The world has witnessed 29 instances of hyperinflation in the last 100 years, the latest being the one in Zimbabwe (2007-09). A striking commonality in all these is policymakers hitting upon the same mistakes and the ensuing outcome. I intend to address this in the light of an economic environment characterized by sluggish economic growth and thereby easy monetary policies by central bankers around the world.
The question I address in this article - Are we headed for another major hyperinflationary period?
I say "Hyperinflationary Period" because the phenomenon stretches over quite some time. The period of 1986 to 1996 witnessed as many as 18 cases of hyperinflation.
The table below gives a list of hyperinflations in the history of capitalism.
So, the talk is not about a possible hyperinflation in one country. With the current monetary policies, several countries in the world could potentially experience hyperinflation or high inflation.
Before I discuss the probability of hyperinflation in the foreseeable future, there is another important observation to make from the last hyperinflation in Zimbabwe.
The chart below gives the relation between the rise in inflation and money supply in Zimbabwe (1994-2009).
Clearly, the inflation and money supply (M3) have risen in tandem in Zimbabwe. A look at all other instances of hyperinflation in history, shows a similar trend.
However, in the current context, one important factor needs to be considered when looking at the probability of hyperinflation in U.S. or in the eurozone - the dollar and the euro are global currencies unlike most of the currencies in the past, which returned to their intrinsic value of zero after hyperinflation.
Keeping this factor in mind, presented below is the money supply for selected economies (especially after the financial crisis).
It is very clear that the money supply has been surging for all the major economies in the world. The same holds true for many other countries not shown above.
However, things do not end here. Consider the following:
Economic growth remains anemic for developed countries and is slowing down meaningfully for developing countries. Investors can expect more quantitative easing and further increase in money supply as we head towards another possible global recession (discussed in one of my earlier article).
The unfunded liabilities as a percentage of GDP is high for the developed countries and more money will flood the system as governments increase their debt to fund the liabilities. I discussed this issue in another of my recent articles.
Consequences of Surge in Money Supply -
As shown above (in the case of Zimbabwe), an increase in money supply does lead to higher inflation. In my opinion, global inflation will trend up in the medium to long-term with a probability of hyperinflation in some countries.
Also, inflation can be concentrated to few asset classes in a large economy. Just as an example - The robust increase in money supply in China lead to spiraling real estate prices and a real estate bubble in some regions.
I also expect industrial commodities, agricultural commodities and energy prices to trend higher over long-term. Therefore, an increase in money supply is likely to manifest itself in the form of inflation in natural resources leading to loss of purchasing power for individuals.
I personally don't expect hyperinflation in the United States or the Euro Zone. However, I do expect very high inflation (crossing double digits) in the next 5-10 years. Also, real interest rates will remain negative in U.S. and the eurozone.
For developing economies like China and India, inflation might remain a problem for a prolonged period. In my opinion, these countries have an important tool to control inflation - currency appreciation.
I do expect the currencies of emerging markets to trend higher in the long-term. In line with this, I would look to have long-term exposure to currencies and stocks markets in emerging economies.
Investors in the developed economies need to have at least 30-50% of their portfolio in emerging economies (primarily invested in equities, currencies and real estate).
I would consider long-term exposure to the following asset classes in order to generate returns that would beat inflation.
Exposure to physical gold and silver or investment through gold and silver ETF's - SPDR Gold Trust ETF (NYSEARCA:GLD) and iShares Silver Trust (NYSEARCA:SLV). Both these hard assets serve as honest currencies.
Exposures to equities in emerging and developed markets as equities tend to outperform government bonds in times of inflation. Further, global equity market valuation looks reasonable as investors shy away from risky assets due to economic uncertainty.
I would like to add here that long-term exposure to equities in emerging markets would give investors the benefit of stock market appreciation as well as currency appreciation.
For exposure to industrial commodities, I would personally prefer commodities such as copper and coal (which are an integral part of growth and development in emerging economies).
Crude oil would also be an excellent long-term buy with significant upside still to be seen in per capita consumption of crude in emerging economies. Further, weakness in currencies would also lead to money flow into natural resources like crude. Investors can consider Exxon Mobil (NYSE:XOM) for long-term investment. With diversified assets and a good dividend yield, XOM is an attractive buy.
Exposure to the agriculture sector can be considered through purchase of farmland or through investment in companies owning farmland. I had discussed this investment theme in one of my earlier articles.
In conclusion, many currencies might be nearing the end of their life cycle and it is generally preceded by high inflation or hyperinflation. Even with the probability of such a crisis, investors can benefit from exposure to the right asset class. More importantly, the purchasing power needs to remain intact. The discussed investment options will ensure that investors easily beat inflation and preserve their purchasing power.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.