What is stagflation and what does it mean for my investments?
In this article, we are going to go into a bit of economic theory, revisit an old phrase and discuss what it might mean for you as an expat in Europe. For some of you, this might not be the most exciting of topics, but we consider it an important topic to discuss and to see what we can learn from the lessons of the past.
Stagflation is a term that makes many people think of the 1970s. There was an oil price crisis, and a mix of inflation lowered growth and stock markets that were not growing.
So why are we talking about stagflation now, 40 or 50 years after it was an economic issue?
To answer that question, we need to be clear on what stagflation is and what causes it. Then we can discuss why it is being debated now and what you can do about it.
What is stagflation?
You probably know what inflation is. It is the increase in the prices of goods, or looking at it another way, the decrease in purchasing power of cash over time.
Stagflation is a situation in economies when there is slow economic growth, rising prices, and high unemployment.
Why are people talking about it now?
It is being discussed and debated now because there are some economic parallels, but also some important differences.
One of the similarities is that in the 1970s, following economic shocks, the governments, particularly the US government, notably increased the money supply. They did it to address falling economic output and increasing national debt.
In the last 18 months, world markets have seen notable increases in money supply and governments and central banks have flooded the markets to support the global economies in the wake of the Covid-19 crisis. They did this because economic output – production of materials and purchases of goods – fell dramatically in 2020. The objective was to avoid a global recession. So you can see there are some similarities to the economy of today.
There are, however, some important differences. In the 1970s, inflation was considerably higher than today. The 1970s falling into the epoch from 1965 through to the early 1980s in the US is referred to as the period of great inflation. The graph below shows how high inflation was in the 1970s, in the stagflation environment, compared to today.
Source: https://www.federalreservehistory.org/
Compare this to where inflation is today. The graph below shows the spike in inflation this year, but it is off a very low base and is only approaching 2009 levels.
Besides inflation, economic output is another factor to assess. In the stagflation of the 1970s, an increase in monetary supply by governments followed reduced economic output. The economic output slowdown in the 1970s was quite different from the economic downturn of 2020.
The economic slowdown we saw in 2020 was not caused by fundamental economic problems, but by the global pandemic. The coronavirus spread forced the temporary closure of businesses, production and distribution which led to a fall in economic growth.
With the combination of increased funds pumped into markets and economies re-opening in 2021, there has been an economic growth rebound.
As stated by the Bruegel research (https://www.bruegel.org/2021/11/is-the-risk-of-stagflation-real/) this time the ‘stag’ and the inflation have been separated. We had the ‘stag’ in 2020 with the market output decreasing but the ‘flation’ in 2021 due to markets rebounding. Importantly, they state, that as we didn’t have both at the same time, the risks of stagflation today are not as great as in the past.
What does it mean for you?
One of the most notable risks for investors now is that of inflation over the medium term. As inflation continues to rise, the cost of living increases and you need to be able to continue to maintain your quality of life. One risk is that expats cannot continue to afford to invest regularly. This can impact directly on longer-term retirement planning, which we know often sits outside formal pension systems for expats.
Secondly, it is important that your capital does not erode by this faster inflation by sitting in cash and not earning an adequate return.
For both these points, our recommendation is to get good independent advice. Make sure you are assessing and rebalancing your portfolios, assessing your investments against your objectives to make sure you remain on track, across economic cycles, and that it remains appropriate and relevant for your circumstances.
You can speak with us to address these questions and we can be contacted at info@extinvestments.com or via our website: https://blackswancapital.eu/book-an-appointment-black-swan-capital-europe/
