In my newsletter of May 2020, I discussed fear (which was rife at that time) and tried to look beyond Covid. The ‘beyond Covid’ bit concerned inflation and here I look at the interaction between inflation and risk.
Market Commentary
As stated previously, in a world of low interest rates (and boredom) investors are increasing their risk acceptance because of the shift from TINA (there is no alternative) to TRINA (there really is no alternative) and below I throw inflation into the mix. There is of course no guarantee that we will find ourselves in inflationary times and whilst we believe that inflation is coming down the tunnel many of our contemporaries disagree with us. Emotions are driving markets more. President Biden adopts fiscal approach.
What is Inflation?
In this respect – not what you get when you get on the scales during lockdown - fiscally, inflation may be defined as a general tendency for prices to rise linked to a fall in the value of money. For those who want a bit more on the why’s and wherefores’ of this I suggest you refer back to our newsletter of May 2020 and also look at the following link https://www.bankofengland.co.uk/monetary-policy/inflation/inflation-calculator. I think most of you have a pretty good idea of what inflation is – particularly those who are over 50. Inflation averaged over 3% a year from 2009 – 2019, which is historically low.
Why Inflation Drives Risk Taking
Money is only any good as what you can buy with it. It is a medium of exchange. Zimbabwe in 2008 illustrates this quite well when a wheelbarrow of Z$ would not buy you a loaf of bread. So, it is no good having loads of dosh in the bank because it is just numbers – the point is – what goods or services can you buy with your money?
This introduces the concept of ‘real’ returns. Real returns are the amount of return an investor receives less the current inflation rate. Example – return on investments 7%, inflation rate 2% real return 5%.
However, following on from the above point if the rate of inflation is higher than the returns you are getting then you are going backwards. Backwards not in terms of the total at the bottom of your bank statement of course but in respect of what your money will buy. Refer first paragraph of this section.
Enter TRINA. Some who have only ever held money in banks and building societies historically are suddenly being forced to take risk to maintain the value of their money. This is where getting the risk-return relationship right is really important – don’t get impatient and put it all on black.
Summary
As noted above we are in TRINA country and if inflation takes off the Governments historical approach has been to try to control it by monetary policy – reducing the money supply / increasing interest rates. Increasing interest rates at the moment when we want to get everybody back to work would not seem sensible. Allowing inflation to run for a while is likely the lesser evil – and of course it effectively reduces the burden of debt and Governments around the world have plenty of that…
p.s.
Always a silver lining…. My daughter is a barber and still lives at home. She is of course shut down but at least during lockdown I am able to offset a tiny bit of the cost of housing and feeding her with a free haircut every week.
p.p.s
During lockdown I am now using social media far more – we as noted above - have a new company Facebook and I am exploring LinkedIn. The inevitable consequence of this is that it seems there are lots of people in exotic locations (to whom I am apparently related) who are at the point of death and want to leave me millions of dollars, all I have to do is provide my bank details to them…