Inflation (even ‘low’ inflation) is the largest destroyer of wealth - worse than fraud, fees, taxes

Catching up on my reading during the European heatwave, so a bit late to comment this one

When you say defensive assets a.k.a debt is most exposed to the value destruction via inflation, it make me think of the other side of the bet. You mention that governments like inflation for this reason.

Is there a case for ordinary investors to be beneficially exposed to this effect by sustaining a moderate amount of debt while continuing to invest in high-quality growth assets?

Hey Cameron - thanks for the feedback. Yes if debt (ie being a lender) is killed by inflation then borrowers should benefit from being on the other side of that trade. Problem is borrowers pay interest rates that are determined by inflation (eg if inflation is 10% then lending rates will be 12-15% or thereabouts, but if inflation is 2% then lending rates will be 5-7% etc). So the cost of inflation is built into higher interest rates paid by borrowers.
Businesses should obviously carry a decent level of debt to invest in productive assets. Same for governments (unfortunately they waste most deficit spending on current spending, not productive assets). And property investors (for the right properties). On gearing up to buy shares, I have only ever recommended it once in my life and probably will not again. That was in my newsletters in early 2009 right at the bottom of the GFC sell-off. Many readers reported that they made a lot of money from gearing up into shares in early 2009 but I will probably never recommend that again in my lifetime. Time will tell!
cheers
ao

Ashley,Treasury bonds do have a role in diversified portfolio. We are heading for either stagflation or a deflationary recession. In deflation the only asset which offers growth potential is long term treasuries which can double their prices when interest rates fall. In the 1970s when inflation was rampant people hated bonds but no one ever imagined that in the early 1980s they would commence a 4 decade bull market. I am sure you know more than anyone that it's impossible to make a correct economic prediction and one can go from inflation to deflation suddenly, therefore I worry about people being underweight in bonds especially tresuries.

hi Johan - thanks for the feedback and comments. I have found that Gov bonds can be quite useful as short term tactical plays when yields collapse in early recession cycles. I did this successfully in the early 1990s (which was mostly just a lucky bet really), and in client portfolios (and my own) in 2008, 2011 and 2018. But you need to be very nimble because the gains on bonds as yield fall in early recession cycles are very quickly given back when yields rise coming out of the middle of recessions, so the ability to act quickly is the key. Otherwise most investors are usually better off being passive throughout. Saves worry, timing, and transaction costs
cheers
ao

Firstly Ashley, thank you for your profound and unqiue insights which so perefectly illustrate graphically, to make them so understandable to a much wider audience than would be regulkalry engaged. It is very much appreciated.

Secodnly, a question I cannot resolve. Why are raising interest rates the traditional strategy to fight inflation, when the immediate impact most often simply raises costs, and in turn prices, which leads to high inflation? I get the theory around supply and demand, and understand the theory that higher rates lessen demand, and theoretically lessen the pressure on prices.

..BUT...my onservation from particulalry the extreme of the '70s-'80's inflation is that demand only reduces by a level that does in fact reduce inflationary pressure when those rate rises are in themselves extreme...ie 1% or more?

Surely if rates are reduced, that will more directly reduce inflationary pressure, assuming their is accompanying policy to hold down the one sector that does run away too easily, namely house prices?

Hey Bruce - first, thanks for the great feedback. Much appreciated! On the question of fighting inflation by raising interest rates - the aim is to slow spending, which in turn slows sales turnover, production and employment, which in turn reduces wage pressures and spending. Raising rates also slows business investment and hiring, which reduces wages pressure and spending. At a basic level, increasing interest costs leaves less money in people's pockets to spend. Before central banks controlled interest rates, governments used to slow spending / increase costs via a host of other methods like increasing sales taxes, income taxes, import tariffs, cutting import quotas, upward revaluations of exchange rates, etc. All of these increased domestic prices and reduced spending, inflation pressures and wage pressures. With each there are time lags and unintended consequences. Cheers ao

Thanks so much for this, Ashley. It's a great post and a fascinating (scary?) topic. I really appreciate the time you put into it. I think it would also be interesting to see the same chart but with typical investment returns added in. So you can see what your real performance would be, after inflation and typical returns. Great work. Thanks! - dave

hi Dave - thanks for the great comments and questions. As to the impact of inflation on investment asset returns - I have done a truckload of work on that over many years. Check out some of the linked articles at the end of the above story. After that, by all means come back with more questions!
cheers
ao

I would like to thank you for the education that you provide with your newsletters. Probably the best commentary I have ever come across over many years (I am 73). I am collecting your newsletters, but if you decide to make a volume/book let me know.
Regards
Antonio

Hey antonio - thanks for the great feedback and your kind words. It's always good to hear from readers out there. My next book is going to be on ETFs, written for Aussies. There is plenty of stuff out there on ETFs but everything is either uninformed/vague waffle written by well-meaning journos, and/or mindless marketing fluff put out by product sellers. Mine will be non-conflicted and practical - hopefully!
cheers
ao

Thank you in advance, ETF education would be very beneficial. Unsolicited suggestion: a section on the economics of ETF providers to understand where they make their profits, and therefore where investors need to be wary (have come across several ETFs charging fees akin to an active manager - for a relatively straight forward index strategy).

Love your work.

thanks Rocko - Yes the term 'ETF' covers a multitude of different types and strategies. I instantly knock out all 'active' ETFs from my list. These are just active funds dressed up to look like ETFs to try to cash in on the ETF boom. I only look at passive ETFs that just track a specific index, and they should do that at very low cost. There are several passive ETFs that still charge high MERs (eg higher than say 20bp). Sometimes because the stocks are relatively illiquid and/or hard/expensive to trade - eg some Emerging Markets. But these types of ETFs are generally too narrow for my purposes anyway, so I knock them out.
cheers
ao

This, and immediately previous article, are excellent reminders of why returns and future income requirements need to be conducted on a ‘real’ basis (ie after inflation).

Perhaps we need to change the conversation to better reflect the ‘200-300bps annual fee’ investors pay away for inflation. A fee most investors would not agree to pay to a funds manager.

Hey Rock - thanks for the comment! That's a great idea to express inflation as 200-300bp per year knocked straight off returns! The other point would be to emphasise that this cost to returns would only apply to debt (defensive) assets (private credit, bond funds, etc) because diversified shares generally have profits and dividends rising over time more or less in line with inflation in most environments.
cheers
ao