Inflation is the term assigned to the phenomenon where there is a sudden upsurge of prices in goods and services within a short period. It signifies that consumers – you and me – have to pay more to enjoy the same level of satisfaction from our purchase.
Inflation is an inalienable part of an economy. It occurs when there is an imbalance or disequilibrium in the demand and supply cycle. In economics, inflation is one of the most studied concepts. There also exist varied opinions among economists on the impact of inflation on the economy.
For some, inflation is a sign of a struggling economy, and for others, it’s an opportunity for growth and prosperity. But there is overwhelming consensus on the impact of hyperinflation on the economy and our lives.
What Is Hyperinflation?
Hyperinflation starts when there is an uncontrolled and unprecedented price rise. It’s a rare occurrence with just a handful of hyperinflationary situations in the past and present around the world. That said hyperinflation hurts our pockets deeply. For example, a cup of Joe, that costs $2 at present, will witness a 1000% increase in price to cost $22 a cup.
Hyperinflation: An Uncommon Anomaly in a Major Economy
Compared to inflation, little is discussed about hyperinflation because there aren’t many cases in the past or present. Experts also believe that high inflation that breaches the inflationary bar of 1000% per year is highly unlikely in a developed economy.
The United States, for example, is nowhere near the hyperinflation rate. The U.S. Federal Reserve System (FRS) considers an inflation rate of 2% as acceptable and in tune with its mandate for price stability and maximum employment.
In the previous decade, the U.S. has seen fluctuations in inflation. The rate hit the crest of 3.4% in 2011. The rate was the lowest in 2019, after the onset of the COVID pandemic. From its lowest point in the past few years, which is 1.81%, it’s gradually rising and prediction is that the rate will cross 2% this year.
Hyperinflation: Improbable, but Not Impossible
While hyperinflation is uncommon and rare, it’s not totally out of the question. Experts like Anders Aslund don’t completely rule out hyperinflation or out-of-control inflation in any country. It can happen anywhere, including the United States, under a few very special circumstances, some of which we’re facing now. Hyperinflation is possible if a country is at war, facing a currency crisis, embarking on widely populist policy, or the fiscal agencies are losing control over the economy.
In 2007, to counter the rising national debt, Zimbabwe started printing more currency, leading to a sudden increase in money supply, resulting in a phenomenal drop in the value of money. These fiscal missteps combined with other factors caused hyperinflation. During that period, the citizens of the country had to pay 10 million Zimbabwe dollars to buy a loaf of bread.
Not too long ago, residents living in the border towns of Venezuela had to cross over into neighboring countries to purchase essential goods including bread and milk.
In the past, even countries that were considered economically developed for that period witnessed hyperinflation. In Weimar Germany, after the First World War, the government printed currency indiscriminately to pay war reparations and give a boost to the economy at the same time. The move led to a huge mismatch between demand and supply. The result was a monthly inflation rate of 322%.
Is the United States Staring at Hyperinflation or Out-of-Control Inflation?
In the previous century, 17 instances of hyperinflation occurred around the world. It happened four times in Western Europe, 5 times in Latin America, but none in the United States.
Historically, only twice did the US come close to a hyperinflationary situation, both as a result of wars (Civil War and Revolutionary War). But, hyperinflation or out-of-control inflation doesn’t need a war to rear its ugly head. It only needs a series of extreme social and political circumstances.
The COVID pandemic has created an unimaginable situation. This sudden lightning bolt from nowhere has shattered businesses, jobs, and the economy. The United States, like every other country, is facing a tough road to recovery.
It appears the government is ready to do whatever it takes to smooth what looks like a rough road ahead. The experts are fearful of this ‘whatever it takes’ mentality of the government.
Some fear the political thought that saving jobs, businesses, and boosting welfare measures by rolling out stimulus packages worth trillions can have a disastrous outcome. All that money pumped into the economy is sure to cause an imbalance.
The argument by some experts that by increasing taxes the government can control the adverse effects of too much money is fanciful. If the past behavior is any indication, the government will put the money back into circulation to boost the economy.
The fear of hyperinflation happening in the United States might be unfounded. But, quantitative easing and fiscal stimulus by the Federal Reserve is bound to create out-of-control inflation.
President of Investment Strategy, David Roche, believes the US might be staring at 3-4% inflation, which could dampen the economic recovery. Already people are spending their savings to counter the increase in the prices of essential goods. The situation is also made worse by stagnating wages and dwindling supply.
The Impact of Hyperinflation or High Inflation on the Society
Imagine a scenario where the price of a cup of coffee doubles before you’re through it. What if you have to pay double today for a carton of milk than 48 hours earlier? The situation in the United States will never get so bad.
That said increase in the prices of essentials isn’t the only thing to worry about. Out-of-control inflation can have a ripple effect to affect society in more ways than one. Here is how hyperinflation or out-of-control inflation can affect you and me:
Effect on Salary, Wages, and Fixed Income
People having white-collar jobs will feel the pinch during high inflation. Their purchasing power reduces due to slow or no corresponding increase in salary to offset the surging prices.
The degree of impact on wage earners depends on the speed at which the wages are adjusted to combat inflation. In the case of out-of-control inflation, the wages always play catch up, resulting in a decrease in purchasing power.
There is always a gap between wage increases and a rise in prices. Before an increase in wages is negotiated between the employer and employees and the wages increased, the cost of living goes further up due to hyperinflation.
Another group that’s badly affected by high inflation is fixed income receivers. This group includes people receiving social security, dependent on fixed monthly rent, living on unemployment insurance, and others. As the value of money continues to fall due to high inflation, their purchasing power goes down.
Effect on Investors
Inflation benefits people holding stocks and shares of companies. As the prices of goods surge, companies make the same or more profit because they pass on the burden of rising production costs to the consumers.
They expand their business leading to higher dividends to shareholders. But not all investors make a pretty penny. People invested in bonds, debentures, or any security with a fixed interest rate will only get a fixed sum.
Effect on Home Value
Very few sectors are immune to the impact of high or hyperinflation. The real estate sector isn’t one of them.
When high inflation hits the economy, as expected, home value and real estate prices rise. That’s because the property developers will have to invest more in the construction as the cost of raw materials increase. There will be a general rise in property prices across the board.
Not all property developers can cope with the high prices of construction materials and at the same time borrow money at high-interest rates. This will reduce new constructions, causing a supply-side constraint, which will eventually lead to an increase in the value of existing properties.
Effect on Retirement Plan Investments
High inflation is particularly hard on the fixed income group like people who are retired or planning for retirement. Suppose you have a retirement investment of $1 million and require $100,000 per year to meet all your living expenses. The money that you saved for a peaceful life after retirement will last for 10 years if the rate of return is 3% and the inflation hovers around 3%.
There is real anxiety among people who fear COVID and the government’s policy reaction to the pandemic will cause uncontrollable inflation. Suppose the inflation rate shoots up to 12% (don’t be surprised, the inflation rate in the US increased to 13.5% in 1980), the money you have saved will last only for a little over 5 years.
Effect on Case Held in Banks
Like everything else, inflation also affects the cash held in banks. During high or hyperinflation, the inflation rate surges well above the interest you get from the saving account (cash held in the bank). This means you’re losing money because the purchasing power of cash goes down as the inflation rate increases.
Consider this; you have $1000 saved in your bank with an APY of 0.009%. Suppose, a year from today, the inflation rate rises by 12%. The item you purchased for $1000 today will cost you $1120 in a year. Even with the interest earned through the saving account, you’ll have to shell out over $100 for the same product.
How to Protect Your Assets From the Effects of Hyperinflation
No matter the state of the economy, the inflation rate, or the value of the currency, there are ways to protect your wealth by investing in real assets. Although no investment is immune to hyperinflation, the following investment options will soften the blow and help you tide over the crisis.
Invest in Real Estate
Buying a home is always a good investment no matter the economic situation. This might not be a good option for those buying to flip the property to make a profit. Buy a house with the intent to hold the asset at least for a few years. People planning to invest in a house by borrowing money from a bank must consider various factors including whether to avail adjustable or fixed-rate mortgage.
There are several advantages to investing in rental properties. The property will generate passive income, protection against inflation, and tax benefits are just a few reasons to invest in a rental property.
Invest in Commodities
Commodity is an umbrella term for a wide range of physical products including coffee, sugar, lumber, gas, grains, spices, and metals. Most of the items in the list are staples; essential goods that we use in our daily lives.
Since these goods are used regularly, the demand stays strong, and their prices are adjusted to inflation and the market demand and supply. People can invest in these commodities like sharers through a brokerage firm.
Invest in TIPS
The Treasury Inflation-Protected Securities issued by the Treasury Department has emerged as an attractive option to protect your wealth against inflation. TIPS aren’t like regular bonds. Although both securities provide fixed interest rates, the principal amount in TIPS is adjusted based on inflation. In exchange of additional protection against inflation the department offers a very low-interest rate for TIPS.
Pay off Debts or Convert Variable Interest Rate to Fixed Interest
When money is losing value and the salaries aren’t rising as fast as you want, it’s time to shed some debt load. Loans such as student loans, credit cards, and mortgages can have a disastrous impact on your financial situation during inflation.
The situation would be worse for those who availed adjustable rates for their debts. This is because the debt interest rate will increase along with inflation. If possible, convert your adjustable interest to a fixed interest rate.
Invest in Stocks
As inflation rises, over time the cash in hand and money in the banks will lose value, because saving interest rates will always remain lower than the inflation rate. Hence, it’s wise to invest in stocks.
Even better, invest in companies that provide essential services and produce raw materials. They are in a better position to weather the inflationary storm. These companies are largely inflation-resistant. So, they will perform better during high inflation, which will lead to higher stock prices for the investors.
Final Thoughts
At best, experts can make an educated guess about the future. Many economists have shared their prediction; either warning of hyperinflation or rubbishing all arguments of impending doom caused by spiraling inflation.
What happens in the future is beyond our control. We should prepare for any eventuality by making smart choices. Good investment choices are only part of the solution against out-of-control inflation.
You can further strengthen your financial standing during inflation by making lifestyle changes. This includes investing in yourself (education, licenses, certifications, etc), focus on your health to prolong your career, save more, reduce spending on cars and luxury items, and diversify investment.
When hyperinflation threatens to drown the economy, dent your portfolio, wipe out your savings, and jeopardize your future, the steps given above will help you maintain your financial stability.