Welcome to Finance and Fury. With everything going on in the world, the notion that inflation could return with a vengeance may materialise.

This will be a two part episode. Today, we’ll look at the potential paths for inflation and quickly assets to hold and those not to. Next Monday, we’ll go into further detail about the investment strategies and why each investment does well in certain conditions.


First, what is inflation:

  1. In economic terms – Inflation is the measurement of the increase in prices of goods = CPI in measurement terms – basket of goods and how the costs to purchase them changes
    1. Central bankers try to use inflation to reduce the real value of the debt to give debtors some relief in the hope that they might spend more and help the economy get moving again
  2. Therefore – inflation erodes the real value of a currency – due to prices of a good increasing – reducing your purchase power unless wages increase at same or greater rate –
    1. Technically – Extreme levels = Hyperinflation is when the prices of goods and services rise more than 50% a month.
    2. If you have $100 bill in your wallet – which could buy you 20 cage free 12 pack of eggs at $5 each today
    3. You have another $100 bill and take it to buy eggs a month later – but the prices go up by 50% – now can only get 13 and 1/3rd egg cartons – reduction of about 33% of your purchase power
    4. If a good or service could cost one amount in the morning but be more expensive by the afternoon – how would you respond?
      1. You would buy more now? Or wait? Buy now – this creates shortages in stockpiles – leads to undersupply which further spikes price rises
    5. Hyperinflation massively increases uncertainty due to a rational behavioural response people make – but not accounted for in economic models – therefore – spending now rather than saving for the future is an ‘irrational behaviour’
  3. Don’t think we will get to hyperinflation – but the IMF is predicting inflation to kick back in for most of the world – between 5-10% – emerging markets will be the hardest hit
    1. But with cash rates low – real returns on holding cash would be negative with even the smallest levels of inflation
    2. So In this episode we will look at the factors that will create inflation along with where to avoid holding investments – and what types of investments combat inflation


First – Causes – number of different causes – but demand and supply come into it – but with some stress to the government budget, such as wars or their aftermath, sociopolitical upheavals (like a lockdown), a collapse in aggregate supply or one in export prices, or other crises that make it difficult for the government to collect tax revenue – many different reasons – as it isn’t just one trigger that creates inflation – requires a perfect storm of situations

  1. Starts for a combination of reasons – but in most cases – step is when a country’s government begins printing money to pay for its spending – increasing supply of money – decreases real value –
    1. It is all about perception – well known example – Germany – Weimar Republic in Germany in the 1920s printed to pay off war debts – along with losing backing for supply of money in the form of gold in the WWI treaty
      1. But number of Deutschmarks in circulation went from 13 billion to 60 billion from 1913 to 1914
        1. First time printed money to pay for WW1 – economy was strong and prepared before war
      2. But German government also printed government bonds – same effect as printing cash – so Germany’s sovereign debt went from 5BN to 156BN DMs
  • But from WW1 – 132 billion marks in war reparations – from taking away production capacity – lead to a shortage of goods, especially food. Because there was excess cash in circulation, and few goods, the price of everyday items doubled every 3.7 days. The inflation rate was 20.9% per day. Farmers and others who produced goods did well, but most people either lived in abject poverty or left the country. 
  1. But today – Every government does this still – not to pay off war debts but fund spending – budget deficit is the term for the indirect way of funding this through bonds – which are purchased off the financial system which received an increase in their money supply from the Central Bank – but MMT claims that inflation isn’t materialising as it is horizontal transaction – no increase in net assets – however – If the monopoly of currency kicks in and there is no netting with debt – and money moves vertically – especially with the supply shock we might face if companies cant survive the locks down – inflation may kick back in
  1. Since inflation is visible as a monetary effect, models of inflation focus on the demand for money.
    1. This is where Economists see both a rapid increase in the money supply and an increase in the velocity of money if the (monetary) inflating is not stopped.
      1. Historically – both of these have been a root cause of inflation or hyperinflation
      2. increase in the velocity of money – central to the crisis of confidence hyperinflation model – where the risk premium that sellers demand for the paper currency over the nominal value grows rapidly
  • radical increase in the money supply in circulation – i.e the “monetary model” of inflation – increased Gov spending would achieve this


Where we are today – Economic environment of ultra-loose monetary and fiscal policies, along with commodity shortages, disrupted supply chains and globalization weakening is setting the stage for a potential surge in consumer prices

  1. monetary authorities – central banks – face pressure to keep interest rates low, capping the cost of servicing ballooned government debt – but they also want inflation to erode this debt too
    1. central bankers have printed trillions of dollars over the years in stimulus to achieve inflation.
  2. Theoretically – it should have worked – but it hasn’t – why?
    1. An increase in the money supply is one of the two causes of inflation – Monetarist theory – but after too much inflation – instead of tightening the money supply to stop inflation, the government keeps printing more – often out of perceived necessity
    2. Milton Friedman – “inflation is always and everywhere a monetary phenomenon” – may have been true back in his day – but not true today – pre-70s money was user demand responsive = only grew through trade – more a country produced, more it could export – leading to monetary influx of funds – leading to companies being able to charge more – so prices went up creating inflation – with it – growth of the economy but only between a bandwith of inflation
    3. Today – with Inflation being targeted and therefore manipulated from Central banks – it has become a function of behavioural psychology – the inflation trend is promised to us – and has been well delivered from the 70s all the way up until a few years ago – hard to get people to change their inflation expectations after the expectation and confirmation bias is there – but issue for central banks is it is very hard to raise inflation from under 1.8% to 2.5% through policy
      1. Anyone paying attention knows that Central Banks are trying to force inflation – i.e. the reduction in the real value of items valued in fiat currency – this for the financial system is something that can be profited off
    4. This leads to the other exacerbating causes – as behavioural is certainly one – monetary side to cover but quickly touch on behavioural –
      1. To make the most of your money – you would want to spend sooner and stockpile on the goods you can
      2. Infation is part of a complex system – i.e. has non-linear developments – therefore cant simply be increased from 2% to 2.5% or 3% – instead inflation hits a point it quickly spins out of control – jumps to 6%, then 9%, etc.
      3. The other is demand-pull inflation. It occurs when a surge in demand outstrips supply, sending prices higher. 
        1. cause people to hoard, creating a rapid rise in demand chasing too few goods. The hoarding may create shortages, aggravating the rate of inflation
      4. But such a prospect is unlikely with such massive increases in unemployment – estimates by the International Labour Organisation show that Almost half of the world’s workforce is in danger of losing livelihoods from the shutdowns.
        1. This would create a deflationary shock – and this is dominating at the moment – There’s a collapse of demand
        2. Inflation expectations, as proxied by five-year, five-year forward swap rates, are near record lows in the U.S. and Europe.
      5. But now with Vertical Money – and if MMT comes into the picture – this demand shock can be negated
        1. Some asset managers have started to hedge their portfolios against inflation – started building an overweight position in commodities for the first time in four years, while going underweight bonds
      6. Why do this now and not in the GFC where there was economic fallout? Today there is a synchronized stimulus between monetary and fiscal policy – with monetary easing supercharged by fiscal spending – as opposed to previous responses during the financial crisis, when central banks cut rates and started QE (which never went to public spending), but governments also reined in budgets.
        1. Created a situation where some economists see commodity costs rebounding with an economic recovery after lockdowns are lifted and stimulus takes effect. Inflation could exceed 5% in 2021, and perhaps even reach 10% — outcomes resembling the aftermaths of World Wars I and II.
        2. Mostly due to the monetary and fiscal expansion being aimed at putting money in the hands of people – will it succeed – who knows – but after lockdowns end and people are given stimulus – there will be some degree of pent-up demand
        3. Also – The further consequences of a potential unwinding of globalization as nations shore up their own supply chain and focus on local production – could lead to price shocks as well
        4. So a lot of this comes down to jobs and employment – if everyone is still out of work in 12 months – and Governments stimulus doesn’t occur at the rates or effect expected – likely no inflation –
        5. But if that loss of jobs leads to a loss of supply – prices may actually go up – especially if demand is stimulated from fiscal policies just a bit


Potential Economic fallout from large levels of inflation – at the national level

  1. Larger levels of inflation send the value of the currency plummeting in foreign exchange markets.
  2. The nation’s importers go out of business as the cost of foreign goods skyrockets – Unemployment rises as companies fold.
  3. government tax revenues fall, and it has trouble providing basic services.
  4. Historically – Governments make it worse – The government prints more money to pay its bills, worsening the inflation
  5. But if the whole world is going through inflation – then it


Is it possible today – well, hard to say for certain, but it is a probability – Today’s environment is drastically different than it was in the late ‘70’s and early ‘80s when inflation was nearly out of control. Today, disinflation is the primary challenge central banks face, not inflation.

  1. Note – am not predicting it or saying it is an imminent likelihood – but if it were to kick off it would happen quickly – jumping from under 2% to 6, 8, 12% – better to be in a position before this happens
  2. World is massively indebted – massive trick though – money technically isn’t in circulation (i.e. printed) – in the financial system or owned to other governments – essentially not in your hands to affect prices
    1. Either of the previous may be the trigger – but the second effect is either loss of some confidence forcing an increase in the money supply – or a loss of all of it – destroying confidence
  3. Today’s markets depend on the artificially low interest rates – Raising interest rates wreck all of the debt in the economy

General information – What assets to avoid

  1. Cash – pretty obvious one – cash is a medium for exchange – not a great asset over the long term –
    1. Great in short term – important to have emergency funding –
  2. Bonds – with debt levels going up – and interest rates being low – if inflation kicks in then bad long term assets –

What assets can do well – ones with real values and with growth or their own inflation in price gains

  1. Commodities and precious metals – Silver – and also gold
  2. Growth assets – Property and shares – Reason – need to get capital growth of assets to offset rising inflation
  3. Borrowing for investments – could be a strategy that works –

Go through these next Monday in detail

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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