All of the conversation earlier this year about inflation being transitory is well and truly over. More and more economists are now realising that inflation is here to stay – the question is just how much and for how long.
A recent paper from the US Federal Reserve suggests that when inflation crosses a certain threshold it enters wage negotiations, and when that happens we start to enter a ‘wage-price spiral’. The current labour shortages and recent inflation suggest we may be about to enter such a spiral.
Since China entered the global economy in the 1990’s, they have also acted as a counterweight to any such wage-price spiral, as the key exporters of deflation around the world. Chinese labour had the effect of keeping wages lower around the world (because companies had the ability to offshore manufacturing) and also pushed down prices of traded goods. However, China’s role as an exporter of deflation may be coming to an end. President Xi Jinping has explicitly stated he wanted to prioritise domestic consumption over exports and corporate profits, as part of his ‘common prosperity’ push.
For investors, this means we need to position our portfolio accordingly. The first thing to note, in times of high inflation, bonds and equities are positively correlated, as they were in the 1970s. This article suggests owning value stocks in Japan, the UK, Europe and emerging markets as the first way to inflation-proof a portfolio. While not covered in the article, property also serves as a good inflation hedge, as the asset value rises with inflation but also the value of the mortgage debt is inflated away. Whatever the strategy, the important thing is that investors have one and are asking of each of their investments, ‘will this investment do well in inflation?’.
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