Value of Index Funds Related to Dollar Creation

Question

I read this article this morning. While I believe the United State economy will remain strong, it did introduce a question for me. In the off-chance that hyper-inflation (or extreme deflation) happens, what happens to the value of index funds? Even in the worst case scenario, companies would still continue to run? If that's true, an index fund will always hold value. What I am trying to understand is the relationship between index funds and a currency I guess. I don't fully understand that relationship.

Answer 1

Here's the thing. BitCoin, Index Funds, Gold Coins, Beanie Babies all have a value which we use currency (e.g. Dollars) to measure. All else being equal the value of those items doesn't change just because of inflation/deflation.

So if inflation makes the dollar worth half as much, your index fund will likely be priced twice as high because that's how many dollars of value you now own. You didn't win or lose. It just changes the number of pieces of paper you need to trade to get the same amount of stuff.

Really the only time you get burned/benefit is if you are holding actual currency, buying in one currency and selling in another, borrowing money, or doing currency trading.

I think the author of that article is assuming the market reaction will drive up or down the value of Gold relativity to stocks in a panic situation. However, that is just speculation and can be very risky.

Answer 2

It's important to remember the ramifications of hyperinflation or deflation. In periods of inflation, the real value (i.e. purchasing power) of a currency is reduced, so the value of your index funds (all else held equal) decreases. However, higher inflation means higher prices, which means higher profits for companies, which means higher stock prices, which may offset that effect somewhat.

Deflation is the opposite effect. Deflation means lower prices, which means that your index fund is worth "more" relatively, but it also means lower profits, which means lower wages. It may also mean that index funds decline in absolute value, which again offsets the deflationary effect somewhat.

There's no way to know what the inflation of deflation will be overall based on all of these factors. The causes of inflation/deflation may have greater effects on the market that the currency itself.

In regards you the article you read - I think putting significant funds in bitcoin, gold, silver, etc. Is horrible advice. Yes they might spike, but if they don't, it won't be the author's fault. It's not his money that's being risked in that scenario. If he's right, you'll see articles praising his visionary power. If not, you'll never hear anything about it.