Einstein, Inflation and start hedging against it

19 May 2021

- Di

Oliver

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Tempo di lettura: 3 minuti

INFLATION HEDGING - Not everybody believes the planet is on the verge of inflation. Data suggests that we are on our way there. I am not going to talk about whether or not we'll get it today (even though I am personally convinced we will). In this post, I will show you why you should be cautious, just in case I am wrong… To be clear, I am referring to CPI inflation. Asset price inflation, on the other hand, is an entirely different story.

How you interpret inflation

Take a basket of products and look at how the price of that basket has changed over time. The effect is the CPI inflation rate, which is expected to reflect changes in the average citizen's cost of living. It is not a perfect or even a decent metric, but it is the number of monetary authorities worldwide that use it as a guide. In most cases, inflation is positive. The cost of living is increasing year after year.

Another way to look at it is that the buying power of your cash savings is dwindling with each passing year. That's probably how you want to think about it because it determines what kind of savings returns, you'll need to maintain your lifestyle over time.

Compound interest hedging everyone from inflation?

You may be familiar with Einstein's quote,

"Compound interest is the most strong force in the universe."

Compounding is thought to be an exponential operation, which explains this. Even if the compounding rate is low, if done long enough, it generates substantial returns.

This also refers to inflation... However, this is not the case for you.

Sample case

Let us say you start with $100,000 in cash and the annual inflation rate is 5%. Your $100,000 in cash has lost 5% of its buying power after a year. As a result, it is worth $95,000. Let us keep playing this game:

$100,000 becomes $95,000 after a year.
After another year, $95,000 will be reduced to $90,250.
After another year, $90,250 would be $85,738.
$85,738 becomes $81,451 after another year.
After another year, $81,451 is reduced to $77,378.
$77,378 becomes $73,510 after another year.

And so on...Few... after just six years of inflation at 5%, your investments have already lost a quarter of their buying power. So, while 5% may not seem like much, it can quickly deplete your savings when accumulated over a few years.

As a result, the possibility of prolonged, even moderate, inflation for the long-term intensity of your buying power cannot be overlooked.

The cases of Brazil and Turkey, how not hedging themselves from inflation

Ask people in Brazil or Turkey how they feel about inflation to get a sense of how they feel:

With Brazil's current inflation rate of 6.8%, you would lose half of your buying power in ten years.
With Turkey's inflation rate hovering about 17%, you would lose half your buying power in just four years.

Central banks are printing money at an alarming rate. The COVID pandemic may have permanently destroyed the global supply chain, putting commodities and everything else at risk of being more costly in the future.

Ideas for dealing with inflation

In the long run, countries like China and Russia (among others) will welcome the US dollar's demise as the world's reserve currency. Although nothing can be guaranteed, there are reasons to be concerned about another monetary regime shift that may resemble the 1970s. If anything like this happens, you will want to be protected against inflation, or you will lose a significant portion of your savings quickly.

Betting on Bitcoin is an excellent way to shield yourself from this. Bitcoin also has the characteristics of a strong store of value from a technical standpoint. Given that Bitcoin is still in its adoption phase, it should perform well even if there is no sustained inflation. You also have various other choices for inflation protection, such as gold, silver, and real estate.... It’s time to start hedging your bets.