If inflation rises, cash value falls

As real interest rates fall and fall, at first via central bank interest rate cuts then via rising inflation meeting central bank’s refusing to hike, cash gets less and less attractive.  From UBS:

Eurozone inflation jumped by the most in over a decade in January, rising from minus 0.3% in December to plus 0.9%. This appears to have been driven by one-off factors. A similar bounce in near-term US inflation is expected, although the Federal Reserve has indicated it will look through any rise it views as transitory. Meanwhile, inflation expectations have increased in the US, yields have risen, and the curve has steepened, in part driven by the prospect of further fiscal stimulus.

But while higher yields and inflation expectations suggest greater optimism over the economic recovery, central banks have made it clear that policy rates are on hold. That means real rates will stay negative, and any lasting increase in inflation will drive them down further. In a world of negative real returns on bank deposits, we recommend investors consider putting excess cash to work.

•Why is cash bad? At current interest rates, holding excess cash reduces your wealth as inflation erodes its real purchasing power. Take the example of an investor with a USD 5 million portfolio and an annual expense of USD 250,000 that is rising by 2% each year due to inflation. Keeping the portfolio in cash would halve its value in just 10 years. Any further uptick in inflation would increase the erosion of real purchasing power.

•How much cash do you need? Professional investors typically keep very low cash balances. The seven biggest pension fund nations globally, which had total assets over USD 42,771bn in 2019, have an average of just 4% cash exposure, while holding around 45% inequities. While private investors may need more than this, especially as they near or enter retirement, we believe many hold too much cash. Our Investor Watch Survey for the fourth quarter of 2020 showed the average client holding 25% of their wealth in cash and cash equivalents. We recommend investors hold only enough liquidity to meet cash flow needs in excess of spending for three to five years, and not all of this liquidity needs to be held in deposits

.•How should I invest instead? Having set aside enough liquidity for upcoming needs, we believe investors should focus on finding yield and growth opportunities. For yield, we see opportunities in USD-denominated emerging market sovereign debt, whose 4.7% yield is around 360 basis points above US Treasuries. Meanwhile, equities are the main driver of growth in most portfolios. The average annual return on the MSCI All Country World index since 1998 has been 8% (USD total return), meaning investors have doubled their money roughly every 10 years. So, while cash holdings are necessary, excessive cash creates a drag on returns. We believe investors should consider their liquidity in three main tiers: Tier 1 for everyday cash needs in the coming 6-12 months; Tier 2 is savings cash for known needs over the coming 2 years; and Tier 3 is investment cash to meet potential investment opportunities over the coming 2-5 years. The first two tiers in our view should be mostly held in cash deposits, and investors who can consider taking on more creditor counterparty risk have the potential to earn higher returns in Tier 3, for instance by investing in short-term corporate bonds. Beyond this, we recommend investors put their cash to work in the markets to ensure they meet their financial goals.

Cash is trash!

David Llewellyn-Smith
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Comments

  1. Isn’t this a given. The only feasible solution to the debt problem is inflating it away, and that only works with low interest rates and high inflation.
    Don’t hoard now!

    • The only thing inflating is house prices and associated debt…… which ironically due to low interest rates are not reflected in inflation figures ( only the interest component is…. ) .

      if you want to inflate debt away you have to inflate everything else other than the debt…. not the other way round…

      • But they are trying desperately to get inflation up there, which they will look through. Will they succeed? I don’t know but they are damn sure trying, continuing to drop rates as inflation stubbornly refuses to rise.

        • They wont while they keep doing it through credit…. If they start doing infrastructure projects instead then they will.
          BUT when they do succeed, and it all takes off, they need to keep it under control. increasing interest rates, then the problem becomes how do people afford their mortgages acquired during this phases…

          While ever they focus on increasing debt to increase inflation in an attempt to decrease debt then they will fail. If they then stop this stupidity the we are all screwed.

      • Jumping jack flash

        At the correct growth rate debt will inflate debt. It already almost does. The only reason it didnt for the past 10 years in my opinion is because they decided that wage theft was the thing to do. Thanks, Howard and Rudd. Wage theft inflates wages for a tiny fraction of the economy who are fortunate enough to be in the position to steal wages. For everyone else it means their wages dont inflate.

        Debt eligibility is a function of wages. At least for now.
        To inflate debt, the first step is to be eligible for the amount you need.

    • ashentegraMEMBER

      ‘The only feasible solution to the debt problem is inflating it away’

      Quite so. The impulse to wash the debt away at the expense of cash-holders to avoid bankrupting the zombies will prove irresistible.

      Further, central bankers aching to ‘normalise’ interest rates will need an excuse, and inflation is the only one that matters. Phil Lowe has said he wants a decent head of inflation underway before he raises rates – pre-announcing reactive, trailing, ineffective policy.

      This way, the value of real assets can be maintained in the midst of the cathartic economic disruption certain to come with raising interest rates from the zero bound.

      Savers defer economic activity; borrowers bring it forward. Government will always be on the borrowers’ side.

    • Jumping jack flash

      Of course.

      And COVID stimulus provides the perfect cover for simultaneous controlled debt hyperinflation.

      The slow melt was far too difficult to endure for very long, if they even gave it a decent try. As soon as they got an opportunity to inflate, austerity went out the window.

      And its no surprise. Banks make their money from selling debt and harvesting the interest. They dont make their money when nobody is eligible for debt, and interest rates are falling!

  2. is BTC cash? good btc discussion yesterday, I have only one point I need cleared up with btc. If you have a price target, doesn’t that mean you intend to sell your btc for $ and therefore it is not the saviour it is portrayed to be but just another speccy and by default you acknowledge $ are the preferred means of transacting because you intend on cashing it in? or if you are are HODLer then when is it ever going to be useful if you intend on never spending your btc? I’m a no coiner HingFBP 🙁 not knocking btc and the industry, as it is obviously an amazing space full of very talented people, I just think this is the obvious flaw in anyones argument for btc and it doesn’t need to get complicated with theories etc).

    • $ are the preferred means of transacting, but a very poor choice for storing value. BTC is intended to store value, not transact regularly. IF you are storing value in $$ you are likely getting screwed, as is often lamented by various commenters here.

  3. so it is clear btc is a speccy/store of wealth. Just like anything, stocks whatever and is to be cashed in at some point for $.
    If Elon had any balls he would discount his Tesla’s to people who purchase in btc, why? because he would be then making a bigger statement that he doesn’t need USD and that btc is only going up. He should decouple the value of a Tesla from the current btc/usd exchange rate and make 1 Tesla worth 1.25 btc or $108000 dodgey USD. Now that would get me into btc in a flash as obviously then it massively incentivises other retailers to do the same.
    Also, the irony of Elon doing this is, to me, that he was made out to be some entrepreneurial genius and golden child to the US tech sector and can’t be touched. Now he goes and sticks it to the USD? lmfao
    ** edit gee I hope btc keeps going up for all those people that are storing their wealth in it

  4. “stocks whatever and is to be cashed in at some point for $”

    Less and less people are thinking they will be doing this. More and more people are figuring that it has more value being used as collateral. Especially as the crypto financial industry continues to build and offers more financial options. Why swap for $, lose a bunch of it to taxes, have a depreciating asset and lose a significant amount of an appreciating asset?

  5. For every dollar spent on Bitcoin CB have to print an extra dollar. Now if it goes on and on up and up then becomes illiquid it will be a big deal

    • exactly tonydd. Reduce liquidity everywhere, which is what the Fed will likely attempt when they feel the economy is off life support from COVID, and we will see who hodls the btc. Fed said they would do what’s needed mainly due to COVID. They threw the kitchen sink at it and liquidity has spilled everywhere. I’ll be watching for signs of tightening as the US exits the worst of the season for COVID and hopefully vaccines have an effect. Then we will see what are liquidity ‘assets’ and what are really the things people need.
      But, the Fed or gov will have to be straight back and do more if there is any tightening. Just have to wait and see.

      • Jumping jack flash

        Agree.
        Im watching the savings level and the debt growth rate for signs that the debt wave is starting. Its taking its time!

        Maybe all that savings will go into btc? I suppose thats one scenario…

    • This is simply not true. the money isn’t eaten by bitcoin, it just goes to someone else. It doesn’t become unspendable, it doesn’t cease to exist.

        • it’s all about liquidity as we saw only a week ago with GME what happens when theres a little $3 billy or so liquidity scare with Robinhood. I assume BTC is coked up on liquidity just like everything else. There doesn’t seem to be a liquidity issue anywhere that I know of but when liquidity starts to dry up, then what?

      • Spent once yes in that its like other inflation protection assets that aren’t intended to be used, they all drag on velocity.

  6. Venezuelan Petro makes more sense, just that the market doesn’t think so yet. Circumventing the USD system and loads of oil that China might be interested in. So, basically an oil backed crypto.
    I get the btc thesis, like I said before you don’t need to over complicate it. It won’t keep going up 2x,3x,4x,5x, it will at some point reach a more stable ‘value’ in whatever it is valued against – and that will still probably be USD. PayPal going to btc was the biggest move for me.
    If an asset keeps rising in value, people hoard the asset – bad for the economy. Inflationary expectations can be good. So what’s your price target since you are going to need dollars at some point?