In case you hadn’t noticed, inflation is running away with us and it’s not going to stop in the Spring, as the Bank of England tried to tell us last year.
I’ve asked my friend Tim Price, a wealth manager and co-founder of Price Value Partners, to write this guest column on where to put your money in these difficult times.
- The pain of inflation
- Inflation can help or hinder your investments
- The single biggest problem facing the world economy today
- A store of value?
the pain of inflation
“Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and ineffectiveness of all traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation.” (From Jenss O. Parsson’s Dying of Money: lessons of the great German and American inflations:)
inflation can help or hinder your investments
Inflation is going to be the swing factor that determines whether you make or lose money from your investments this year. Assets that perform poorly when inflation is high are probably going to do dreadfully this year, both in relative and absolute terms. Such assets have a name: they are called bonds. This is awkward, since the bond markets of the world completely dwarf the size of the world’s stock markets. If bond markets do suffer a correction this year, expect stock markets to pay attention.
Happily, there are also assets that seem likely to benefit from inflation, and they are called commodities. Whereas the likes of cash and bonds are nominal assets – paper promises, if you will – commodities, including oil, coal, energy, industrial metals and precious metals, are real assets, deriving their value from use in the real economy. Four decades of ever lower interest rates have seen bond markets soar to unprecedented levels, with bond yields now derisory. Conversely, commodity markets, and notably gold and silver, have been out of favour for years, which means they are now highly attractively priced, just in time for investors to hedge their portfolios against that higher inflation.
the single biggest problem facing the world economy today
If you accept my argument that the single biggest problem facing the world economy today is a monstrous overhang of debt, you will also have to accept that there are only three ways of dealing with it. One is to ensure sufficient economic growth to service the debt. McKinsey’s conclusion from a recent study of the sovereign bond market is stark: “We find it unlikely that economies with total non-financial debt that is equivalent to three to four times GDP will grow their way out of excessive debt.”
McKinsey are being almost coy. What they describe as unlikely may well be impossible – certainly within the euro zone, which now looks like it is trapped in a deflationary trap of zero growth.
restructure the debt?
The second way of dealing with an unserviceable debt load is to default. Or we could call it restructuring, or perhaps the more palatable-sounding debt jubilee, but it amounts to the same thing. The desirability of extinguishing debt is subjective. What is one debtor’s liability is another investor’s asset. By reducing (or eliminating) the liability, you impoverish (or make destitute) the investor. A widespread government debt default would have the unhappy outcome of bankrupting the global pension fund industry, and probably most banks as well.
inflate the debt
Which brings us to option number three. This just happens to be the time-honoured way in which every heavily-indebted government throughout history has dealt with the problem of too much debt: inflation. Inflation is why, in turn, every major central bank has experimented with some form or other of quantitative easing since the Global Financial Crisis. The purpose of quantitative easing – the printing of electronic money, out of thin air, by central banks, which is then used to buy predominantly debt assets from commercial banks – is to stimulate inflation. A crisis triggered by the build-up of too much debt has been met with even more borrowing (namely, QE).
After the 2008 financial crisis, and the deepest global recession since the Second World War, it was widely forecast that major economies would delever, and pay down their debts. Indeed, we are told – by dishonest politicians – that we live in an age of austerity and deleveraging; that governments are making every effort to pay down their debts. The reality is anything but. What was unpayable back in 2007 is even more unpayable now, given the damage wreaked upon national finances by governments’ appalling mismanagement of the Covid crisis.
We are already starting to see the economic suicide inherent in ESG and ‘green’ investing: since the world is not yet ready to transition to ‘green’ energy, and indeed may never be, the energy shortfall has resulted in vicious demand spirals for things like oil and natural gas. But of all the commodities of the world, the one that most intrigues us is one of the oldest, gold.
a store of value?
Money, of whatever form, has uses. Traditional economists assign money three characteristics. It is a unit of account – we can price things with it. It is a medium of exchange – we can use it as a helpful replacement to the barter system, exchanging one good for another. And it is a store of value – it retains its purchasing power over time.
Our modern electronic money still retains the first two characteristics. But as for the third ! Since the establishment of the Federal Reserve in 1913, the US dollar, for example, has lost roughly 98% of its purchasing power. The pound sterling has fared no better. Indeed every unbacked paper currency in history has ultimately failed. The dollar will be no different. It is only a question of time.
gold and silver
Gold and silver developed as money in a free market. Throughout human history we have used all kinds of things as money – cattle, shells, nails, tobacco, cotton, even giant stone slabs. But gold and silver always won out over the competition. People tended over time to favour the precious metals as money because of their scarcity, durability, malleability and beauty. Their use arose without coercion. Gold is the money of freedom.
Gold is also scarce. And it is horribly expensive, in both capital and human terms, to dig out of the earth and process. To produce one ounce of fine gold requires 38 man hours, 1400 gallons of water, enough electricity to run a large house for ten days, up to 565 cubic feet of air under straining pressure, and quantities of chemicals including cyanide, acids, lead, borax and lime.
a good opportunity to buy gold and other commodities
The language associated with gold is invariably derogatory today. Those of us who see any role for gold in the modern world are dismissed as goldbugs. My response is to label those sceptics paperbugs: they have to believe that unbacked fiat money will last. History, however, is on my side.
In recent monetary history 1971 amounts to Year Zero for gold, because that is when President Nixon finally took the US dollar off the gold standard. This has led to a 50-year-plus experiment in money that remains unprecedented. When Robert Mundell was made a Nobel Laureate in Economics in 1999, he pointed out that the “absence of gold as an intrinsic part of our monetary system today makes our century, the one that has just passed, unique in several thousand years.”
Robert Mundell could see the way the world was going. In March 1997, two years before receiving his Laureate, Mundell would remark, ominously, “Gold will be part of the international monetary system in the twenty-first century.” The author Nathan Lewis agrees. The title of his 2007 book on the subject ? Gold: The Once and Future Money.
The best news of all ? The share prices of commodities companies, relative to the rest of the stock market, haven’t been this cheap for roughly 60 years. Opportunities like this don’t come along very often. Just at the moment in history that you probably want inflation protection for your portfolio, it’s practically being given away.
Tim Price is co-manager of the VT Price Value Portfolio and author of ‘Investing through the Looking Glass: a rational guide to irrational financial markets’.
This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.