such as food and gas, the reality is that many assets are still in a deflationary cycle, particularly real estate, and unemployment is still very high at over 9 percent.

The US economy is largely dependent on healthy real estate and consumption which makes up 70 percent of the GDP. Until more people are employed and real estate rises again, consumption will be weak—and so will the economy.

If the Fed were to take a hard stance to prop up the dollar, the result would be a hard and potentially catastrophic correction in the real estate market as high interest rates made investment harder and less profitable and a continued drawback by employers in hiring and investment. In other words, saving the dollar would most likely send us into a deeper recession, if not a depression. In the long run we would be healthier, but as economist John Maynard Keynes famously said, "In the long run we are all dead." And that is a guiding principle of today's economists.

No one wants to pay for his or her bad decisions today. It's much easier to push them off to future generations, something that's been happening for decades.

I find it to be highly unlikely that we will voluntarily hit the economic self-destruct button in this country. Instead, we will continue our policy of printing more and more money, hoping that this time it will be different. Correction will come, but it won't be voluntary.

This is why I continue to buy gold, silver, and oil. I believe that the Fed will continue to print more, devalue the dollar, and encourage debt and spending. In my mind, I still believe the dollar is toast, savers are losers, and debtors will win. I could be wrong, and you'll have to decide for yourself.

Thanks again for your question.

– Robert Kiyosaki

Original publish date: March 11, 2011