Protect money from inflation 2021

Last updated 30.11.2021

The chart below shows: Inflation is here, and inflation will be an issue in 2022. Everyone should now urgently ask themselves the question: How can I protect my money from inflation?
Since the beginning of 2021, fears of inflation have been increasingly stirred up in the media (newspapers, podcasts, news broadcasts). The inflation report of November 2021 also looks worryingly
looks: The inflation rate compared to the same month of the previous year was +5.2%.

Inflation 2021

Burgeoning inflation in Germany - what to do?

But is this fear of the consequences of inflation, triggered primarily by the loose monetary policy of the central banks, appropriate in the longer term?
Should one be worried about rising inflation rates? What options are there to protect one's money from inflation (2021 and 2022)? 

In this article, we take an objective, realistic look at

  • the inflation situation in 2021 with an outlook to 2022,
  • the consequences of possible longer-term inflation
  • weigh up how likely further emerging demonetization is in 2021 and
  • show which are the best investments at the moment and which should be part of your portfolio in 2021 and 2022.

Initial situation: Current inflation

The loose monetary policy has been in place at least since the financial crisis of 2008, when banks had to be rescued and states reacted with stimulus programmes and money injections at every turn to avert an even deeper crisis and get back to old growth figures. As early as 2008, the spectre of inflation was haunting the media and unsettling many people.

In retrospect, however, these fears were unfounded: from 2008 to 2019, the inflation rate in Germany was always between a low 0.3% and 2.6%.

Demonetization 2021

Inflation rate in Germany, sorted by year

But how is it possible that the fears and negative expectations described (high inflation or even hyperinflation) were so far removed from reality? And is the situation in 2008 comparable to today's situation, in which states are taking on more and more debt to finance emergency aid and economic stimulus programmes? We provide answers to these questions in this article.

The fact is that in the US, for example, no less than 25% of the total money supply (measured in M2) was additionally printed in 2020, as the following chart illustrates:

M2 money supply in the USA

The money supply increased dramatically not only in the USA thanks to massive government support for companies and households due to Corona (source: FED).

The authority responsible for Europe, the European Central Bank, increased the euro money supply (M2) by almost 11% in the period January to December 2020. A somewhat lower value than in the US, but still well above the long-term average of just over 6% (period 2010-2020).

This means that the money supply has increased sharply and we should actually expect inflation, right?

Fact: In August 2021, inflation in Germany was 3.9% compared to August 2020 (source: Federal Statistical Office). September was even worse: +4.1%. And now October with an incredible +4.5%.

Table Inflation 2021:

January 20211,0%
February 20211,3%
March 20211,6%
April 20212,0%
May 20212,5%
June 20212,3%
July 20213,8%
August 20213,9%
September 20214,1%
October 20214,5%
November 20215,2%

How safe are you from inflation?

We have developed a self-test that allows you to find out whether you are well protected in the event of emerging inflation or whether there is a need for action. Test now and see the result immediately.

This speaks for inflation in 2021

Inflation occurs when the total money supply increases while it is distributed over a constant quantity of goods. Individual goods therefore become more expensive and one speaks of inflation. But unfortunately the connection is not quite that simple - otherwise we would already have the answer! 

However, it is not enough that only the money supply is increased, as shown above, but a prerequisite for increasing inflation is also the increasing velocity of money. What the hell is the velocity of money? 

Relationship between government debt and inflation

The velocity of money in circulation determines, among other things, the level of the inflation rate (source: own presentation).

The velocity of circulation defines the speed at which money changes hands in an economy (e.g. in which goods are bought).
If money is printed, ends up in the wallets of citizens and companies (e.g. via stimuli paid by governments and aid for ailing companies), but is not spent there, the velocity of circulation is low. In this scenario, the probability of inflation is low.

Inflationary pressure only increases when households and companies start to spend the money they have saved and thus bring it into the economic cycle. Due to the many lockdowns in recent months, however, there was no inflationary pressure in the first place, as people saved the money under their pillows and did not spend it. 

Theargument for inflation in 2021 is that once the lockdowns are over and the vaccines are widely distributed, these saved amounts of money from companies and private households will come into circulation and we will see a jump in the price of goods: Inflation occurs.

Another aspect that speaks for stronger inflation in 2021 is the general debt situation of the states. Germany's debt amounts to about 70% of its economic output, while other countries are in a much worse position (France 115%, Italy 150%, Greece 187%). 

These debts have to be serviced and cause financing costs. Paying off the mountain of debt is a huge challenge and can really only be achieved in two ways:

  • Option 1 is to increase the state's revenues, for example by raising taxes, but this is politically unpopular.
  • Option 2 is to use the emerging inflation strategically in such a way that yesterday's debt is no longer worth so much tomorrow and can be paid off relatively effortlessly when inflation picks up and thus government revenues also rise through more tax receipts. 

The state thus has no interest in keeping the inflation rate at one to 2 %, but could try to let the inflation rate grow to more than 2 %.

A third trend that plays into the hands of inflation is the deglobalisation that Corona has triggered. In the phenomenon of deglobalisation, value-adding activities (e.g. production) are increasingly located in the home country, as supply chains are interrupted. Since the costs of producing goods, for example, are higher in developed countries such as the USA or Germany (higher wage levels, etc.), this is reflected in the selling price of goods. This leads to price increases and thus: Inflation.

This speaks against hyperinflation in 2021

The mandate of any central bank, apart from fighting unemployment, includes guaranteeing price stability. Central banks have various tools at their disposal to keep inflation in check or to stimulate it.

Considering the goal of price stability, it is the central bank's task to ensure that inflation does not rise above a certain level. This is usually around 1.5-2.5 % per year. If inflation rises above four or five percent, this has various negative effects on the financial system, the economic system, and thus indirectly ultimately on society. So, in order to maintain social peace, a central bank may use tools to cap emerging inflation.

Another aspect that speaks against inflation is the influence of the deflationary effect of our increasingly digitalised world. An example: In the past, many functions of a modern smartphone (calculator, sending messages, making phone calls, taking pictures, mobile working,...) had to be represented by separate products such as a calculator, a photo camera, a computer/laptop, etc., whereas all these functions are already integrated in a modern smartphone. The consumer thus has to spend much less money on balance to get the same number of functions. 

This is just one example of the progressive technological development in many areas, which has a deflationary effect. Ultimately, there is a decoupling between capital and productivity, so that digital products such as an app, for example, have to be programmed elaborately at the beginning, but can then be downloaded millions of times without causing additional production costs. This is a deflationary driver that will accelerate in the coming years and should not be underestimated. However, it should be noted that these developments will probably only show up in the inflation rate in a few years' time, as the influence of technology on inflation is currently still limited. 

Another point speaks against a high inflation rate: If inflation rises, central banks will sooner or later react by raising the key interest rate to correct the inflation rate downwards. In this more expensive interest rate environment, the financing costs for existing loans rise. If a private household, a company or a state is heavily indebted, its financing costs rise when interest rates rise, which often goes hand in hand with higher inflation. States, and thus central banks, are cutting their own throats if they give free rein to rising inflation and sooner or later threaten to become insolvent.

Conclusion: 2021 Inflation - Yes or No?

Due to the greatly increased money supply that has been (and will be) pumped into the financial and economic system, an increased inflation rate is to be expected in 2021. The level of the inflation rate in the short term depends primarily on how people behave after the lockdowns are lifted. However, it is not unlikely that there will be some catch-up effects in private consumption and business investment, which will increase the velocity of money and thus create inflation. 

After this initial rise in inflation that we suspect, the question is how the central banks will behave. Will they try to contain inflation or let it run wild? 

We believe it is likely that central banks and governments will counter rising inflation only after a certain point. We consider an inflation rate of 3 to 4% in the medium term to be quite realistic.

What does inflation mean for investment?

If the general price level (inflation) rises, this has profound effects on various financial investments. The level of the inflation rate is one of the most important criteria for the success or failure of a financial investment.
It is important to remain flexible when considering inflation and to constantly adjust to changes in inflation rates in order to make one's own financial investment a success. In the following we outline the possibilities of reacting to inflation.

Does real estate as an investment suit you?

Which investment is good in the face of inflation?

How can inflation be counteracted?
With medium to high inflation, tangible assets have great advantages over monetary assets. 

As a reminder: tangible assets are all those investment goods that are limited in quantity and the value per investment good therefore develops analogously to inflation as the money supply increases. Tangible assets thus protect against inflation and are not devalued by inflation. If a tangible asset now also actively generates a return, such as rental income in the case of real estate as an investment, the investor benefits twice over.

Tangible assets protect against inflation

Real assets such as real estate as a capital investment, gold or shares can protect against inflation (source: own representation).

Other tangible assets such as gold - simply put - rise in value with it, so that the tangible asset will not depreciate as inflation flares up. 

In addition to real estate, the tangible asset class also includes shares, gold, bitcoin and exotic financial assets such as classic cars, wines and art objects.

Which investment is bad in the face of inflation?

When it comes to inflation, the worst investments are those that have fixed interest rates and are tied for a certain period of time (e.g. government bonds, corporate bonds with fixed maturities) as well as cash. 

Due to an increasing amount of money in the system and an inflation of goods, cash is devalued insofar as one can buy fewer goods for the same amount of money. In addition to the aforementioned, money values also include overnight money, fixed-term deposits, etc.

Inflation-proof investments

What is the best investment at the momentthat also works well in the face of inflation? In our view, the conclusion of the above argument boils down to a broadly diversified portfolio with an overweighting of real assets. 

Inflation decides which capital investment makes sense.

In the case of inflation, a stable portfolio should have an overweighting of tangible assets, e.g. real estate as an investment (source: own presentation).

A Real estate as an investment is a relatively safe haven and probably one of the smartest investment decisions in the medium to long term. However, other tangible assets also belong in a broadly diversified portfolio (for example shares, gold, possibly also bitcoin). 

In addition to the real asset share in the portfolio, it could also make sense to hold short-term government and/or corporate bonds in the portfolio in order to limit the volatility of the portfolio. 

We would be happy to explain to you in a non-binding information session how a property as a capital investment protects normal earners against inflation and how a "normal" investor can implement an investment in a property as a capital investment.

Inflation 2022

As we can see, in 2021 we are facing one of the strongest inflationary periods in decades in Germany. In the media, it is often said that the currently prevailing demonetization is only "temporary". 

However, only the inflation rate is actually temporary, not the price level itself. If a bread roll at the bakery costs 5% more today than it did a year ago due to the prevailing inflation, then we cannot expect falling prices and a reduction to the old bread roll price for the coming year. The "old" price level of the previous year is history - inflation has triggered the price increase and cannot be reversed.  

Inflation 2022

Inflation 2022 explained using the example of a bread roll.

Thus, if the inflation rate is only temporary, it does not mean that we will return to the old price level. Instead, it means that the FUTURE inflation rate (i.e. the price of bread rolls in 2023) will not remain as high as we saw in 2021. After all, the usual inflation target of our central banks is around 2%. 

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