strikes? You might expect the stock prices to decline to reflect the billions of dollars in claims. Quite often, however, the result is exactly the opposite and the stocks rally.

Why do insurance company stocks rise on bad news? The answer is that people tend to buy insurance after big disasters. So the insurance firms are indeed hurt by the claims that they pay, but they also gain from the marketing of their product. Often the gains exceed the losses, and this can cause the stock price of insurance companies to go up after a disaster.

This response to disaster points out that in insurance, just as in other areas, most people tend to be exactly out of sync with the money-making strategy. The time to buy insurance is obviously before the event, when no one is buying and the insurance rates are low, not after the event when everyone is buying and rates are high.

Twenty years of Goldilocks has lulled most of us into exactly the wrong position. We have come to expect price stability. That means our lizard brains are likely to be underprepared for price instability, in the form of either inflation or deflation. To the extent that many of us are in the same position, now is the time to insure ourselves against price instability on favorable terms.

Here are three strategies to protect your wealth against both inflation and deflation. They are all ways to buy insurance in case we leave the Goldilocks world of low and stable inflation.

Buy at Todays Prices

The first technique is simply to buy at todays prices. If you buy the home that you plan to live in for some time, then you are protected against price swings. While you may suffer as compared to your alternatives, you will be safe within your home. Similarly, some states allow you to pay college tuition ahead of schedule.

If you buy the stocks of companies that own natural resources, then you are protected from commodity price changes. For example, if you own the stock of oil companies, then you will benefit from any subse-

quent rise in oil prices. If you buy the correct amount of such stocks, you can completely protect yourself from the effects of commodity price changes.

If You Borrow, Lock in Current Rates

Recall that high inflation is a jubilee where debts are effectively erased. The higher the inflation rate, the lower the true cost of repaying debt. In the 1920s, German debtors were able to pay off their mortgages with marks that were essentially worthless. Thus, high inflation provides a financial windfall to debtors.

This inflationary benefit to debtors is only true, however, for those with fixed-rate debt. A growing percentage of Americans are financing their debt with adjustable-rate loans. If inflation rises, these people will find that their payments have increased commensurately with the new inflation.

If you want to insure yourself against price changes, choose fixed rates for all of your debt. With fixed rates, your debts decrease in real value in inflationary environments. What about in deflationary times? In deflationary times, you can refinance your debts at lower rates.

So fixed-rate loans are better than variable-rate loans in inflationary times, and fixed-rate loans are no worse than variable-rate loans in deflationary times. Are fixed rates, therefore, a free lunch? The answer is they are not, because the fixed-rate loans are offered at higher rates than variable loans. The extra monthly payment for a fixed loan can be viewed as purchasing insurance against price changes. If the previous analysis is correct, then the world may be pricing such insurance at unusually low and attractive prices. Thus borrowing at a fixed rate may not be a free lunch, but it might represent a value meal.

Buy Inflation-Protected Securities

The U.S. government sells bonds that provide complete protection against inflation. The amount that these bonds pay is adjusted each year

for the prevailing inflation rate. If inflation is high, the bonds pay more to reflect the lower value of each dollar.

Lets compare the payoff to an investment in a 10-year inflation-protected bond to an investment in a traditional bond without inflation protection. To be concrete, we will compare a $1,000 investment into U.S. government bonds with and without inflation protection. Both bonds pay interest over the years and then make a lump-sum payment at the end. Whereas a traditional, noninflation-protected bond simply returns $1,000, the inflation-protected bond adjusts the $1,000 based on the amount of inflation.

Thus, the inflation-protected bond returns at least $1,000, and perhaps more. How much more? That depends on the inflation rate. To see the specifics, Table 5.1 compares the final payment for the inflation-protected and the noninflation-protected bonds under four different inflation scenarios.

Scenario 1 is no inflation. Scenario 2 is a continuation of the Goldilocks environment of 3% inflation per year. Scenario 3 is a return to the late 1970s in the United States with 13% inflation per year. Just for fun, scenario 4 considers prices rising at 500% a year (although this inflation rate is high, it is far lower than the rate in Germany during the hyperinflation). So what do our bonds pay in these four scenarios?