Thoughts on Macro: Inflation or Deflation?
Updated: Oct 1, 2020
Have you been seeing aunties shopping in jewelry shops recently?
Did that make you question "wa so many people no job, aunties so rich can shop there"?
Do these aunties actually know something that we don't or are they anticipating high inflation?
In this post, I will attempt to unravel aunties' secret and write about how the current macro environment will affect investing.
To start things off, I am neither a finance nor macro expert so whatever that is mentioned in this post is purely my opinion formulated from watching a lot of Youtube and reading FinTwit. It should not to be taken as any form of financial advice.
Firstly, what is inflation?
According to Investopedia, inflation is defined as:
... the rate of increase of prices for goods and services while purchasing power decreases.
Simply put, let's say that it takes $1 to buy a banana yesterday. Suddenly, it costs $2 to buy the same damn banana today. So in this scenario, inflation is at 100%.
Most common people would probably think: "Wa lau how come this jio so ex now? This jio make from where? Inside gold is it?" are completely missing the main point of lower purchasing power.
Although inflation is bad for consumers, it is generally considered good for the economy.
To illustrate, let's assume that annual banana price inflation rate is 10%. Banana companies would definitely love to expand their production (who wouldn't want an annual 10% guaranteed increase in revenue?). Bigger plantation = more workers needed = jobs created. Banana workers can expect higher salaries as well and would be able to afford more goods/services. Hence, the cycle continues onto the other sectors thereby creating a strong economy.
This is just an overly exaggerated example, inflation at 10% is actually pretty high (public would go bananas). Ideally, central banks want inflation to be at 2% because some economists believe that it is the sweet spot whereby the economy operates most efficiently.
However, too much inflation is also bad. Anything beyond 50%, you will have something called hyperinflation which has been a huge concern lately since the Feds has been "printing" money at an unfathomable rate.
I just had to bring back this video haha
What is deflation then?
Basically, it is the opposite of inflation.
In a deflationary environment, prices for goods and services go down. Conversely, the value of our money goes up. Shops going on sale and tech gadgets becoming cheaper over the years are some examples of deflation.
Sounds like a great time to be shopping right? Indeed, having some deflation can increase demand for particular goods and services.
Despite so, economists believe that it is bad in the overall picture as only few get to enjoy the benefits. Why is that? Let's come back to the banana example. Imagine again that for some reason, every store is giving a 50% discount on bananas.
Banana companies will have a problem as the business becomes unprofitable to produce bananas. To lessen the pain, they resort to cost saving, wage cuts, restructuring etc. If the situation still doesn't improve, banana companies fold and more jobs are lost. Ex-banana workers with no income, have to cut spending and only buy what is essential.
With reduced consumer spending, other businesses face the same problem and resort to slashing prices in order to remain competitive. Thus, the cycle repeats, leading to a cascade effect commonly known as a "deflation death spiral".
Of course, this is just a simplified explanation. There are other types of deflation as well as causes.
Likewise for deflation, too much of it will have dire consequences. An example would be The Great Depression which happened during 1929 and lasted 10 years.
Okay.. so what does it have to do with investing?
Depending on which is occurring, you might want to size your cash position accordingly.
High inflation
Generally, it is not a good idea to have too much cash on hand as its value will decay by doing nothing in your savings account. Instead, value could somewhat be retained or possibly increased by investing in:
Precious metals like gold: due to its scarcity, high CAPEX requirement to mine and process
Bitcoin: similar concept as gold but the crash in March shows that hodlers don't really understand its purpose
Equities
Assets
It is also probably an opportune time to take on debt as the repaid amount will slowly be inflated away.
There is a high chance for a bull market in the short term because everyone will want to dump their cash at least into stocks. This is what US has been trying to achieve through money printing. By giving people stimulus checks, they can continue to prop up the market while inflating their trillion dollars debt away and make Trump look great.
High deflation
We might see high unemployment rate as companies are cutting cost by reducing manpower. People become risk adverse due to the gloomy economy outlook and when job security becomes questionable. Pretty similar to what Singapore is experiencing right now except that it has been aggravated by the pandemic.
There is a high chance for a bear market in the short term due to uncertainties which leads to people holding cash and hunker down. Hence, it is recommended to de-risk by cutting weak positions and avoid taking on more debt.
Are we facing inflation or deflation?
The million dollar question.
Singapore
According to MAS, Singapore has been experiencing -0.4% inflation for the past few months now and expects deflation to persist for the rest of the year.
Some might ask: "Zhun bo deflation? My favourite chicken rice got no discount leh." Well, firstly how MAS determines inflation/deflation is by tabulating CPI (Consumer Price Index) and core inflation. CPI is defined as:
...the average price changes of a fixed basket of consumption goods and services commonly purchased by resident households over time...
Even though we're not getting cheaper chicken rice, we should see more discounts in other products.
Do check out the really nice infographic on CPI prepared by Statistics Singapore here to understand more!
US
CPI dipped from 0.6% to 0.4% which indicates disinflation (decrease in inflation rate) but where does it lead from here? There is so much discussion by macro experts on Youtube regarding it, watching them just leaves me confused af.
So, instead of going down the rabbit hole of trying to understand both sides' arguments, I think it is much simpler for layman like myself to look at the US dollar index, DXY.
USD does appear to be getting stronger slowly.
Then, combine it with other factors:
High unemployment
On-going pandemic (reduced economic activity i.e. spending)
Lack of new stimulus checks.
and you might have a recipe for deflation for now.
Closing thoughts
Okay back to the question, why are aunties buying gold? Are they expecting high inflation to occur in the near future? Not necessary. People invest in shiny rocks because gold has a high tendency to perform well whenever there is fear in the market.
Perhaps aunties ARE really rich.
Lately, I've been placing more emphasis on learning about macro (especially the US since crypto is denominated in USD) and how it has an effect on investments. Kinda regret not realizing this earlier, would have put in more money into US market and let Mr Powell pump my bags haha. Oh well, better late than never.
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