Growing discussions of reflation among economists underscore the complexities of modern markets. After years of battling deflation, the nation is now entering a period of reflation, with inflation not far off, argue analysts. Even big banks like Goldman Sachs are warning investors about the situation and urging them to buy gold and sell off their government bonds.
For nearly a decade, central banks have been fighting deflation. This is a situation where economies essentially stop working and prices decline rapidly. It was deflation that caused the Great Depression to be so severe and last so long—it’s extremely difficult to get a stalled or dead economy moving again. Globally, the most recent victim of significant deflation was Japan, only showing solid signs of coming out of a decades-long slump late in 2016. 1
The opposite of inflation, deflation 2 occurs when the supply of circulated money in an economy decreases. During periods of deflation, wages and currency hold a greater purchasing power than normal.
Since the recent U.S. presidential election, analysts have increasingly expressed concerns over reflation 3. One of President Trump’s promises during his campaign was swift economic growth. Such an acceleration of the economy, however, shifts the challenge from fighting deflation to controlling inflation.
To combat deflation, governments may adopt a reflationary fiscal policy 4, which can include cutting taxes and altering the supply of money. The goal is to boost the country’s economic activity and output.
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Most modern economists see mild inflation as an overall good thing. However, it is extremely important for individuals to understand the long-term ravages of any form of inflation. If you can remember a 10¢ cup of coffee or a $2 movie ticket, you have lived through those very effects. Just as compound interest works to your advantage over the long term, inflation compounds its destructive impact over time.
For example, if you are planning for retirement on a 30-year timeframe, just a 2 percent annual level of inflation will erode as much as 35 percent of the purchasing power of your savings.
Inflation occurs when prices increase and the purchasing power of currency decreases. Fluctuations in supply and demand and corporate price hikes are two factors that can cause inflation.
Goldman Warns of Inflation
These factors are why firms, such as Goldman Sachs, are advising investors to consider the impact of reflation and inflation. The chief strategist for this global firm, Peter Oppenheimer, recently sent a note to the company’s clients addressing this new reality.
He observes, “The implications of a clean Republican sweep of both houses are probably as important for the markets as the unexpected presidential result. … Market performance indicates a continuation and intensification of the reflation trend since the summer.”
Ultimately, the firm is advising investors to sell government bonds and buy gold to protect their portfolios from the threat of inflation.
Gold a Safe Haven
Inflation is one of the potential outcomes of passing legislation to cut taxes, approve infrastructure spending, and reduce stock market regulation—all of which the current administration has proposed. Before inflation becomes an economic reality, it is essential to rebalance one’s portfolio.
Experienced investors turn to assets like gold to protect their purchasing power during periods of increasing inflation. The historic role of gold as a safe haven investment allows investors to take comfort in times of global economic uncertainty and when reflation begins to erode the underlying value of other assets.