What is Inflation?
Inflation refers to a general progressive increase in prices of a set of goods and services over a certain period, usually a year.
When price levels rise, units of currency buy fewer goods and services. This means that inflation is in correspondence with a reduction in money’s purchasing power. For instance, when price levels of groceries increase, a dollar doesn’t get you as much as it could in a grocery store months or years ago.
Typically, we see a 2% inflation rate every year. It is when the rate goes above this percentage in a short period that inflation becomes a concern.
In this article, we will look at the fundamental causes of inflation, who benefits from it, the negative effects as well as the best ways to hedge against inflation.
What Causes Inflation?
There are different factors that can cause inflation in an economy. Typically, inflation results from an increase in demand for products and services or an increase in production costs.
- Cost-push Inflation
This can occur when prices rise due to increased costs of production, such as wages and raw materials. The supply of goods and services decline due to the increase in costs of production while the demand for goods remains unchanged. A major sign of cost-push inflation is a rise in commodity prices of major production outputs like wood and oils.
- Demand-pull Inflation
This is caused by an increase in demand for goods and services as consumers are ready to pay more to obtain that product – as outlined in the economic principle of demand and supply. For example, COVID-wary customers being ready to leave the comfort of their homes to spend money.
Negative effects of Inflation
- Scarcity of basic needs
If there is inflation and it leads to higher prices of basic necessities like food and housing, it can also lead to scarcity of food or even drought.
- It reduces the value of money
Inflation can be a worry because it makes money saved in the present less valuable in the future. It also erodes consumers’ purchasing power.
Who benefits from inflation?
Once inflation has a significant effect on an economy, those on the other side of the spectrum are likely to benefit from inflation.
- Alternative Investors
Alternative investments like real estate, cryptocurrency, art, and wine are well known as investments that can “beat inflation.” They are well known for protecting investors against the purchasing power of money. Ultra-high-net-worth investors are big investors in alternative investments, and studies have shown that these investors have more than 50 percent of their assets in alternatives.
For example, alternative investments, including cryptocurrency, art, real estate, and whisky, all beat inflation in 2021. Art, Bitcoin, and Ethereum also provided a larger return than stocks in 2021.
Alternative investors do not have to be “super-wealthy” to make investments. An average alternative investor can invest in real estate, buy cryptocurrency, and invest in spirits and fine wine.
- Companies
Some companies can benefit from inflation if they tactically charge higher for their products due to a surge in demand for their goods and services. For example, realtors sell at higher prices if the economy is doing well and demand for housing is high.
Inflation can increase the profit margins of businesses and provide them with pricing power. When profit margins are rising, the prices of products and services increase at a faster rate than production costs.
- Stock owners
Although consumers do not really benefit from inflation, stock owners can benefit from holding on to assets in affected markets. For example, investors in gas companies might see rises in the stock prices of gas companies if gas prices are rising.
