How does a strong dollar reduce inflation
Inflation protection in 4 steps: This is how it works
Inflation stands for a creeping loss of value. Particularly in the current phase of low interest rates, inflation should be taken into account, as it is often what makes the difference between loss and profit. As an investor, you must therefore take precautions and protect yourself from inflation.
We will show you the history, forms, causes and effects of inflation and how you can effectively protect your capital against it. Do not let yourself be gradually expropriated. Get to know the appropriate defense techniques now.
The reactions to the coronavirus will continue to have a strong impact on markets and prices for currencies, stocks and precious metals in 2021. You can find further information on our topic page for investors.
Inflation - what is it?
Inflation stands for currency devaluation. The term comes from Latin and stands for "to puff up". When the money supply in a country grows faster than production, average prices rise. The price level rises overall, so that your money is devalued.
Inflation can also be caused by rising raw material or production costs. Increased tax rates can also contribute to inflation.
What forms of inflation are there?
- One form is "creeping inflation". With her, the annual rate of price increase is less than 5 percent. These "moderate" Form of inflation is the type of inflation that predominates in industrialized countries. It is seen as positive for the economy, because it favors consumption and at the same time enables you to borrow money cheaply.
- A high inflation is less good for the economy. Prices rise faster than wages, so that citizens' fortunes are wiped out. At the same time, citizens 'and investors' confidence in the currency is weakened. This further exacerbates inflation.
- The "hyperinflation" is characterized by uncontrolled and extremely rapid price increases. Hyperinflation is the nightmare of any economy and can bring it to a complete standstill.
- The contrary of inflation is deflation. During deflation, the general price level falls. This is bad for the economy because consumers keep putting off purchases. The state and central banks therefore always try to avoid deflation.
Inflation is not measured according to gut instinct, but with the help of a price index. The price index looks at a selection of around 750 different goods and their price increases over a certain period of time. For this purpose, “average families” are determined for which a certain “shopping cart” is defined.
In order to measure inflation, one now determines the percentage by which the price of this shopping basket has risen. Usually over a period of one year. The calculated average prices and price increase rates of these shopping baskets then result in the inflation rate of an economy.
To illustrate how inflation works, we offer you a fictitious example. The prices of different foods and their price increases within a year are compared.
Food price increases
|product||Price 2016||Prize 2017||inflation rate|
|1 egg||1,00 €||1,02 €||2 %|
|1 liter of milk||1,00 €||1,03 €||3 %|
|1 bread||1,00 €||1,01 €||1 %|
|Headline inflation||2 %|
The inflation rate is determined from the price increases for certain products. Not everyone is equally affected by inflation. This is due to the different shopping baskets that are accepted for different types of consumers: singles buy different products than families, old people buy different products.
Who will benefit and who will lose from inflation?
Inflation favors debtors and harms creditors. The real value of receivables is shrinking as a result of monetary devaluation. As the largest debtor, the state is therefore also the biggest winner. Because if the inflation rate is higher than the interest rate at which the state borrowed money, the national debt melts away by itself.
How is the key rate related to inflation?
On the state side, inflation is controlled by the key interest rate. If the key interest rate is lowered, the banks will borrow more money. The money supply increases and with it the rate of inflation.
If the key interest rate is increased, the banks borrow less money from the central bank. This slows the growth of the money supply and slows inflation.
The biggest losers from high inflation are citizens, especially those from the middle class. You are not prepared for unexpected price increases. Salaries rarely rise in proportion to inflation, which burdens citizens.
The hyperinflation of the Weimar Republic and the consequences
In a healthy economy, the interplay between raising and lowering the key interest rate works. However, this does not always work, and some countries have already failed because of poor monetary policy. A well-known example is the Weimar Republic, which had maneuvered itself to the economic and political abyss through self-induced hyperinflation.
Inflation usually works in the background, and very few feel its consequences immediately. It was different in the 1920s. The greatest war in human history to date, the First World War, not only destroyed millions of lives, but also hit the European economy hard.
The warring parties had mainly financed their costs by issuing bonds and printing money. The loser pays the bill. Five years after the defeat, Germany was also in ruins economically: reparations had to be paid, war bonds serviced and the country rebuilt.
The French occupation of the Rhineland in 1923 brought the barrel to overflowing. The German government called for passive resistance, primarily by striking the factories. In return, they continued to pay the workers' wages.
To service the salaries, the German government printed money, causing the worst inflation in German history. The money printing caused more and more money with no material value to flood the country.
As money was worth less and less, wages and prices exploded. Money had become the plaything of inflation and thus practically play money. The inflation was so high that the value of money could plummet within a few hours. This is called hyperinflation, an extreme form of normal, "natural" inflation.
The following table shows what Hyperinflation means.
|product||Price June 9, 1923||Price December 2, 1923|
|1 egg||800 Reichsmarks||320 billion Reichsmarks|
|1 liter of milk||1,440 Reichsmarks||360 billion Reichsmarks|
|1 kilo of potatoes||5,000 Reichsmarks||90 billion Reichsmarks|
|1 tram ride||600 Reichsmarks||50 billion Reichsmarks|
|1 dollar||100,000 Reichsmarks||4.21 trillion Reichsmarks|
Hyperinflation ensured that the savings of many Germans were completely wiped out. In particular, the war bonds, which were still considered safe at the beginning of 1914, turned out to be money destroyers. This caused great unrest within the German population and permanently reduced confidence in the still young Weimar Republic. Numerous historians assume that the poor economic situation and thus also the inflation are partly responsible for the seizure of power by Hitler and the Second World War.
Extreme inflation in Zimbabwe
Another well-known example is Zimbabwe. There was extreme inflation here between 1980 and 2015. A total of four versions of the "Zimbabwean Dollar" were introduced. It was of no use. Inflation could not be stopped and the currency was withdrawn from circulation on October 1, 2015.
So you see: inflation can be very dangerous and not only has a major impact on your personal financial investments, but also on entire countries and economic areas.
Protect yourself from negative interest rates and inflation
Secure your wealth. That's how it's done:
Protect your assets with an ETF portfolio
Causes of inflation
However, inflation is not only caused by failed monetary policy by states, but also “quite naturally”.
A distinction is made between monetary, demand and supply-induced inflation developments. Most of the time, all factors play together in an economy and each influence the inflation rate to a certain extent.
- Monetary inflation describes the state in which states or central banks print money and thereby increase the amount of money.
- Demand inflation arises when the demand for goods exceeds the supply. Due to the increased demand with (for the time being) constant production, the prices of the goods rise.
- As Supply inflation The term is used to describe the situation in which price increases are triggered on the supply side. For example, when companies pass on increased costs to consumers and prices rise as a result (cost pressure inflation). Or when companies raise prices without first increasing costs in order to increase their profits.
Protecting money from inflation - this is how it works
Inflation is a natural part of the monetary system and should always be considered when investing.
Of course, in some years there is a higher rate of inflation, in others a lower one. As an investor, however, you should base yourself on the average of two percent in the long term.
So make sure that the interest or return on your investments exceeds or at least compensates for inflation. Only then will you protect your money against inflation.
To one Value retention you have to be in Germany to get there at least two percent return per year generate. To one Profit too must achieve Return Your investment this two percentstill exceed. The difference between the return minus the inflation results in your effective, true return.
Protecting your capital from inflation - easier said than done
However, protecting against inflation in 2020 is not at all easy. The key interest rate is 0.0 percent - and has been since March 10, 2016. Almost no interest is paid on traditional savings investments such as overnight money, fixed-term deposits or savings accounts. In contrast, the inflation rate was 1.7 percent in January and February and 1.4 percent in March (Statista). There are enormous fluctuations due to the reactions to the coronavirus. Inflation is currently devaluing Germans' savings.
But which forms of investment are suitable for protecting against inflation? We have checked the most popular asset classes for you.
The supposedly simple inflation protection
The stock exchange offers direct protection against inflation: inflation-linked bonds. These bonds are linked to the inflation rate. If the inflation rate rises, so does the interest rate. The reverse is also true.
However, these bonds are not necessarily suitable for stock market beginners. A lack of transparency and hidden costs can often be found with this type of investment.
To really hedge against inflation, upgrade your money:
Inflation Protection - The 4 Ways To Protect
1. Invest money profitably and protect capital
You can only achieve real protection against inflation by investing your money profitably. This is the best way to counteract inflation. The nice thing is: you not only protect yourself against inflation, but also increase your capital at the same time.
The following asset classes are subject to fluctuations in value - but in the long term the trend is upwards. Inflation also helps, even if it is only moderate.
Attention: Please note that higher returns also come with higher risk. With higher returns, you beat the inflation rate, but of course with higher returns, you face new risks.
2. Stocks and stock ETFs to protect against inflation
Like real estate or precious metals, stocks are tangible assets. Because behind the shares are companies with associated real values such as factory buildings, machines and personnel.
They are quite suitable as an inflation protection, because usually the exchange rates rise when the money supply rises. As always with stocks, it all comes down to what stocks you own. If companies manage to pass on the cost increases caused by inflation, then you as a shareholder will benefit from the inflation.
But the prerequisite is that the real wages of the customers keep up. If the purchasing power of a company's customers falls, the prices cannot be passed on to them. Customers can no longer afford the company's products or services.
It always depends on the right amount. Studies show that stocks perform best up to an inflation rate of five percent. On the other hand, higher inflation rates cause serious problems. In most cases, however, this affects the entire economy and also other asset classes.
Equities are therefore suitable as protection against inflation at a moderate to increased inflation rate of up to five percent. In addition, you will face many unpredictable risk factors. Of course, it all comes down to the right stocks. Even without strong inflation, even in a functioning economy, a company can go bankrupt.
In the long term, an equity investment should beat the inflation rate by two percent. The DAX, the largest German share index, has so far generated an average increase of eight percent per year. Your real return would be plus six percent per year and thus well above inflation.
The profits of individual companies are also suffering from rising inflation. In the past we have observed that the majority were quite able to pass the rising prices on to consumers. In this way, companies could at least keep profits stable. For this reason, it makes sense to invest as broadly as possible in stocks. For example, via inexpensive exchange-traded funds (ETFs / index funds).
Conclusion on stocks and stock ETFs to protect against inflation
In the long term, a broadly diversified equity portfolio has always offered very good protection against inflation in the past. With moderately increased inflation, stocks offer a good environment for price gains. However, if the inflation rate rises rapidly, share prices can temporarily suffer more from the negative macroeconomic effects.
3. Real estate as protection against inflation
"What is safer than an investment made of concrete and steel?" What sounds plausible at first, often turns out to be an error.
A property works well as a protection against inflation when you, as the buyer, pass the higher costs on to the tenants. Because together with inflation, the running costs for the maintenance of the property also rise. Financing costs can also increase if you do not have a fixed interest rate agreement with the bank or if it is about to expire. If the rents do not rise proportionally to the costs, you as a landlord make a loss. Strong and rapid rent increases are usually difficult to enforce against tenants. During severe or even hyperinflation, this is immediately a hyper problem.
Real estate is a good protection if you sell it during high inflation. As inflation rises, so do real estate prices, so you may be able to sell your property for a much higher price than you originally paid. To do this, of course, you need a buyer willing to pay the higher price. But watch out for real estate bubbles!
If you do not have enough capital to purchase your own property, you can also invest in real estate funds. Participation in the real estate industry is possible even with small amounts.
Also, beware of the state: in theory, it can set special taxes and compulsory mortgages at any time. In 1948 this was practiced in the course of the currency reform.
Conclusion on real estate protecting wealth from inflation
As real assets, real estate is also suitable for long-term inflation protection. But be careful: If the financing and management costs rise faster than current income due to inflation, a deficit can arise.
4. Infrastructure funds to protect against inflation
The expansion of the infrastructure will remain an important topic in Germany and the world for a long time. In addition to bridges, motorways and airports, there have recently been investments in communication networks and renewable energies. In addition to individual investments, more and more funds are being offered that bundle various infrastructure projects. Investing in infrastructure funds can therefore be worthwhile, especially because most of them offer above-average interest rates. The need is enormous and will continue to grow.
Infrastructure funds offer a comparatively high level of stability and predictability. The companies in which the funds are involved are often "quasi-monopoly". These are secured by long-term contracts and are less cyclical. Infrastructure funds are therefore well suited as a supplement to inflation protection
Conclusion on protecting against inflation with infrastructure funds
These funds are characterized by consistently high demand and predictability. As tangible assets, they are an interesting form of investment for protecting against inflation, since rising operating and maintenance costs can usually be passed on to consumers. Often, however, they are not easily accessible as an investment for private investors.
These systems are only suitable under certain conditions
1. Gold - the classic crisis protection
Unlike paper money, gold cannot be increased indefinitely. That is why it enjoys a good reputation as a "currency in crisis". Gold is also independent of states or central banks.
Furthermore, gold is one of the oldest means of payment in the world and cross-cultural. Even the Romans paid with gold coins.
However, the value of gold always depends heavily on the market price. There is no guarantee that gold prices will rise when inflation rises. Gold is not so dissimilar to paper money and crypto currencies like Bitcoin, Ether & Co. It is ultimately only worth as much as believing in it. You can't eat it or produce something with it, and you can't live in it either.
The status of gold as a protection against inflation is controversial
The past has shown that the rate of inflation and the price of gold do not necessarily behave in relation to one another as one would expect. Examples here are the years 1980 and 1981, when inflation was very high, but the price of gold did not rise. On the other hand, the gold rally between 2001 and 2005 cannot be explained either. At the time, inflation was on the decline.
In his article "Real Assets" (2012), finance professor Andrew Ang from Columbia Business School empirically proves that gold is not a good protection against inflation. According to his research, the gold price developed much more slowly than inflation over long periods of time between 1875 and 1970.
This shows that inflation is not the only cause of an increase in gold demand. Rather, it is the fear of instability in the monetary system. Fear is increasing the demand for gold. And this instability can be triggered by high inflation. Another disadvantage of gold is that it does not generate any interest or dividends. In the past it has also been shown that the entry point in gold is extremely important, but difficult to find. If you get in at the wrong time, you often have to wait a long time until you have your investment back at all. As an alternative to gold, there are always other precious metals such as silver or platinum.
Also note the storage costs for gold, especially for larger quantities. Gold needs to be kept safe and secure. Both against burglars and against damage. Safes and protection regularly cost money. Inflation also increases the cost of these services.
Experts recommend investing five to ten percent of the portfolio in gold or other precious metals as an emergency reserve in the event of a crisis. Due to the price fluctuations, investors should always see their gold investment as a long-term investment and crisis currency just in case.
Conclusion on inflation protection with gold
Gold is a good and well-tried protection against crises. Concern about the stability of the (paper) money system in particular causes the demand and thus the price of gold to rise regularly. The sometimes high fluctuations in the market price, the lack of dividends and the storage costs are problematic.
2. Corporate bonds
Corporate bonds are an alternative to stocks. Many companies can no longer and do not want to rely solely on banks for their financing. You are looking for additional sources of finance on the stock exchange. You can use a bond to provide companies with the financing they need and earn interest at the same time.
When it comes to corporate bonds, the company's creditworthiness plays a crucial role: you should be able to answer the question of how good the company's future solvency will be. Because the company can only service the interest and principal payments due if it has a good credit rating. Basically, the higher the risk, the higher the interest. Although bonds from large corporations usually offer lower interest rates than bonds from medium-sized companies, their creditworthiness is often higher.
Conclusion on corporate bonds
If the interest rate on corporate bonds is above the inflation rate, this offers protection against the inflation-related loss of purchasing power. However, bond prices usually fall when inflation rises. They are therefore only suitable to a limited extent as protection against inflation.
3. Crowdlending & crowd investing
Crowdlending enables (mostly smaller) companies to invest in loan projects. In return, investors receive regular interest and principal payments. Crowdlending offers an average interest rate of over five percent per year. At three percent, crowdlending is still well above the inflation rate.
It is important that the borrowing companies meet their payment obligations towards the investors. If this works, you should beat inflation easily with crowdlending. The risk here lies in rising inflation. Compared to the default risk, the investor is now only rewarded with a comparatively low interest rate.
A special feature of crowdlending is that you receive interest and principal payments at regular intervals. In this way, you can channel some capital from crowdlending into other asset classes if necessary. It offers a bit more flexibility than corporate bonds or stocks, which can only be liquidated at a loss.
Equity crowdfunding can also be a way of protecting against inflation. In addition to a fixed annual interest rate, investors also receive a possible profit-sharing option. Of course, it is important to choose good investment projects backed by wealthy companies. Small investors should rather avoid crowd investing projects by start-ups and rely on established medium-sized companies and well-known companies.
Conclusion on crowdlending & investing
Crowdlending and crowd investing offer above-average returns. This is an interesting alternative, particularly in the current low interest rate environment. In terms of risk profile, they are similar to stocks and corporate bonds. If inflation is very high, however, these types of investment will no longer offer adequate protection against inflation.
Investments not suitable as protection against inflation
There are asset classes that at first glance seem like a safe protection against inflation. On closer inspection, however, specific pitfalls become apparent. We tell you where to watch out:
1. Daily money / fixed deposit / savings book
The interest rates for these asset classes are currently extremely low. On average, 0.1 to a maximum of 0.5 percent interest is paid per year. Since the inflation rate averages two percent per year, these forms of investment are currently unsuitable for inflation protection. You can slow down the loss of value a little by optimizing, but you cannot stop it completely. Investors who rely on these forms of investment are expropriated coldly.
Conclusion on daily, fixed-term deposits and savings accounts
The current interest rates for these types of investments are below the inflation rate. They are therefore unsuitable for protecting against inflation and can slow down inflation as much as possible.
2. Art, jewelry and other valuables
Art, jewelry, luxury items and diamonds are valuable and enduring. In a perfect world, you could use these items to hedge against inflation.
"But it doesn't work quite that simple, because anyone who wants to earn money with such material assets needs a great deal of specialist knowledge," says Jürgen Raeke. Raeke is the managing director of Berenberg Privat Capital and an expert in real assets. The problems in the markets for alternative real assets are a lack of transparency, the lack of central trading venues and illiquid markets. There is only a small group of buyers for many alternative tangible assets. It is accordingly difficult to find a buyer for your jewelry or art when you need them.
Experts recommend that you stay away from alternative real assets as an investment if you do not have special expertise. Accordingly, alternative tangible assets such as jewelry, luxury items or art are not suitable as protection against inflation for the average investor.
Conclusion on jewelry, art and other valuables
Alternative real assets are only suitable for experts. They are not suitable as reliable protection against inflation for everyone. They require a high level of expertise, and small markets with no liquidity make trading difficult.
|Suitable as inflation protection||Limited suitability||Not suitable|
|Stocks & Equity ETFs||Gold (in the future cryptocurrencies such as Bitcoin)||Daily money / fixed deposit / savings book|
|Real estate / real estate funds (note running costs!)||Corporate bonds||Art, jewelry and other valuables|
|Infrastructure Fund||Crowdlending & crowd investing|
Wish list inflation protection
You notice: The practical implementation of inflation protection is difficult in times of low interest rates. That is why we have created a wish list for you to conclude with which you can orientate yourself.
- Leave with yours Return calculation for the investment inflation rate always with flow in.
- To offset inflation in Germany, your investments should at least two percent return achieve. The difference between the interest / return and the inflation rate gives your effective, real return.
- Use Asset classes like stocks and real estate, partly also corporate bonds as well as crowdlending and crowd investing, the higher interest rates as the inflation rate exhibit.
- gold should be a complement represent, but is rather crisis currency as protection against inflation. Gold is only valuable because it is rare. In the case of bulk sales, the price will go down quickly.
- Avoid You like asset classes in low interest rates Overnight money, Fixed deposit and Savings accounts. They are safe, but unprofitable. Interest rates are so low that inflation devalues your savings day after day. You lose money.
- In alternative real assets like Jewelry, art, wine or vintage cars You should only invest if you have one yourself in these areas absolute expert or an expert who does it for you. If not, enjoy them - but don't think of them as an investment.
Inflation is a constant companion of our monetary system. Don't let it intimidate you, but always think about the real loss of value. In the current phase of low interest rates, you as an investor need to be active in order to protect yourself from inflation.
Tip: use the inflation calculator
Use an inflation calculator to calculate the depreciation of your money. The free inflation calculator helps to calculate price increases, inflation and loss of purchasing power.
Protect yourself from negative interest rates and inflation
Are you ready to protect your wealth for the long term?
How to use an ETF portfolio to secure your assets
- What are some eating habits of Americans
- Why customers don't buy from you
- Who killed Jesus?
- Have you ever written an unpublished book?
- What are the pregnancy vitamins
- How does long-term hunger feel?
- How does PayPal make money 1
- Like snakes
- GameStop dies
- Why is sex not allowed in public?
- Are abs attractive to women
- What screams I'm a musician
- How do I distribute content marketing
- What is the specific fuel consumption
- How many Americans work in Corporate America
- How can I better involve unhappy employees
- Why do people passionately love guns
- How does underage drinking work
- How does WordPress hosting help
- How many feet are there in 35 meters
- Why do so few countries trust China
- What's worse than cancer
- What was Plato's most famous work
- Which is better Base or Hubspot CRM