A few weeks ago, I went to buy a pastry for my coffee break. As if it was nothing the cashier asked for 3 bucks for something that last week had cost 2.80. It brought memories of my teenage years in Mexico where runaway inflation was common.
Some people in the west are not familiar with inflation and what it means; unaware of the effect it will have on their savings, their wealth, their plans for the future. I want to share with you what I learned as a kid.
What is inflation?
NOUN
economics
“a general increase in prices and fall in the purchasing value of money.”
Inflation is coming
Our current inflation situation started with Corona, as people started using the money they were not spending in services (Restaurants, parties, travel) to buy goods. This, together with some planning mistakes by manufacturers created shortages of components across multiple areas in the economy.
Suddenly a laptop that you could usually order for delivery in a few days could only be delivered in a few months. Purchase managers threw money at trying to get critical components, prices went up, and suddenly sales guys realized they could ask for more money without much push back from the market.
If there had been a chance that the central banks could control this, the ongoing war in Ukraine reduced these plans to ashes. Both Russia and Ukraine are big suppliers of basic commodities, not only oil but grains and other agricultural products. Reduced supply and steady demand will result in price increases.
Along these lines, I want to share my experience growing up in Mexico with inflation, with the goal of giving you some ideas not to be hacked by it. Note that I am no financial advisor, just an observer who has seen things.
What does inflation do to you?
Low inflation is actually a desirable thing. It helps all of us believe that we are making progress because we are earning more money or the value of our investments goes up. The problem is when inflation causes a spiral of prices going up, salaries going up, prices going up and the central banks can not control it.
The chart above helps visualize how low inflation is what makes you sell a house that you bought for 70 in 1999 at 105 in 2019.
I remember my early days as a business owner in Mexico. The country went through several periods of inflation caused by exchange rate shocks and wrong fiscal policy of the government. In my business we were selling industrial supplies to manufacturing industries. Every month there would be price increases from our suppliers. Depending on what had gone up sometimes we would have sold material cheaper that what it costed for us to replace it.
High Inflation felt like swimming against a roaring sea with every new wave threating to bring you under.
After a few months, the following became clear:
- Keeping stocks of material was the best way to keep your capital afloat
- Money in the bank would lose value every month.
- Long-payment terms by customers were really bad business.
So, while circumstances have changed, and inflation is not looking like it is going to be fully out of control, there are still some things that I can share with you from my experience that might be of help.
What can you do to protect against inflation?
Liquid assets like cash or money in the bank will lose value; especially in saving accounts where your money is locked. While it is true that banks will raise interest rates on your savings they would be tailing the real inflation.
Assets that are scarce can be a good place to park your money; it could be real estate, gold, and even some crypto currencies (But not all). We live in strange times though, let me explain by looking at this in detail:
Small excursion on the stock market:
The stock market will turn into a rollercoaster, mostly because the central banks need to raise interest rates to control inflation, and this would lead to many companies and individuals that have been profiting from a lax economic policy getting in a dire financial situation. In the words of Warren Buffet:
“Only when the tide goes out do you discover who has been swimming naked”
However, it is not guaranteed that inflation will be the main issue. The real issue with the stock market is that they are at historical highs, and thus probably due for a correction. I got two graphs below showing stock market and inflation for over 100 years. You can see how the drops in the stock market often match the high inflation periods of WW1, WW2 and the oil price shock of the 1970s:
Small excursion into real estate market:
This is a mixed bag, depending on where you start.
- If you have a house and a mortgage at fixed rate set to mature long term you are good. The reason is that while the interest rates will go up, you locked them while they were low, and while the value of your property might fluctuate, you will still pay less in interests than the market would require you to do if you had a variable interest rate.
- If you don’t own real estate and you want to get into it, you might risk buying at the top of the bubble. Look at the graph below:
Remember our inflation graph: buying for 70 to sell for 105, means 50% gain. The real estate graph goes now from 70 to 278, almost 400%. Fanniemae (A US credit institution for housing) predicts a deceleration on growth.
Small excursion into Gold, Commodities and similar investment vehicles
Gold behavior is quite interesting. It goes up during crisis and goes down when the economy is doing well. The problem with Gold now is that it is near its highest level:
Gold is a good proxy to a business buying goods that it can sell more expensive at a later stage. Where the alikeness ends is that the market for Gold is liquid and quite volatile.
Another investment which is modeled in scarcity like Gold is Bitcoin. I single out Bitcoin because there is a fixed limit of coins that can be in circulation thus creating an artificial scarcity. If you can stomach the environmental bad karma, Bitcoin could be an alternative to gold. Again here with all the volatility that the market dictates.
And this takes us to commodities, which are the closest thing you can get to being a business and buying goods you can sell quickly:
People will have to eat, the war will reduce the crops and exports of grains, unfortunately for many people in the world prices will go up. Investopedia has some recommendations on commodity indexes available.
Conclusion
I have tried to make the following points:
- Inflation is coming
- You need to protect your savings from it
- To keep money in Long-Term Savings accounts is a really bad idea
- To keep cash is also a bad idea (Except for what you need to be liquid).
- If you own a business, stock on items that you can sell easily
- If you have your own house with a long term mortgage (greater than 5 years) you are sitting pretty.
- If you already own a house but have no long term mortgage, talk to your bank now.
- If you want to buy real estate property now, make sure you know what you are doing, you’ll probably buy near or at the top of the wave.
- If you are heavy on stocks, it might be time to consider getting out, or brace for the ride.
- Hold on to those gold coins that you inherited from your aunt.
Overall, I wish you well, good health, prosperity, and peaceful times.