How to manage finances during high inflation? Understanding inflation, strategies, and investment breakthroughs guide

The Meaning of Inflation and Current Dilemmas

In the past two years, soaring prices have become the norm, forcing central banks to implement consecutive interest rate hikes. Taiwan has already gone through five rate hike cycles. Many people feel fear when they hear the word “inflation,” but honestly, we need to first understand what inflation really means in order to respond effectively.

Simply put, inflation is the devaluation of money. Over a period of time, the prices of goods keep rising, and your cash purchasing power declines accordingly. The most commonly used indicator to measure this phenomenon is called CPI (Consumer Price Index), which directly reflects the extent of price changes.

How Does Inflation Form?

After understanding what inflation is, it becomes clearer how it occurs. In simple terms, it’s because there is too much money in the market but too few goods. Excess currency chases limited goods, causing prices to naturally rise.

Specifically, there are several driving factors:

Demand-Pull Inflation: When consumer demand increases, sales of goods go up, companies expand production, profits grow, and this further stimulates consumption, creating a virtuous cycle. During this period, the economy is growing, but prices are also rising.

Supply-Side Push: When raw material costs surge significantly, companies are forced to raise prices. For example, during the Russia-Ukraine conflict in 2022, Europe’s energy supply was cut off, causing oil and gas prices to skyrocket tenfold. The CPI in the Eurozone increased by over 10% annually. In such cases, the economy can actually suffer.

Excessive Money Supply: When the government prints money without restraint, hyperinflation often results. Taiwan experienced this in the 1950s, when 800 million French francs could only exchange for 1 US dollar.

Self-Fulfilling Expectations: Once everyone expects prices to rise, they rush to buy in advance, demand higher wages, and businesses follow suit with price hikes, trapping society in an inflation spiral.

Why Do Rate Hikes Suppress Inflation?

When the central bank decides to raise interest rates, the cost of borrowing increases. For example, if a loan interest rate rises from 1% to 5%, the annual interest on a 1 million loan jumps from 10,000 to 50,000. Ordinary people naturally become less willing to borrow and prefer to deposit their idle funds in banks.

As a result, market liquidity decreases, demand for goods drops, and unsold products need to lower prices to attract buyers. Overall price levels decline, and inflation is contained.

However, there is no free lunch. While rate hikes can combat inflation, they also bring side effects. Companies may lay off workers, unemployment rises, economic growth slows, and in severe cases, a recession can be triggered.

Moderate Inflation Is Actually Beneficial to the Economy

Many people sigh at the mention of inflation, but moderate inflation can actually act as a catalyst for economic growth. When people expect future prices to be higher, their consumption motivation increases, boosting demand and encouraging companies to invest. This leads to increased production and economic prosperity.

China’s early 2000s is a typical example: when CPI rose from 0 to 5%, GDP growth accelerated from 8% to over 10%. Conversely, when inflation turns negative (deflation), people prefer to save rather than spend. Japan in the 1990s experienced this, with an economic bubble burst followed by deflation, ultimately leading to the “Lost Thirty Years.”

Therefore, central banks worldwide set inflation targets within a reasonable range. Developed countries like the US, Europe, UK, Japan, Canada, and Australia target around 2%-3%, while other nations generally aim for 2%-5%.

Who Are the Winners of Inflation?

It’s important to clarify that although inflation devalues everyone’s cash holdings, some individuals can actually profit from it. The most typical example is debtors.

Suppose you bought a house 20 years ago with a loan of 1 million. With a 3% inflation rate, after 20 years, that 1 million is only worth about 550,000 in real terms. You only need to repay roughly half the original amount. Therefore, those who borrow to acquire assets—such as real estate, stocks, gold—benefit most during high inflation periods.

Stock Market Performance Under High Inflation

During low inflation periods, hot money flows into stocks, pushing prices upward. But during high inflation, the opposite happens: governments tend to adopt tightening policies, and stock markets come under pressure.

The 2022 US stock market is a textbook example. In the first half of the year, the US CPI rose to 9.1% year-over-year, a 40-year high. To curb inflation, the Federal Reserve raised interest rates seven times, totaling 425 basis points, pushing rates from 0.25% to 4.5%.

High interest rates make corporate financing difficult, suppressing stock valuations. As a result, 2022 saw the worst performance in 14 years, with the S&P 500 down 19% and the tech-heavy NASDAQ dropping 33%.

However, not all stocks perform poorly during high inflation. Energy stocks are often an exception. In 2022, the US energy sector returned over 60%, with Western Oil up 111% and ExxonMobil up 74%. The reason is simple: when oil prices rise, energy companies’ profitability increases the most.

How to Allocate Assets During Inflation

In the face of high inflation, proper asset allocation is key. Investors need to find a portfolio that can counteract inflation erosion and achieve long-term appreciation.

Performance of Various Assets Against Inflation

Real Estate: During high inflation, market liquidity is abundant, and funds tend to flow into property, driving up prices.

Precious Metals (Gold, Silver): Gold is inversely related to real interest rates (real interest rate = nominal rate – inflation rate). The higher the inflation, the more valuable gold becomes.

Stocks: Short-term performance varies, but in the long run, returns tend to outpace inflation.

Foreign Currencies (e.g., USD): In high inflation environments, the Federal Reserve usually adopts a hawkish stance, leading to US dollar appreciation.

The Power of Diversified Portfolios

A simple and effective allocation method is the three-way split: 33% stocks, 33% gold, 33% USD. This combination captures stock growth opportunities, preserves value with gold, and hedges with the US dollar, spreading risk more evenly.

Traditionally, investing in these assets requires opening accounts with different institutions, which can be cumbersome. Now, more convenient options exist, such as Contracts for Difference (CFDs), which bundle stocks, precious metals, forex, and digital currencies into one platform, allowing one-stop allocation and leveraging to amplify returns.

Summary

Inflation means your money in your pocket is shrinking. Moderate inflation stimulates economic growth, while excessive inflation causes harm. Central banks’ interest rate hikes are common tools to fight high inflation but come with economic costs.

To protect wealth and achieve growth during inflation, investors must build diversified asset portfolios. Stocks, gold, USD, real estate—all have their advantages. A well-balanced combination maximizes anti-inflation effects and reduces risks associated with any single asset. Of course, how much and how to allocate depends on individual risk tolerance and investment goals.