CONCLUSION
This chapter documents the role of money supply in the economy and fi-
nancial markets. Before World War II, persistent inflation in the United
States and in most industrialized countries was nonexistent. But when
during the Great Depression the gold standard was dethroned, the con-
trol of the money supply passed directly to the central banks. And with
the dollar or other major currencies no longer being pegged to gold, it
was inflation, and not deflation, that proved to be the evil that central
banks sought to control.
The message of this chapter is that stocks are not good hedges
against increased inflation in the short run. However, no financial asset
is. In the long run, stocks are extremely good hedges against inflation,
while bonds are not. Stocks are also the best financial asset if you fear
rapid inflation since many countries with high inflation can still have
quite viable, if not booming, stock markets. Fixed-income assets, on the
other hand, cannot protect investors from excessive government is-
suance of money.
Inflation, although kinder to stocks than bonds, is still not good for
equity holders. Fear that the Fed will fight inflation by tightening credit
and raising real interest rates causes traders to sell stocks. Inflation also
overstates corporate profits and increases the taxes firms have to pay.
Furthermore, because the U.S. capital gains tax is not indexed, inflation
causes investors to pay higher taxes than they would pay in a noninfla-
tionary environment.
Fortunately for shareholders, central bankers around the world are
committed to keeping inflation low, and they have largely succeeded.
But if inflation again rears its head, investors will do much better in
stocks than in bonds.CHAPTER 11 Gold, Monetary Policy, and Inflation 205