Inflation is the one of the few words that strikes fear into the heart of the government. Those who can remember the lessons of history will recall Germany’s Weimar Republic, where hyperinflation in 1922 rendered the currency worthless.
When workers were paid, they’d throw wads of cash to their spouses waiting below, who’d load it into wheelbarrows to go shopping before prices rose again. A famous comic of the time shows a thief stealing the wheelbarrow and leaving the cash behind.
More modern examples of countries experiencing hyperinflation include Zimbabwe and Venezuela. But how does rising inflation cause such big problems?
The inflation rate target
Inflation is measured by how much the costs of goods has risen over the past year. For example, an inflation rate of 1% means that a carton of milk which cost £1 last year, will cost £1.01 this year.
The most popular way of measuring the inflation rate is using the Consumer Price Index (CPI), calculated using an average basket of thousands of goods. CPI jumped from 2% in July to 3.2% in August, which is far above the Bank of England’s target of 2%.
Why 2%? Some inflation is good; it encourages consumers to spend now, rather than pay more later, which keeps the economy ticking over. But if the inflation rate is too high, consumers have less purchasing power in real terms. And after having to spend more on essential bills, they’re left with less disposable income.
Some experts are forecasting a 4% CPI inflation rate by the end of this year. There’s a supply chain crisis feeding the issue, with shipping costs now up 100% for some retailers. And the ongoing labour shortage is sending wages higher as well. There’s also been a surge in the price of raw materials making building work more expensive.
And rising inflation combined with low interest rates means many savers are forced to invest in asset classes like the stock and housing markets. This can create market bubbles that sometimes end in disaster.
The best way to fight inflation is to raise interest rates, but this is likely to cause as many problems as it solves. And the Bank of England knows a rates rise could cause the next housing market crash.
What I’m doing next
Some stocks do better than others when inflation gets out of hand. I think the largest gold miner in the world, Barrick Gold, is a solid pick in an inflationary environment. FTSE 100 giants Rio Tinto and BHP Group are other picks for me. They’ll benefit as long as the prices for raw materials continue to rise. Of course, as the world recovers from the pandemic, supply chain issues will resolve and bring the prices down again. And if inflation gets under control, there’s better returns to be had elsewhere.
Drinks giant Diageo and tobacco king Philip Morris are also strong candidates. The high demand for their products means that they can continue to increase prices above the inflation rate and customers will still buy them. The same argument can be used for National Grid, which is integral to the UK’s energy use.
The Bank of England still thinks the high inflation rate is “transitory.” But if it continues to rise, I’ll need to act defensively.
Make no mistake… inflation is coming.
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Charles Archer has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo and National Grid. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.