Inflation will destroy your wealth.
Make no mistake, a ruling authority that tries to encourage inflation is stealing from you.
For most of us normal people the concept of inflation is bad.
In this article, we’ll look at:
- How inflation affects us.
- Different types of inflation.
- The danger of inflation.
- How to protect yourself from it.
The Impact of Inflation
Unless you are a central bank trying to convince everyone that 2% year on year inflation is a good thing to aim for, then when you hear the I-word, it’s invariably going to have negative connotations.
For most of the population, the impact of inflation is obvious. The prices of the items we need to live normal lives are increasing.
That is the one type of inflation that scares us most. Because if the cost of living is going up, then we need to find more money from somewhere just to stay the same.
We have to work harder, take second jobs etc. just to remain as we are. It hardly seems fair, especially as we have no control over it.
It’s arguable who really has control over inflation. The mainstream idea is that central banks should. But time and again, they have proved that they don’t.
As time progresses, ordinary people have to work more for less reward. One of the dangers of this is, if you can’t make the money that you need, then you borrow it.
This is a major part of why individuals, countries and increasingly the global economy is grinding to a halt. Too much debt.
Different Types of Inflation
There are different types of inflation to consider. They are not all the same and they affect our lives in different ways.
1. Consumer Price Inflation
When there aren’t enough goods or services to meet demand, then the providers of said goods and services will increase the price. This is a basic effect of supply and demand (Artificially restricting the supply of a commodity will also result in inflation.)
This causes consumer price inflation.
It’s measured by taking a “representative” basket of goods, that we are all supposed to need and regularly use. The choice of items varies from place to place, and it’s dubious how representative they actually are.
The government compiles the statistics, and they have little incentive to give you the true inflation rate.
2. Wage Inflation
Wage inflation is another supply and demand issue. It’s caused when workers can ask for more money, as their skills are in short supply.
The average person is not going to complain too much about this kind of inflation, as it benefits them (That is, if their wages are going up by more than the cost of living.)
3. Asset Price Inflation
Asset price inflation, including but not restricted to stocks and property, most often occurs when an excessive amount of money or credit is pumped into them.
The odd thing about the cost of housing is that it is not included in consumer inflation rate indices, when it is one of life’s basic needs. The government will be happy to tell you inflation is low, when for people who don’t own property it is extremely high.
The case for whether asset price inflation is good or bad depends on which side of the asset ownership fence you stand.
For homeowners who see their property prices going up month on month, it could be seen as good. Governments encourage this as it makes homeowners feel wealthy.
For renters though, it is a stressful and damaging situation to be in.
Runaway inflation in asset prices leads to bubbles. These inevitably burst often causing widespread damage to everyone, including those who do not hold assets, as they deflate.
Companies will try to hide inflation from you.
We’ve all been to the supermarket, picked up our usual bag of potato chips and said “hey, I though these bags used to be 100g. Now, they’re 90g”.
But the price remains the same.
And just like the animals in Animal Farm, we complain about it for a while… but eventually we forget about it and carry on living our lives… thinking “it has always been like this, so what can we do?”
The Danger of Runaway Inflation
Most people believe that central banks can control inflation and the economy. And their major instrument to do this is controlling interest rates.
It is not outside the realm of possibility, that they cannot actually control inflation. Inflation can get (and has got) out of control leading to a state of hyperinflation.
The most obvious example of this is the Wiemar Republic of the 1920s.
You can see pictures online of families filling up prams with banknotes just to buy a loaf of bread. As soon as they were paid they had to spend the money before it became worthless.
This truly indicates the meaning of inflation as far as paper currency is concerned.
It is not really that prices are going up, that is just an effect. It is actually the money losing value, and in these extreme cases becoming worthless (the paper it was printed on would have been worth more).
This has happened more recently in Zimbabwe, too.
One of the causes of inflation that doesn’t get mentioned a lot is a weak currency.
When a country’s currency is weak, it costs more to import things. Thus the imported goods cost more to buy for the consumer.
This is a particular problem for countries that import oil, as oil is priced in dollars. If their currency is weak against the dollar, of course.
The Effect of Printing Money
Since the Great Financial Crisis, central banks around the world have sought to stimulate economic activity by flooding the markets with printed money through various quantitative easing programs.
They have largely failed.
They have not induced inflation in wages but they have created inflation in assets. Nice if you own assets, harsh if you don’t.
The main beneficiaries of this printed money have been those close to its supply ie. banks.
They have then funneled it into assets that they favour, most obviously property. This has helped those who have already got property… but is detrimental to those who don’t.
Those with debts stand to benefit from inflation, as the nominal value of what they borrowed goes down.
For those on low wages or fixed incomes such as pensions, the significance of inflation is much higher… and they suffer disproportionately.
4 Ways to Protect Yourself Against Inflation
If you stick with the old adage that “Cash is King” then you have two things to think about.
First, it’s nice to have a big pile of cash on hand, for sure. It feels comforting to have that spending power close to you. And it is always good for when buying opportunities come along.
There are always going to be dips, corrections and even crashes in the market.
When the market dips, then you have the opportunity to buy some stocks or funds that get dragged down with the dip. There may be nothing wrong with said stock. Its just that:
- Sentiment takes over.
- People panic sell.
- The price drops.
There is an opportunity for you to buy good assets that are undervalued.
The same opportunities present themselves during market corrections and even crashes. You just need to decide when to take the plunge.
If you don’t have a lot of cash you may miss these chances.
However, if you do stay in cash and inflation takes off, it could leave you behind very quickly.
What assets can you hold to protect against the effects of inflation?
Now, it entirely depends on what type of business a particular company is in. In a period of inflation it’s better to be holding stocks of companies that can pass on price increases to their consumers more easily.
Therefore, commodities companies would be able to do that better, rather than say consumer goods companies.
If the economy is still operating, then there will be a need for raw materials. The producers will have some pricing power, and they will be able to sell at higher prices. If their output prices are increasing faster than their input costs, then they should be good.
Consumer goods manufacturers on the other hand, will have more difficulty passing on the increase in their input costs. They are reliant on what the end consumer can pay.
And if the end consumer’s wages are not increasing above inflation, they will not likely pay higher prices.
Generally, over longer time periods, property has nearly always increased in value. I can’t categorically state that it has, as someone will be able to quote an instance where it hasn’t. So, I have to say generally.
There will always be local examples that do not fit the narrative.
However, if you can invest in property that is GOOD VALUE at the time of purchase, then you should be able to protect against long term inflation.
Notice the mention of value.
If you buy property when it is in a bubble (as it seems to be more often lately), then you may not realise gains on it after the bubble deflates.
You need to buy a property that is fair or under value.
It also needs to yield enough that it covers all your expenses. If a property is costing you money, then you are entirely relying on capital appreciation (Which is part of your inflation protection as well, by the way.)
If you invest in property over the long term, after purchasing it at a fair value, then you should come out ahead.
3. Index-Linked Securities
Access to this type of product will entirely depend on your location and circumstances. But you may be able to buy certain bonds whose coupon will be linked to a price inflation index. The amount that any individual can purchase might be restricted.
Also, your age might be a factor. In the UK some bonds like this are only available to pensioners.
4. Precious Metals
At the forefront of many people’s minds when they hear about inflation protection is gold. For one reason or another everyone seems to have an idea that is a good thing to hold during periods of inflation.
Different people, with different vested interests, will tell you different things about gold.
- Goldbugs will tell you that gold is money, and that people will flock to it in an inflationary period.
- Bankers will tell you that the age of gold as money is dead.
Unfortunately the number of people in western countries who have experienced REAL inflation is decreasing. So most of us have no REAL idea of the misery it can cause.
If you look at the chart of the price of gold over the last 30 years you will see a spike in the gold price in 1980. That coincided with the end of a period of high inflation, and a massive hike in interest rates by the Fed.
The next massive climb up and top in 2011 did not coincide with a period of inflation.
Rather this was a time when the people were losing trust in paper money… because of the actions of governments and central banks.
Therefore, if and when we do get a dose of very high inflation (or heaven forbid a hyper-inflation) you can guarantee that there will be a run to gold.
You cannot change people’s base instincts.
At a time like that it will be a matter of “return OF your capital”, rather than “return ON your capital”. So, some exposure to precious metals might be a good idea.
What are your thoughts on inflation? Do you trust governments and central banks with controlling inflation? What is the best way to protect yourself against inflation. Please leave your comments below.