Bracing for Higher Inflation

Do those numbers indicate that inflation will rise in the coming months? Nobody knows for sure. But here are three things we do know: Inflation won't stay low forever. When inflation does rise, it will sock retirees especially hard. And the best time to buy insurance against any hazard is before everyone else is worried about the problem.

On Feb. 26, when Alan Greenspan practically launched an international selloff of equities by telling a Hong Kong audience the U.S. might plunge into recession later this year, that wasn't actually the most interesting thing he said. Greenspan also explained why overall inflation has been so low for so long across so much of the planet: Countries from Estonia to Ukraine to China have converted to capitalism while trade barriers have been falling. As a result, tens of millions of skilled but relatively cheap workers entered a globalized economy, reducing corporations' labor costs and tamping down wages in developed nations. From the height of guns and butter in 1968 through the end of the Cold War in 1991, prices rose at an annualized rate of 6.1% in the U.S. But the inflation rate has been just 2.6% a year since 1992.

Eventually, though, price increases will lead to pressures for wage increases and further price increases, even in an internationalized economy. You can start arguments among economists by asking them to guess when that will happen and where prices will spike first in America; Greenspan's guesses are in two or three years and low-quality debt.

When inflation does pick up, it will affect retirees and near-retirees particularly severely. Every household experiences its own rate of inflation, depending on which goods and services it buys. And seniors consume a lot of health care, where prices are already rising rapidly and are likely to keep climbing: Americans age 75 and over direct about 16% of their total spending to health insurance, drugs and medical services and supplies, compared with a national average of about 6%. In contrast, young 'uns tend to put dollars into Internet services, PCs and phones, where prices are plunging.

Since 1987 the federal government has calculated an experimental price index to try to capture price changes for the typical basket of goods and services purchased by Americans who are 62 and older. The results are consistent: The CPI for seniors has been higher than or equal to the overall CPI every year, with the difference ranging up to 0.63 percentage points per year. Your personal inflation rate may vary from the national average by much more than that. The bottom line is that if you spend heavily on health care (or education — another category in which prices are surging) and not so much on technology, you have special reason to worry about rising prices.

Inflation hits seniors in their assets, too. When prices rise, the value of a dollar drops, which means that if you're holding investments valued in dollars, you lose wealth. Conversely, it means you'll gain if you're holding debt to be paid off in fixed amounts. Seniors tend to have relatively large chunks of their portfolios invested in cash and bonds, while younger people are usually paying off fixed-rate mortgages. "Even moderate inflation leads to substantial wealth redistribution...inflation benefits the young and hurts the elderly," wrote economists Matthias Doepke of UCLA and Martin Schneider of NYU in a research paper published last December. Doepke and Schneider found that, for example, if inflation were to rise 10 percentage points over a 10-year period, seniors would be forced to reduce their spending by 14%.