Exploring an obsession with inflation
A spectre keeps haunting investors: Inflation. It is a spectre that proves to be as elusive to grasp as its fallout is hard to contain following a breakout. In simple terms, inflation is what happens when money gets sick and devalues. Along those lines, hyperinflation happens when money dies. As the driving forces of past inflation have never been alike, there is no panacea for protecting financial wealth against debasement.
Why are economists and policymakers so obsessed with inflation? The simple answer is because it transfers wealth and power. Inflation is a transfer of wealth from old to young, from rich to poor, from consumers to producers, from creditors to debtors, from the private sector to the public sector, from developed countries to developing countries, and so on. These are rather controversial claims and ones we seldom hear made in public.
Inflation, in fact, should not only matter to economists and policymakers — it should matter to all of us, for whether prices rise, fall, or remain stable, they have a crucial effect on the economy and society overall. This may also be the main reason why the mandate of almost all central banks is to keep prices steady. In doing so, they ensure peace between the economic actors in society.
Investors may now conclude that while inflation may be out there, its causes and impact are highly uncertain. As is often the case, future outcomes are radically uncertain. So before applying strategies that have worked in the past, thereby courting the danger of preparing for kinds of inflation that are obsolete, investors would do better to acknowledge that they cannot possibly know much about what kind of inflation will happen and how.
Neither life nor wealth will feel much safer after this admission, but the individual investor may nevertheless feel better having surrendered control. In a second step, one could still look at past experiences, if nothing else but to see the agnostic stance confirmed. Barton Biggs offers the relevant evidence in his brilliant book Wealth, War & Wisdom. Biggs’ recommendation in the face of concerns about inflation is to hold a well-balanced mix of real assets and some of their derivatives, such as equities. But in that case, why not go straight to gold or real estate to insulate one’s wealth against debasement? Because history shows that there has never been a panacea for inflation.
After raising all the ‘ifs’ and ‘whens’ of radical uncertainty, you will probably have little faith in forecasts. And rightly so. There is just one thing that strikes me when looking at long-term charts. At the time of writing, bond yields in the US are still near their all-time lows, i.e. below two per cent. Compared to the double-digit bond yields of the 1970s’ inflation bonanza, this looks like deflation rather than inflation.
If you look at the long-term cycles, you see that inflation tends not to break out overnight. The current situation looks more like the 1950s than the 1970s, and there was a long way to go between those two decades. As a matter of fact, the period between the early 1950s and the mid-1960s, when rates moved up due to the better growth prospects of post-war societies, was one of the most rewarding eras in history for financial assets. Stocks posted bumper years, while bonds suffered only moderately in real terms and delivered positive nominal returns.
The journey to higher — and therefore more normal — inflation rates and bond yields may be a rewarding one. While some of the policies facilitating the normalisation of inflation may sow the seeds for a new 1970s’ type of turmoil, this may be years, if not well over a decade, away. Before that happens, investors should try and enjoy the ride.
The writer is head of research at Julius Baer. Views expressed are his own and do not reflect the newspaper’s policy.