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What is inflation and how does it affect us?

What is inflation and how does it affect us

The topic of inflation is affecting us daily. Experienced investors know that the purchasing power of money stored in checking or savings accounts in banks is slowly decreasing, which means that it is important to protect the wealth with appropriate investment. The diversification of the portfolio is the key to success in beating inflation and increasing your wealth.

Inflation is connected to devaluation of currency and the increase in prices as an effect of increasing the money supply. It is a rise in price levels that is affecting each and every one of us. Inflation can be spotted everywhere from gas stations to restaurants or grocery shops, where you have to pay more for the same products and services. Inflation is simply creating the rise in the price levels of all goods and services.

When is inflation occurring?

Inflation is one of the most important macroeconomic phenomena which can be seen through the increase in prices of products and services. The prices in all the markets are changing all the time, but their evolution does not necessarily need to be the same. While the prices of groceries can increase, the prices of electronics can decrease during the same period. It is important to note that inflation does not mean an increase of prices of one commodity or grocery, rather an increase in the overall level of prices.

What is causing the inflation?

The inflation is affected by different segments of the purchasing basket, which means that those whose prices have changed the most have the biggest influence on inflation. What also counts is the ratio that the given products have on the average spending of the households.

Harmonized index of consumer prices is one of the most used measures of inflation in the Eurozone, known under the acronym HICP. Thanks to this index, one can compare the change of price levels in the Eurozone. The impact of oil on the HICP is 4.6%, whereas the impact of coffee and tea is around 0.4%. HICP is counted by approximately 700 different products and services and the measures usually take place in over 1 600 cities across Europe. HICP is counted on a country level by different offices, while on the Eurozone level it is computed by Eurostat.

What is inflation

Inflation: Harmonised Index of Consumer Prices (HICP). Source: ecb.europa.eu

Inflation also affects the external, economic balance of the financial world. For instance, if the inflation is rising in one of the countries compared to its neighbours, the export is becoming less profitable and import, on contrary, is becoming more desirable due its increases. The inflation level is usually around 2% in the medium term, and tends to be stable and predictable, which is however not the case right now.

How is inflation calculated?

Price indices are some of the most common ways inflation is measured. Consumer price index (CPI) is looking at the prices in the consumer’s basket. The division of goods or products is dependable on the Eurozone-wide norms. The GDP deflator as well as producer price index (PPI), which computes the prices of production at the wholesale level, are both common measures of inflation as well.

Looking at the reasons for the inflation, inflation is divided into demand-pull inflation and cost-push inflation. While the demand-pull inflation is connected to purchasing power of the households and increased demand for the goods or services until their prices rise, cost-push inflation happens at the side of supply and is connected to the price increases of energy, wages, raw materials connected to product creation and thus has an effect of the cost of the end product or service.

How is inflation affecting money in your bank account?

In case you are holding your money in bank accounts, the purchasing power of the amount decreased about 7.5% YoY in January. This simply means that the same amount of money can buy you about 7.5% less than it could a year ago. This also shows that money in the bank, in savings or checking accounts are not earning any significant interest and are not even close to beating inflation. It is more than common to see the interest rate on the accounts being at the level of 0.01%. Pretty hilarious.

The main question thus is, how to protect your wealth from inflation

Most investors are therefore looking at different options on how to increase their purchasing power through investment and thus avoid the effects of inflation, which is pressing the value of money down. The key to a successful security of your wealth is a well-balanced portfolio. Investing in real estates, cryptocurrencies, commodities, bonds, stocks, art, start-ups, whisky, jewellery or even cars are just a few of the most common options. Some asset or hedge fund managers also point out that it is crucial to have a portion of your portfolio in cash or cash like equivalents in case of an acute liquidity need or day to day life.

Traditional checking or savings accounts are far from being optimal and even retail investors are slowly figuring it out and are looking more into possibilities of investing into funds. More experienced investors know that they need to diversify their portfolio appropriately, and not only bet on one asset or asset class. Quality can be one of the stores of value, and one of the ways to get quality products is through auctions.

According to AMR´s Art & Collectibles Report 2021 – Q1 & Q2, last year investors mostly looked at luxurious watches, books, handbags, jewellery, traditional cars or different types of art. Investors, for instance, are ever-more interested in watches of Cartier from 1950 – 1970, precious models of Patek Philippe Nautilus and Aquanaut or Rolex. Luxurious handbags and purses also saw rising demand last year with Hermés and Chanel being the most sought-after brands.

Luxurious men’s watch Patek Philippe Nautilus 5712R

Luxurious men’s watch Patek Philippe Nautilus 5712R. Source: Patek.com

Gold has been traditionally regarded as a store of value. Investors, who like to have their investments in tangible form, still prefer gold bars, bullions or coins. This vastly traded commodity around the world has also on significant advantage – in many cases, gold has an exemption from taxation, since investment gold is not subject to different taxes or VAT. Having a gold bar in your safe simply means having a very liquid asset all around the world, especially in times of economy or geopolitical distress, like we are seeing now.

It is also important to see the benefits of silver, since this commodity has countless use cases mainly in production and across industries. Over 56% of all the silver is used in production or has an industrial purpose such as healthcare equipment, electronics, batteries or solar panels.

Cryptocurrencies as a safe haven asset?

Cryptocurrencies have been a phenomena of the 21st century. The market capitalisation of these assets has reached almost 3 trillion dollars in 2021, before retracing back to about 1.7 trillion as of now. In the last year, Bitcoin has hit its ATH several times, most recently in November of 2021, when it reached over 69 000 dollars, while it was being traded just about 10 000 dollars in the autumn of 2020.

Yet, the cryptocurrency world is not only about Bitcoin. There are several interesting projects, some of which might have higher returns ahead of them than Bitcoin itself.  While many projects tend to offer high returns, these usually come with much higher risk, which needs to be considered before investing into cryptocurrencies. Few of the most important characteristics or advantages of cryptocurrencies are anonymity (in some cases), speed, decentralisation, transparency or global reach.

The theory stating that Bitcoin can become a safe haven asset in times of high inflation was derived from the fact that bitcoins are emitted (in the process of mining) at a constant, diminishing rate with the finite amount of 21 million bitcoins. At the same time, fiat currencies such as dollars, pounds or euros have an unlimited supply and are only constrained by the printing machines, governments and central banks. Thus, if the overall supply of fiat currencies increases, it is likely that the price of Bitcoin can increase as well.

The ability of cryptocurrencies to increase the returns of investors and decrease the volatility in the long-term time horizon needs to be tested. Moreover, many regulators are still eyeing the cryptocurrencies and are asking for more supervision and in some cases even bans of usage of these assets, which are just a few of the risks that need to be accounted for with regards to cryptocurrencies.

If you do not want to risk anything while investing into cryptocurrencies, contact us and we will gladly help you on your crypto-journey.

Published: 06. April 2022
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