I’ve been a Trusted Advisor in the Freedom Founders for some time now.   Freedom Founders was started by a friend of mine, David Phelps.  He is a visionary who is concise with his thoughts about what is happening within our economy and so much more.  David and I are both very passionate about alternative investments via real estate (that’s a big piece of what Freedom Founders is all about) and we tend to be aligned on our views on the economy, too.   A few months ago, David wrote this article about inflation and debt that I found especially relevant.  It’s a topic we’ve written about recently, too, but I think you’ll appreciate his take on it.  David was happy to let us share the article, which you can read below.

— Greg

How You Can Get on the Right Side of the Debt Tsunami 

by David Phelps

We are entering an economic scenario in our country (and globally) that most have not seen, experienced, or endured in their lifetimes.  The preponderance of current business and investment decision-makers had not yet begun their careers in the 70s and 80s.  For them, this is uncharted territory.

You cannot predict the future based on the past.

The world is too complex.  “Black Swan” events are by their very nature impossible to predict.  However, we can use the past to understand the underlying forces and factors behind historic events.  Such knowledge can help us identify principles to successfully navigate those underlying forces in the future.  As the saying goes, history doesn’t repeat itself, but it does rhyme.  This is why the best advisors do not prescribe tactics, but rather principles followed by specific strategies.  I do not have a crystal ball.  No one does.  But I can see echoes of the past in current events.  I see principles at work.  I see these things with enough clarity that I can confidently make tactical decisions even in the face of uncertainty.

What are some of those factors today?

Inflation vs Deflation … Follow the Debt.

As I’ve often said before: “Follow the debt.”  The US is the greatest debtor nation in the world today by a significant margin.  The US money supply grew by $3.8 Trillion in 2020 alone.

“In one year, we created enough new dollars to equal 20% of all dollars ever created in the history of our nation.”

Inflation always favors the debtor.  It creates an opportunity to pay back today’s debt with tomorrow’s less valuable dollars.  Our government is spending massive amounts of money to satisfy the demands of the American masses, arid then monetizing the debt with inflation.  This tampering/meddling with the economy is creating artificial, manipulated market conditions. Left untampered, the economy, with globalism and advancements in technology, should have a deflationary effect: goods and services should become cheaper through innovation and automation.  That is not what we’re seeing right now.  Our economy is being recklessly “managed.”

All of this new money is outpacing the deflationary effects caused by globalism and technology. Of course, the federal reserve likes to play “God” with the economy.  They tell us not to worry — this is merely transitory.  Of course they’ll tell you not to worry.  They said the same thing back in 2006 as the subprime financial mortgage crisis was melting down.  They will tell you what they want you to believe.

Inflation is like Compound Interest … in reverse.

Inflation has a very similar effect to compound interest — but in reverse. Over time, inflation can completely erode the growth and value of your wealth.  The longer the time period, the greater the impact. There is no “neutral” position.  If you want your wealth to grow, you must outrun inflation.

This is why much of the conventional wisdom is so flawed.  Those who think they are being “conservative” with their money by getting out of debt and saving money (what we’ve all been taught by well-meaning parents, grandparents and others, like Dave Ramsey), may well find themselves on the wrong side of the tidal wave of debt and inflation that is coming.  Sadly, many will drown, or at best keep their heads above water.

May the Force Be With You — don’t try to swim against the tide.

If you are borrowing money at an interest rate of 3-4% on a business or real estate or other type of investment, and if inflation is rising at the same 3-4%, then realize that the cost of your borrowing (your interest rate) is negated by the inflation rate.  In this example, the cost of borrowing is offset to zero.

What would you buy, acquire, or invest in if your cost to borrow was 0% interest?

What if the inflation rate is even higher than our cost of borrowing?  If our cost of borrowing is 3-4%, but inflation is running at 5-6% (I remember back in the seventies and eighties, inflation was running in double digits, up to 74.5%), there is actually a negative cost to borrowing.  This becomes a major opportunity.

Of course, I’m not suggesting borrowing to inflate your consumption lifestyle.  I’m not talking about building a bigger house or buying more cars.  I’m talking about using debt in a wise way to grow wealth.  I’m talking about aligning with the forces that are at work in the market, rather than trying to swim against the tidal wave, which will exhaust so many well-meaning people in the coming years.

Can you use the debt at fixed rates over a long period of time so that inflation will erode that debt?  You can — if you’re strategically using that debt to invest in cash flow producing assets that are also hedged against inflation.

Businesses can be such an asset.  Many of you are in business and that’s a good thing, as long as you are building a real business asset and not just another job.  Of course, real estate can also be such an asset.  You know my bias for real estate.  I love real estate because it’s so easy to acquire with leverage.  If you acquire the right properties with excellent management in place, and you use leverage properly, you have the opportunity to use inflation to reduce your borrowing costs to zero (or even negative)

I call this “shorting the dollar.”  This is turning the force of inflation in your favor.  You’re surfing the tidal wave instead of getting pummeled by it.  Sadly, too many people will keep swimming with all their strength in the wrong direction only to look back in the years to come and wonder what went wrong.  Doing everything “right” by conventional wisdom is no guarantee of success.

Cash flow producing assets are better than cash.

It would be a tragedy to reach the end of your career, when you are ready to step away from active income production, only to realize that the nest egg you worked so hard to accumulate isn’t worth what it once was.

The traditional accumulation model does not have a good answer to the threat of inflation.  That’s why most financial advisors will tell you that you need 6, 8, even $10M before you can retire.  They are hedging their bets.  How much purchasing power will those dollars actually have in 5 years?  10 years?  20 years?

If you can manage to save that much with ever-increasing taxes, good for you.  But let’s say you couldn’t get there.  Now you’re forced to use a depletion model.  If you withdraw 3-4% of your nest egg per year, it might last 20-25 years (assuming nothing unexpected comes up either personally or economically — a lot can happen in two and half decades).  Doesn’t sound like much of a plan to me.

Add to that the effect of inflation, and the purchasing power of your nest egg may deplete so quickly that your ability to take any principal out on the way is going to be negated completely.  If your nest egg isn’t creating sustainable income that outpaces inflation, you’re in trouble.  For most, their nest egg is not creating any income, or it’s very, very low.

The key to creating income is to invest in cash flow producing non­monetary assets.  The way to protect that income against inflation is the investment in the same cash-flowing assets.  That’s why alternative investments in real estate beats financial investments on Wall Street hands down.