The loose monetary policy since 2008 and the high inflation of the last few years have made savers and investors worry about the value of their money. Hyperinflation is seen as the worst-case scenario. In this post, we discuss how to invest for hyperinflation by analyzing how different assets classes would behave.
- How to Invest for Hyperinflation
The economy of the 2020s is exposed to both inflationary and deflationary forces, even though most people are not aware of the latter. This means it is difficult to predict in which direction the cost of living is likely to evolve.
However, since governments would take advantage of a deflationary environment by increasing public spending as they did during the decade after the 2008 financial crisis, thereby making sure that prices do not go down, it makes little sense to really prepare our investment portfolio for deflation.
The inflationary scenario is a lot more dangerous. The high inflation rates of the last few years have led to a significant increase in the cost of living and, simultaneously, to a drop in the standard of living for a large portion of the population.
A more extreme version of high inflation would be hyperinflation. And, while the likelihood is low, it makes sense to invest in a way that we have hedged in place for a hyperinflation scenario.
Hyperinflation is undoubtedly the most catastrophic monetary and economic outcome of the mismanagement of a country. Officially, hyperinflation happens when prices rise more than 50% on a monthly basis. However, much lower rates, such as 50% per year, can already be considered hyperinflationary when we analyze how different asset classes react to such prices increases.
Hyperinflation is produced by an excess of currency issuance by the government. To understand it better, hyperinflation can be triggered a government printing too much money to pay for its expenses.
Such a situation implies that the government spends much more than it collects in the form of taxes. Instead of cutting spending or increasing taxes, government officials decide to fill the gap by creating money out of thin air. This leads to a massive rise in the general price level and a brutal devaluation of the currency.
Among the extreme cases of hyperinflation throughout history, we can highlight Germany in 1923, Zimbabwe in 2008 and Venezuela over the last few years. More moderate cases that can still be considered hyperinflationary for our analysis would be Argentina from 2001 or Turkey since 2019.
It should be noted that hyperinflation is not a modern phenomenon. Both Ancient Greece and the Roman Empire experienced hyperinflationary periods. They were triggered by the same circumstances: out-of-control public deficits and massive monetary expansion. The results were also the same: total loss of the value of the currency in the first place and need for a new currency to reestablish stability.
How to Invest for Hyperinflation
In order to learn how to invest for hyperinflation, we will discuss how different asset classes are likely to react under such circumstances.
Cash would suffer heavily in a hyperinflationary environment. While its nominal value cannot decrease, its real value would plummet due to the high inflation rates.
While it is true that cash can earn a yield similar to the short-term interest rates set by the central bank, in times of hyperinflation, such interest rates tend to be much lower than the rate at which the value of the currency is depreciating.
Therefore, cash would be one of the asset classes to avoid during hyperinflation.
Stocks represent partial ownership in a company. From a macroeconomic point of view, stocks can be viewed as a percentage of the country’s business sector. As a result of that, the performance of stocks is driven by two main variables: the level of economic activity and the price level.
While it is true that stocks would allow us to safeguard some of our wealth by having invested in companies instead of cash that is becoming worthless, hyperinflation is a destructive force for the economy and usually leads to civil unrest.
As a consequence of that, the economy would suffer heavily, corporate margins would compress, many companies would go out of business and, when adjusted for inflation, the value of those stocks would have dropped significantly.
Therefore, stocks can only be considered a partial inflation hedge. If we want to own stocks in times of hyperinflation, we should be invested in companies that own a lot of capital assets, such as machinery, or produce commodities. The value of those things would not go away just because the currency has lost its value.
3) Long-term Government Bonds
Long-term government bonds are similar to receiving cash in the future. While they do pay some interest, the rates we would receive would be significantly lower than the inflation rate.
Because hyperinflation would push interest rates higher, the nominal price of long-term government bonds would collapse. As a result, not only would the value of the currency in which these bonds is denominated go down, but its liquidation price would be much lower. The end result would be that the real value of long-term government bonds would virtually evaporate.
When it comes to shorter term government bonds, they would behave like a hybrid between cash and long-term government bonds, with its performance somewhere in between. Therefore, we could also completely write off their value on an inflation-adjusted basis.
4) Corporate Bonds
Corporate bonds share some risks with stocks and some risks with government bonds. Its performance depends on both the business cycle (like stocks) as well as interest rates and inflation (like government bonds).
In case of hyperinflation, we can expect corporate defaults to disappear since the value of the currency would have collapsed. However, by the time we receive that cash, it would be mostly worthless. And the interest income we collect while we hold those corporate bonds would not be nearly enough to make for the loss in purchasing value.
This is why, in times of hyperinflation, financing virtually disappears for corporations looking to borrow money.
Gold and other precious metals such as silver are among the assets that would perform best in times of hyperinflation. In general, the value of gold rises whenever there is currency depreciation or economic and social instability. This makes investing in gold a must to prepare for hyperinflation.
Because gold and silver have historically been used as money by most countries and societies, they would be prime candidates to take over this role again. Precious metals are likely to not only retain all its purchasing value but even increase it, especially if we want to use them to acquire some assets later down the line like stocks or real estate.
One key advantage of gold is that it concentrates a lot of purchasing power without taking up too much space or being very heavy. Therefore, it can be used to take a significant amount of wealth with us wherever we go.
If you want to see how the price of gold evolved during the Germany of the 1920s, check out the following post from Goldsilver.com.
6) Real Estate
Real estate would be another type of asset that would perform well in times of hyperinflation. Therefore, it is a great asset to invest in for hyperinflation.
Whether your real estate purchases are financed with mortgage debt or paid fully in cash, the real estate would retain its real value as the buildings and the land would remain.
However, any portion of our purchases that we finance with debt would be mostly free. This is because the value of the currency and all debts denominated in it would collapse. Therefore, it would make sense to take on mortgages to accumulate as much real estate as possible.
The return of commodities as an investment assets depends on two main factors. On the one hand, it is about the level of economic activity while, on the other, it is about prices.
While it is true that the economy would go into a depression in times of hyperinflation, commodities would be able to keep most of their real value since they are real goods that exist in the physical world. Oil and timber are useful regardless of the currency one uses. Therefore, they would behave similarly to real estate.
This makes commodities, together with gold and real estate, another asset to invest in to hedge the risk of future hyperinflation.
Finally, here is a summary of how different asset classes are likely to behave in the long run under different inflationary scenarios. They are listed from best to worst, and the color indicates if they should be owned (green), if owning them would be ok (yellow) or if we should avoid them altogether (red):
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