Wednesday, February 28, 2024

Who Makes Money During an Inflation? A Historic Overview

If we didn’t have history to refer to, thinking that everyone loses amidst an inflation would be a logical presumption – we know that’s not the case – so who actually ends up on top during an inflation? And can you possibly join the profiteers?

Let’s have a look at the past extremes of each end before we delve into the present.

The Great Depression

Experienced worldwide from 1929 until around 1939, the Great Depression was the world’s biggest economic downturn. From extreme job loss and deflation to terrible consumer demand, the Great Depression set a benchmark of how poor economic growth can be.

The United States in particular experienced the harshest effects of the downturn, with nearly half of their banks failing and research suggesting approximately 15 million unemployed people. Interestingly, the peak of the coronavirus pandemic led to a similar level of an undesirable economic situation – as a result of isolation and extreme closures – comparable to the downturn of the Great Depression.

But one of the biggest lessons we can learn from the Great Depression, is the one’s without debt were in a far better position others. After World War 1, many people with average incomes were buying items that were considered more luxurious at the time, and this was possible because during this period it was much easier to acquire debt.

But here’s the downside – individuals with a high consumer debt were financially crushed during the Great Depression, while people with no debt survived and in some cases they succeeded. Other than being debt free, those who were mostly unaffected had a side hustle which contributed towards more security during shaky times.

So what’s the key message? Be debt free, have a side gig and of course, minimise unnecessary spending.

The Great Inflation

On the other side of the extremity is the Great Inflation, which is currently trending for the wrong reasons.

This tumultuous economic event witnessed interest rates rise close to a staggering 20%. This unfortunate event took place during the 1970’s and took its toll on commodities, stocks and bonds.

Once again, the ones who profited from this unfortunate event were those who held onto cash or investments which had long-term growth potential. While stocks and bonds had seen some short-term losses, it was the investors with gold that benefited from its tendency to be a safe-haven during turbulent times – the same was true for commodities such as oil.

During this time, wages and salaries were also increasing but people were being outraced by a constant hike in prices – resulting in some people being worse off regardless of more money to take home.

Hard and soft commodity prices sky rocketed at the same time and purchasing power of savings dropped at an alarming rate. In summary, everything was expensive and people were struggling to plan their weekly purchases, whilst at the same time many lost their trust in governing bodies.

At the end of the day, it was the people which had savings that were winning. Individuals which had money set aside – still struggled no doubt – were able to get through the Great Inflation without ending in debt or scraping by as they wait for their next pay cheque.

If we combine the two learnings from the Great Depression and Inflation, we end up with: be debt free, have savings, minimize unnecessary spending and have a side gig. In theory this sounds great, but how achievable is it for the average Joe?

Back to Recent Times

The current inflation is nothing like the 70’s, but that doesn’t mean it’s not challenging.

Consumer price index (CPI), an indicator used by economists to measure percentage change in inflation, clearly tells us the story of recent times. It’s a fact that debt has been rising in most countries since 2008 but the correlation isn’t clear cut with the CPI.

From 2008 in Australia, the CPI peaked at 5% and here’s a snippet from the Australian Bureau of Statistics from the last five years:

  • 2018 =  1%
  • 2019 = 1.8%
  • 2020 = 0.9%
  • 2021 = 3.8%
  • 2022 = 7.8%

The CPI from 2021 was the harbinger of an inflation which became very evident the year after, where hikes in prices were experienced by everyone across the globe.

The global financial crisis of the Great Recession is a much closer analogue to today’s environment – McKinsey

We defined what’s needed to survive an inflation, but whose making money of the back of everything becoming expensive?

The People Who are Cashing In

Right now the person with a fixed-rate and low interest rate mortgage on their home has a big advantage over the latter.

Similarly to the Great Inflation, the current situation also favours important metal holders because the value has mostly sustained throughout the ordeal. Usually gold is able to keep its worth over an inflation in the long run – although the metal has its volatile moments – people with such commodities are better positioned than people with money in a bank account.

Energy

Albeit with no surprise, the energy sector is the next one to make the list of profiting during an inflation. For an industry to not be profitable during an inflation, it requires people to stop spending money which leads to reduced demand of the product or service. But energy sources such as petrol and electricity are a necessity in this world, hence the demand remains strong and people continue to purchase it regardless of inflated prices.

Agricultural Industry

Typically an industry which struggles with being underpaid, an inflation helps the food and agricultural industry. Farmers which provide staple items such as milk and potatoes commonly struggle financially, but the food they produce is a necessity and often times the demand increases during an inflation as people avoid eating out due to costs.

Staple foods will always be resistant to demand issues and the agricultural supply chain undoubtedly benefits from an inflation, but this advantages is also passed onto agricultural stock holders which will notice their stock value bump up.

Loaners

Banks and mortgagers are always making money and an inflation makes no exception. Interest rates drastically increase during an inflation, which means people owe even more money.

The same cost increases apply to credit cards and the interest rates take money out of pockets for personal loans, business loans and home loans. Because of this, bankers and lenders are cashing in more than ever.

Investors of Commodities and land

Commodities are split into two categories, namely hard and soft.

A hard commodity comprises of natural resources such as oil, copper, gold and rubber, whereas a soft commodity is agricultural or livestock. The price of hard and soft commodities spike during an inflation, but because they are all integral items – demand remains, profit increases, stockholders benefit.

Real estate however, isn’t so simple. As mentioned earlier, the cost of borrowing increases due to interest rates but any new houses being built become a problem as material and labour become more expensive.

This is where rental property owners are winning the most. Interest rates make the cost of borrowing too high and developing new properties becomes too expensive, which leaves rental properties as the only option.

The same cycle was noticed during the great inflation and this pattern is likely to remain.

The Overview

Inflation is a tough road to navigate and being on the winning side is generally quite difficult. Not being able to cash in during an inflated economy is common but as long as you can follow the main learning from the Great Depression and Great inflation, then you are well positioned to handle the current situation.

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