Inflation in the industrialized world is not of much concern to global money managers and strategists in the near future. However, when it comes to the longer term, they aren’t so sure.
The concern stems from the significant amount of liquidity in the financial system, thanks to central banks buying bonds or providing loans. At the moment, much of that is sitting on U.S. and European banks’ balance sheets. When this money gets loaned out, there could be an inflationary problem as the money multiplier kicks in. That’s because money loaned out is used to purchase goods and hire staff; the accompanying increased demand for goods and services and growing income leads to further purchases and jobs, quickly multiplying the impact of the original loans.
Furthermore, debt-laden governments may want to encourage higher inflation, as that would make paying back what they owe easier. In fact, the higher the inflation, the easier it is to pay back debts because revenue will be pushed up by the higher inflation while the amount owed remains the same.
Indeed, some global money managers and strategists believe that debt monetizing is the only answer in Europe. At a certain point, that debt will be so high that government revenue won’t be able to keep pace with the debt-servicing costs, so the debts will keep on mounting. “Europe has to inflate,” says Jurrien Timmer, director of global macro for Fidelity Management & Research Co. in Boston. “It can’t grow out of its fiscal problems.”
Some investment analysts believe the same thing applies to the U.S. Among these is Ross Healy, chairman and CEO of Strategic Analysis Corp. in Toronto, but he doesn’t think inflation is the answer. Healy recommends paying off debt through the sale of major assets, such as roads, ports and other infrastructure.
Other analysts, however, don’t rule out the U.S. trying to monetize its debts.
Higher inflation is still possible, but even the current, relatively low inflation is eroding the purchasing power of your clients’ assets down the road — and will continue to do so. Central banks in most industrialized countries are targeting a 2% inflation rate, which will reduce purchasing power by around 20% in 10 years. That is, it will take about $12,000 in 2022 dollars to buy what your clients can get for $10,000 today.
To guard against the potential impact of higher than expected inflation, Norman Rashkowan, executive vice president, investments, and chief North American investment strategist for Mackenzie Financial Corp.’s Maxxum funds in Toronto, recommends having 10% of a portfolio in real-return bonds. With RRBs, the principal is increased semi-annually by the inflation rate, and interest payments are based on that principal.
Holding some equities also is advisable, as they usually appreciate at least in line with inflation and frequently rise by more, reflecting sales growth. Prices of hard assets, such as real estate and natural resources, are also considered good inflation hedges. Resources are considered particularly good right now because demand will continue to increase with the strong growth in emerging countries.
Money managers are split on whether it’s worth investing in gold. That’s because the price of the yellow metal is based on investor sentiment and is subject to big swings. IE