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Bouts of inflation are as old as human civilisation and is often a key characteristic of times of economic turmoil. In modern society, and especially since the invention of fiat currency, inflation-led crises have been relatively common around the world. Severe rises in the costs of goods and services (aka hyperinflation) have led to societal breakdowns and war, whilst moderate levels of inflation have subdued living standards for many in the middle-class for long periods of time.
Some of the more well-known inflation crises over the past century include that of post-WWI Germany (where prices rose over a billion-fold) and Zimbabwe (where prices rose over a trillion-fold). This is vastly different from the global inflation scare of the 1970s, which saw the price of goods in many countries rise by 2-to-3-fold over the course of the decade.
Overall, inflation can be caused by a number of factors. The examples of hyperinflation were mainly generated through excess money printing and a plunge in trust in the respective government's ability to repay foreign obligations. Milder inflation can also have this as a root cause (this is perhaps a contributory cause of the current inflationary cycle), but generally involves money printing at somewhat sustainable levels (e.g. quantitative easing).
Demand-pull inflation, on the other hand, occurs when there is a spike in demand for goods or services in an economy. This can arise due to a large growth in wealth in the citizenry (e.g. a commodity boom) and is generally of a much lesser concern. The current bout of rising prices, however, would likely fall under the cost-push mode of inflation. This is where costs are rising largely due to the increasing cost of production inputs (e.g. oil and gas prices, wages), which force producers to pass on these increases to consumers.
As suggested, more than one of these causes can be at play at any one time. Furthermore, conditions can lead to a cycle of demand-pull and cost-push inflation, whereby rising wages can lead to both higher demand and higher prices. This can, in turn, lead to higher wages which can again push up demand and prices. Thus, labour market conditions and levels of productivity also play a role in periods of inflation.
Whilst rising prices are a problem for most households, issues can be somewhat offset if wages also follow higher. However, for those that require income from investments in order to fund lifestyles, inflationary pressures require portfolio returns that will grow in line with rising consumer prices. This is known as an 'inflation hedge' with many assets exhibiting correlations with inflation.
In historic cases of inflation being caused by excessive money printing or distrust in central authorities, traditional hedging strategies have primarily involved investing in gold (and other precious metals). As a quasi-currency, the value of gold compared to the domestic currency is likely to appreciate in such periods. Gold is also less at risk from capital controls, which may impact the purchase of other foreign, 'safe-haven' currencies (e.g. USD) as an inflation hedge.
For this same reason, cryptocurrency might also be seen as a potential tool to protect a portfolio against rising prices. It should not be a surprise that it's meteoric rise has coincided with massive increases in money supply for the world's biggest central banks. However, the protective qualities of cryptocurrency need to be weighed against its high volatility and evolving nature.
Another main way in which to help a portfolio move with rising consumption prices is to invest in consumer goods. In the event of cost-push inflation, this might be done by investing directly into production inputs such as raw materials, energy and agricultural commodities. The easiest way in which investors might gain such an exposure is through commodity futures or a commodities fund manager. Where demand-pull inflation is of most concern, the share market can be the best place to take advantage of higher prices. This is due to the pricing power such inflation can provide companies, helping to give earnings a boost.
One final inflation-hedging instrument available to investors is that of inflation-linked bonds or financial products (e.g. indexed annuity). In these investments, bond or product issuers take on the risk of excessive inflation, with income derived from such increasing in line with rising consumer prices. These types of hedging instrument are likely to be effective regardless of the type of inflation being experienced.
It should be noted, however, and as is the case with all assets, the best time to invest is before the event…
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