In this video we’ll explain what hyperinflation is, what causes hyperinflation
and what have historically been the best and worst performing investments when high inflation does occur.
How will cryptocurrency perform during hyperinflation?
Governments around the world are conducting quantitative easing or basically printing money at unprecedented rates as a result of the pandemic.
Ever since fiat currency stopped being backed by the gold standard, governments have been given the licence to print money
and history has shown that money printing can often be a precursor to uncontrollable inflation which can potentially cripple countries
with some famous recent examples being Venezuela and Zimbabwe.
Will it get that bad all over the world and if it does, what can you do about it?
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What is high or hyperinflation?
An inflation rate is the annual percentage rise in the cost of living, also referred to as a consumer price index or CPI.
Most Federal Reserves around the world target an inflation rate of about 2%
as this is considered to be a reasonable amount of growth in an economy whilst providing investment certainty.
However, too much inflation is problematic as the price of goods and services get out of control
and people can no longer afford things they need in their day to day life like food and transport.
When inflation reaches a monthly inflation rate exceeding 50%, this is generally termed hyperinflation.
There have been countless stories in countries hit by hyperinflation of people turning up to work in the morning,
and not being able to afford a bus trip home by the afternoon.
For context of how bad the problem is in Venezuela
the Central Bank of Venezuela (BCV) itself officially estimated that the inflation rate increased to approximately 53.8m% between 2016 and April 2019.
What causes hyperinflation?
The popular belief is that printing fiat currency causes hyperinflation because as the money supply goes up,
this means there is more money chasing the same amount of goods and services.
However printing money doesn’t necessarily lead to hyperinflation as was evidenced in the Global Financial Crisis or GFC.
It is probably better to think of printing money as a symptom of a collapse in the real economy.
Throughout history it has been shown that a loss of confidence in money
where there is no real productivity backing the value of the money is the real cause of hyperinflation.
One famous example was in Germany after WWI where the Allies occupied the Ruhr valley where most of Germany’s industry was based
after Germany failed to make reparations under the Treaty of Versailles.
In retaliation, the German workers went on strike whilst the government had its central bank continue to print money without a real economy.
The big question for us right now is how the economy will look post-COVID
Will there be a big recovery as everyone is hoping for, similar to the GFC?
Or will there only be further instability leading to a loss of confidence and a risk of hyperinflation?
It should be remembered that hyperinflation is a very extreme occurrence and therefore unlikely to occur.
As high inflation is a more likely occurrence, this section deals with the types of investments that typically perform
the best and the worst during periods of high inflation which may offer some lessons as to how they could perform during hyperinflation.
Let’s start with the worst investments.
Cash. It’s pretty obvious that cash is one of the worst investments during high inflation.
Cash will simply lose value - by holding onto it you can purchase less and less with it every day.
Think of it as a leaky bucket that will slowly eat away at your savings.
Therefore you’d want to invest in something that will offer returns that beat the rate of inflation.
Fixed interest bonds. Fixed interest bonds do poorly during times of high inflation.
This is because when inflation rises, lenders will demand higher interest rates to keep up with the rate of inflation so their money lent doesn’t lose value.
However this means that a bond that is fixed at a lower interest rate is less valuable now as you could go into the market and get a bond with a higher interest return.
Growth stocks. Growth stocks, for example many startups operating in the tech and digital space,
have little to no cash flow in the short term but are projected to earn cash flows in the medium to longer term.
A common way for valuing stocks is the discounted cash flow method which values a stock by valuing all future cash flows expected to be generated.
However future cash flows need to be discounted by a discount rate because money now is worth more than money in the future.
The higher the inflation and interest rate, the less the future cash flow is worth which negatively impacts the value of growth stocks.
Now let’s look at the types of investments that typically perform the best during times of high inflation.
Real estate. It tends to be the case that any asset with a limited supply will move in line with inflation.
As the amount of available land is limited whilst money supply increases, this means real estate tends to perform well during times of high inflation.
Commodities. Commodities can include agricultural goods such as soybeans, wheat and livestock, which are often referred to as soft commodities,
and commodities which need to be mined like gold, or oil otherwise known as hard commodities.
Commodities have historically been seen as a good inflation hedge,
although ultimately each type of commodity may have other supply and demand issues which means each commodity will need to be assessed on its own merits.
Value stocks. Value stocks typically do better than growth stocks during periods of high inflation.
This is because value stocks are stock that have strong current cash flows
so the discounted cash flow method tends to value these stock more favourably than the future cash flows from growth stocks.
A big unknown is how cryptocurrency would perform during hyperinflation given it has only been around since the GFC which did not cause hyperinflation.
In theory, a limited supply cryptocurrency like Bitcoin should perform well during hyperinflation
as the supply of fiat currency goes up relative to the supply of Bitcoin.
Further, loss of confidence in fiat currency is often caused by a loss of faith in governments to fix the economy
- which cryptocurrency was developed precisely to overcome.
Therefore it would seem that cryptocurrency would probably be one of the better investments if hyperinflation occurred.
However given how diverse the cryptocurrency market is, it is difficult to paint a broad brush as to how it would perform.
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