Adventure Capitalist

I have had a discussion over the past several days with a friend who rightly worries about the inflationary risks of current fiscal stimulus, budget deficits and money printing (renamed to the less alarming “Quantitative Easing”), and the effects it might have in devaluing his rather sizeable savings.
Yet despite his worries, he is hesitant about diversifying his savings into investments in other asset classes, and is hesitant to even put part of his money into another currency despite holding most of his savings in a currency which has been constantly and purposely debased by the central bank over the last decade. The rationale seems to be “at least I can’t lose more than whatever inflation runs at”.

But HOW much is inflation going to be?
Over the last 20 years or so, we have been spoilt with historically low increases in consumer prices in comparison to other periods in history where fiat money has been used. However, as any investment- or fund manager will tell you to avoid jailtime: “past performance is no indicator of future performance”. Just because we have been fortunate to live with 2-3% yearly consumer price increases in the past couple of decades, doesn’t mean we couldn’t go back to the 10-20% that was commonplace in the seventies and early eighties. It also doesn’t meant  that things couldn’t get even worse than that.
To make a parallell: if you would have put money in the US or any other western stock market in 1980 and just held it until 2000, you would have made a bundle of money. But if you invested in 2000 and held until now, you would have lost money in real terms.

Consumer Prices vs. Inflation
Another point of note is that Consumer price changes are not actually a real measure of inflation - inflation is per definition the increase in the money supply (amount of money circulating in the system). Even if consumer prices have only risen by 2-3% in the last few decades, it doesn’t mean there hasn’t been inflation, it just means that the newly printed money has gone elsewhere.
There was a massive stock- and tech bubble in the late 1990’ies which came crashing down eventually. After that we had a massive real estate bubble, and we all know how that ended. Both of these where symptoms of inflation of the money supply and the malinvestments that follow when too much money chases too few investment opportunities/resources.
Inflation is a little like putting a garden hose down into the ground and turning it on: you don’t know where the water is going to bubble up, but you can be sure it will bubble up somewhere eventually. The same thing goes for inflation: prices will rise somewhere, you just never know where. In the last 20 years or so, we have been fortunate enough that the price rises have mostly not been in consumer prices such as food, but consumer prices have in no way reflected real inflation, as the picture below of the US Monetary Base growth illustrates in no uncertain terms (do note what has happened since the early eighties when our current debt super cycle started):

Consumer Prices vs. Purchasing Power
Yet another point is that rises in local consumer prices don’t actually reflect the loss of the purchasing power of your money. Imagine that you held all of your savings in British Pounds in 2007. Three years later, those same pounds would have lost approximately 25% in value compared to other major currencies, such as the US Dollar, Euro and Swiss Franc, and even more to some others. The same 2007 monetary value would have bought you 33% more “stuff”, if you had held your savings and made your money in Swiss Francs instead of British Pounds since.
In other words, compared to people who held savings in some other currencies, you would have lost 25% of your purchasing power if you held British Pounds. If you lost 25% of your net worth in the stock market, I’m pretty sure you would feel a bit deflated, yet when the same thing happens to your savings, people seem ok with it, as long as it is the same or higher nominal number that shows up on their bank statement. If this isn’t cheating yourself and allowing politicians and central bankers get away with daylight robbery, I don’t know what is.

All Value Is Relative
The point I’m trying to get across here is that there is no such thing as “absolute value”, there are only overvalued and undervalued assets.
Many of us have been fooled into thinking that our wealth and purchasing power is the same as our net worth in nominal currency terms, less the consumer price change per year. This clearly isn’t true: what if you wanted to buy a house for your family after house prices and rents have risen 50% in 3 years? What if you wanted to move to another country and all of a sudden found that your new home was much more expensive than what it was the last time you visited because your purchasing power had decreased due to exchange rate changes?

So What Should I Do To Protect My Net Worth?
Well, I am not going to give investment advise here, I just want you to realise that your money isn’t particularly safe, and isn’t an asset class that is safer to hold as by some weird magic. Sure, it is a good idea to hold enough cash to fill your daily expenses without duress and make sure you can survive a potentially lean earning period so you don’t have to hold a firesale of assets currently undervalued by the market.
But the only long term safety you have in protecting your net worth is to learn how to identify if and when different types of assets are overvalued or undervalued. To blindly hold cash in your savings account is a great way to put yourself at risk of allowing the tides of time and the governments “inflation tax” to slowly, or maybe even quickly impoverish you without you even realising what hit you.