A recent article in the New Zealand Herald by Mark Lister (Craigs Investment Partners) suggested that the best way for an investor to beat inflation is to have an allocation of precious metals in a portfolio. Inflation affects the holders of monetary assets, e.g. bank deposits, savings, loans,government securities – as money loses value, so do these assets. Therefore, savings in real assets such as property are also advisable to beat the inflation monster. However what was interesting about the article was the history of global inflation and money over the last 100 years. Over that time period inflation has averaged 4.5% but it has been the last 10 years that has seen it accelerate significantly.
The table shows inflation rates of industrialised countries since 1900. Switzerland is the only country to have maintained an average inflation rate below 3% over the time period. One has to ask why other countries have found it so hard to keep inflation under the 3% level. Up until the mid 1970’s most major currencies were backed by precious metals. What it bascially meant was that a country could only print more money if it increased its stock of gold or other precious metals – the currency was backed by these precious metals. The rationale here was that the notes and coins could be exchanged for precious metals which meant that you couldn’t just print more money (quantitative easing) like they have been doing over the last couple of years. It was in 1971 when President Nixon suspended the convertibiity of US dollars into gold and by 1975 most other developed countries had followed suit. This led to a new era of just prinitng more money and currencies become known as fiat currencies – no inherent value. The term derives from the Latin fiat, meaning “let it be done” or “it shall be (money)”, as such money is established by government law. The key aspect about fiat money is the fact that its value relies entirely on the confidence the public have in it.
Up to 2000 Switzerland still kept linking its currency to gold and it was only after a referendum that authoriites loosened the requirement to hold a certain amount of gold as a back-up to paper money. Today, it’s as easy as a few extra numbers entered on a computer keypad. Printing money doesn’t achieve much other than inflation. There is still the same amount of goods and services to go around, but now there is more money chasing the same amount of goods, so the price simply goes up in reaction, which in turn makes your money worth less in terms of its purchasing power.