By: Douglas J Utberg

One of the concepts that can emerge from irresponsible fiscal and monetary policy on the part of the government is what Dan Amerman refers to as the financial “reset” button.  Practically speaking, this is the phenomenon that occurs when a government floats away its debt by inflating the currency and reducing the purchasing power of the dollars already in circulation.

The danger posed by this “reset” button is that it will destroy the purchasing power of all people who have dollar-denominated assets, and dollar-denominated payments from annuities, pensions, or government programs.  In addition to this, inflation will increase the nominal value of an asset without increasing its underlying purchasing power.  However, the government will recognize this increase in nominal value as a taxable gain and the investor will be left with less purchasing power than he or she had before the inflation occurred in the first place.

The reason why governments use the “reset” button is to clear out excessive amounts of debt by diminishing its value through inflation.  This seems all but inevitable, given the current government debt of $13.7 Trillion, and the unfunded entitlement Liability of $76.4 Trillion in 2010 dollars.  When this eventually happens, it will result in many people of low to moderate income being ‘pushed off the edge’ into desperate poverty.  This is likely to be accelerated by the relatively large pool of people who have become dependent on government subsidies and have not developed marketable skills that can be used to earn income at inflating rates.

The other group of people who will be adversely affected is senior citizens that are dependent on social security and pension payments.  As the purchasing power of these payments is destroyed through inflation, it will push many of the retired population to lower levels of prosperity and possibly into poverty.

This “reset” button will need to be invoked because of the spending liabilities that have been undertaken by government agencies in an attempt to buy votes with government policy and taxpayer money.  The hitch is that taxes can no longer be raised high enough to fund the spending, so the only answer left is to destroy the purchasing power of the currency.  In this case, the people who will be damaged the most are the ones who have become dependent on government entitlements . . . meaning that the policy of spending to win elections will inevitably impoverish the people whose votes are being purchased with the spending.  Not quite the warm and fuzzy compassion that you see in political campaigns.

Escaping the Inflation Trap

Once people fully understand the specter of inflation, and its likely impact on their financial wellbeing, the natural reaction is frequently to despair.  This does not have to be you, since there is a historically proven way to escape the inflation trap.  This trick is accomplished by understanding that inflation destroys all dollar-denominated paper assets . . . including debt.

Thus, if you have a real asset such as an income property that is financed with fixed rate debt, the inevitable inflation will increase the dollar-value of your property, but your loan balance and payment will remain flat.  Furthermore, your rents are likely to increase with the inflation, as the cost of new housing increases in nominal dollars.  By building a portfolio of income producing assets that are financed with long-term, fixed-rate debt you can actually benefit from inflation.  The advantage of this strategy is that you can leverage the expertise of local market specialists to select high quality properties in strategic micro-markets with excellent property management.