Wednesday, 6 October 2010

Credit Suisse on Inflation - How It Happens, What to Do

Credit Suisse's Global Investor 1.10 report has a lot of worthwhile content on inflation:
  • How Inflation Comes About, a one-page Sim City like picture that shows how the financial system and key bits of the economy interact to create the beast we abhor - from Central banks, through commercial banks, the labour market, the capital market, the goods market. Brilliant communication! There's even a helicopter hovering over the stylized city - a sly reference to Helicopter Ben?
  • an assessment of Inflation as the escape route for high-debt countries - they say it is "unlikely" because many countries have "... experienced the painful consequences and destabilizing effects of runaway inflation," and won't want to experience it again; but it's much more likely in emerging market countries and commodity exporters and those least affected by the real estate crisis ... hmmm, sounds a fair bit like Canada
  • a sidebar on who is best at inflation forecasting - surprise, it is not that implied by subtracting the yield on real return bonds from the nominal return of government bonds - they were the least reliable! Best at the one-year ahead inflation forecasts were ... drum roll ... the central banks. Note how they all slightly under-estimate actual inflation. Based on the expectations on this Bank of Canada page, which does NOT seem to include a forecast by the Bank itself, 2011 looks like it will be in the 2.5-3% range in Canada.
  • an inflation history graph going back to 1500 - inflation was a lot lower and more stable between 1800 and 1900!
  • people almost always feel inflation is worse than the official CPI numbers say. Most people are not inflation-conspiracy believers, they simply notice and feel the pain a lot more on the purchases they rely on most. It's a new area of behavioural finance, an extension of the "you feel losses twice as much as gains" idea. Hmmm, maybe that's why I think life is cheap here in the UK compared to Canada because wine is definitely a lot less expensive (lots of good table wine at the equivalent of $6.50 per bottle)
  • asset inflation caused by lax monetary policy and boosted by leveraging is very dangerous - no kidding - but take away the leveraging, as in the tech bubble, and the lasting real economy effects are not nearly as bad
  • an Adjusting to Inflation article shows different asset classes performed differently in different high-inflation periods . In the 1970s, gold, oil and commodities did best, but between 1986 and 1990 commodities did really well, oil was ok but very up and down and gold did very poorly, much worse than CPI. They then go on with the table below to identify which kinds of assets they think will do well in different economic environments. Their conclusion is one with which I cannot but agree - since you cannot know exactly when and in what form inflation will arise, the best investment strategy is to maintain a balanced diversified portfolio but to be sure to include things like gold, commodities, real return bonds and other hard assets.
  • there are personal accounts from three individuals who have lived through either hyper-inflation (Zimbabwe and Argentina), or deflation (Japan) - a strong reminder that we do not want to go there, diversified portfolio or not.

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