February 9, 2010 - Inflation. The Federal Reserve Chief and the governors believe it to be the worst of all possible scourges for the U.S. economy. The spectre of it looms large as the government throws more and more money at problems like unemployment, mortgages, and bank bailouts. It would seem inflation is inevitable as that money sloshes around in the economy, driving up prices for fewer goods as manufacturers slow or stop production due to lack of demand. So what's an investor to do?

If that doesn't give you much comfort, there are physical things you can do to prepare for inflation. But remember, the accepted, most common wisdom is that inflation will be a huge problem. Rarely is the most accepted opinion correct. Remember that in the 90's everyone thought technology would answer all our problems and that as we became more efficient neither deflation nor inflation would inflict us again. Charmingly naive.

A house can be a great inflation hedge. If you still own one, it will most likely appreciate in value as people begin to buy again. With new housing starts very low, demand could outstrip supply quickly. A home is the most common inflation hedge, but it's not liquid. You can't sell it in a few minutes, days or weeks. And if you do sell, you have to live somewhere, either renting or owning. Your house is a real asset. Inflation feeds on real assets since money becomes less valuable as it buys less and less due to higher prices.

Other items to consider: gold. There's an ETF (exchange traded fund) called SPDR Gold Trust (GLD) which is a good surrogate for buying gold directly. The ETF actually buys and hold gold as investors buy into the fund. It will track the price of gold almost exactly, and investors don't need to worry about storing their investment safely, much less carrying it home. If you like oil or other commodities, there are ETF's that track those as well. You can find out more about ETF's at AOL's ETF Center: Exchange-Traded Funds (ETF) Center - AOL Money & Finance or at Web sites such as Google Finance or Yahoo! Finance or MarketWatch.

Another possibility: TIPS. It's the government security (Treasury Inflation Protected Securities) that raises the interest rate on bonds when interest rates go up. They offer a guaranteed "real" yield that reflects changes in the official consumer-price index. The value of a TIPS bond's principal grows with inflation, as do the subsequent interest payments. The problem is that right now TIPS pay only 1.3%. Still if you worry about inflation, this is one instrument that will keep you at least abreast of it, maybe even a little ahead. And it's liquid.

One other idea: getting out of dollars into other currencies or foreign bonds or stocks. While this sounds good in theory, the reality is that all foreign investment carry two added risk levels: the political stability of the country and foreign exchange rates. While the dollar should go down in value as inflation develops, if the country in which you hold currency has even higher inflation, the dollar can appreciate, rendering your investment worth less. Tread carefully in foreign waters.

There's no doubt inflation will come. The key is not to bet too heavily on when and how much. If investors put all their funds into one or two of these investments, and inflation is mild, then they will get no reward for their foresight. But prudent investors will have some of their dollars in various securities and assets as the inevitability of inflation, if this business cycle is like all the others, becomes a reality.