In the midst of the constant headlines concerning government ‘bailout’ initiatives that have resulted from a credit crisis in the financial sector, one must stop to wonder whether the government is acting responsibly and what the likely results of these actions will be. (In truth, one doesn’t have to wonder that much … the government is acting with an almost complete lack of anything resembling financial responsibility.)

The core driver of this problem is that public agencies making market decisions will tend to make them based on political expediency instead of market effectiveness.  From the perspective of a politician, “long-term” thinking only lasts until the next election.  The reason is because most politicians are unconcerned what will happen after they are out of office and can no longer take credit for successes, and will not be subject to blame for problems.

Unfortunately, this decision making framework has spilled into the realm of government subsidies and bailouts.  This has amplified the scope of collective irresponsibility since public resources are not only used to sustain an out of control government, but have now been expanded to supporting businesses that are uncompetitive in the free market and depend on political support with taxpayer money for their success.  This has allowed many companies and executives that made destructive decision to stay in business because of public funds that were granted by government officials.

In a free market, companies that make critical errors would be re-structured in bankruptcy, or liquidated and sold off to new investors.  Unfortunately, the US government is choosing to drastically increase the amount of currency in circulation as a means to finance its spending, including bailouts to keep the failing companies afloat and stem the impact of a sharp reduction in credit availability.  (This process is also known as ‘printing money’)A  This drastic increase in circulating dollars will eventually produce significant inflation.  This is caused by increasing the amount of currency in circulation, but keeping the amount of national output the same . . . more money chasing fewer goods MUST result in increased prices.

When inflation occurs, it de-values savings, home equity, and fixed-rate investments like CD’s and Bonds because those instruments tend to increase in value very slowly, and the purchasing power of the dollars they are denominated in consistently erodes.  Conversely, inflation rewards people who have taken out a large amount of fixed-rate debt by de-valuing the principal & interest payments.  Effectively, inflation punishes responsible behaviors like saving and paying down your mortgage while rewarding irresponsible behaviors like taking on large amounts of debt.

Ultimately, living with an irresponsible government means that you will be indirectly punished for acting responsibly.  By working hard to earn a high income, keeping lots of money in savings, and paying off your mortgage, you will be set-up for a tremendous double-whammy from taxes and inflation.  The massive government deficits make some form of future tax increases all but inevitable … much of this will be driven by inflation pushing up the nominal wages of individuals and corporations, driving “bracket creep” where people’s higher nominal income is taxed at higher marginal rates.  The second half of this pitfall comes from de-valued savings and home equity.  The people who have worked the hardest, sacrificed the most, and saved the most diligently will be punished by the inevitable inflation that is bound to stem from many decades of irresponsibility.

Fortunately, there is a way that regular people can profit from future inflation.  The prime strategy for beating inflation involves using long-term debt leverage to purchase investment assets that produce income and appreciation.  The most common way to do this is through rental real estate investments.  The way this works is that you purchase a rental property with a fixed-rate loan and lease it out to tenants.  When the inflation starts to hit, it will push up the home value & rents because the increased amount of dollars in circulation will be chasing after the same number of houses & rental units.  Since your investment is financed at a fixed interest rate, your expenses will stay relatively flat while your income inflates.

In the end, there is nothing that any one person can do to stem the tide of collective government irresponsibility that is overshadowing the entire global economy.  However, there are things that each individual person can do to protect themselves and their families from the effects of inflation.  Ultimately, our future is driven by the decisions that we make each and every day.  As you go throughout life, make sure that each decision you make is one that will help to create a brighter future.