Inflation is a complex economic issue with various definitions across different contexts. Economists, business people, and politicians argue that moderate inflation levels are necessary for driving consumption and that higher spending levels are essential for economic growth. But the primary concern is, “Who benefits from inflation?”
The Federal Reserve targets annual inflation in the U.S. to maintain business profitability and prevent consumers from waiting for lower prices, and some argue it prevents deflation.
Inflation negatively impacts the economy. It makes savings difficult and promotes riskier investment strategies while benefiting some businesses or individuals at the expense of others.
This article focuses on the impact of inflation, specifically on the largest beneficiaries and losers.
What Is Inflation?
Inflation is a rise in prices over time. it indicates a decrease in purchasing, as indicated by the average price increase of goods and services. A percentage increase in prices indicates that a currency unit purchases less than it did in previous periods.
As compared to deflation, Inflation is a period of economic growth where prices decrease and purchasing power increases, while deflation is a period of decreased prices.
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Understanding Inflation
Human needs extend beyond individual products, requiring a diverse set of products and services for a comfortable life despite easy price changes over time. These include commodities like food grains, metals, and fuel; utilities like electricity and transportation; and services like healthcare, entertainment, and labor.
Inflation measures the impact of price changes on a diversified set of products and services, providing a single-value representation of the increase in an economy over time. Rising prices reduce purchasing power, affecting the cost of living and causing a deceleration in economic growth for the general public.
Economists generally agree that sustained inflation occurs when a nation’s money supply grows faster than economic growth.
Causes of Inflation
Inflation is primarily caused by an increase in the money supply, which can occur through various economic mechanisms. Monetary authorities can increase a country’s money supply by:
- Printing more money and providing it to citizens.
- Legally devaluing i.e. the process of reducing the value of the legal tender currency.
- The banking system is used to lend new money through reserve account credits, typically by purchasing government bonds from secondary market banks.
In all these instances, money loses its purchasing power. The causes of Inflation can be grouped into three types: demand-pull inflation, cost-push inflation, and built-in inflation.
Demand-Pull Effect:
Demand-pull inflation occurs when an increase in money and credit supply leads to a faster increase in demand for goods and services than the economy’s production capacity. Increased financial wealth leads to increased consumer sentiment, higher spending, and higher prices due to a demand-supply gap between higher demand and less flexible supply.
Cost-Push Inflation:
Cost-push inflation occurs when increased prices in production process inputs, such as money and credit, increase intermediate goods costs, particularly when a negative economic shock affects key commodity supply. Expansion of the money supply can lead to a speculative boom in oil prices, causing higher costs for finished products and services, and resulting in rising consumer prices.
Built-In Inflation:
Built-in inflation is influenced by adaptive expectations, where people anticipate future inflation rates to remain consistent, leading to increased demand for goods and services. Increased wages lead to higher costs of goods and services, perpetuating a wage-price spiral where one factor influences the other.
Advantages and Disadvantages of Inflation
Inflation can be seen as either beneficial or detrimental, depending on one’s perspective and the speed of the change.
Advantages
Inflation may be beneficial for individuals with tangible assets priced in their home currency. This increases their value and allows them to sell at a higher rate. It often prompts speculation by businesses and individuals in risky projects, as they anticipate better returns than inflation.
An optimum inflation level encourages spending, boosting economic activities. A balanced approach maintains an optimum range of inflation, allowing for increased spending and saving, despite falling purchasing power.
Disadvantages
Inflation can negatively impact buyers and holders of assets in their home currency, making investors consider inflation-hedged asset classes like gold, commodities, and REITs, as well as inflation-indexed bonds, to protect their portfolios.
The Inflation rates can significantly impact an economy, causing uncertainty in purchasing, selling, and planning decisions. This leads to increased time and resources spent on research and adjustment, despite the fact that real economic fundamentals are not always accurate.
Low inflation rates can cause serious economic problems due to the entry of new money and credit into the economy, which is controlled by specific individuals or businesses, leading to price level adjustments and circulation.
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Here is an outline of the major beneficiaries and losers of inflation.
Who Benefits From Inflation
According to Wayne B. Gray, an economics professor at Clark University, suggests that increased prices can be detrimental to buyers but beneficial for sellers. He also explains that the impact of monthly price fluctuations depends on the type of goods and services being purchased and sold.
Here are inflation’s biggest winners and losers.
Inflation Winners:
#1. The Energy Sector:
If you regularly fill your car’s tank, you are likely familiar with this fact. Despite high inflation and rising energy costs, energy demand rarely decreases as consumers and producers continue to use gas for transportation and power operations. Energy companies raise prices to maintain or increase profits, passing on increased costs to consumers and benefiting investors.
Energy prices have surged due to a perfect storm of factors, according to Eric Diton, president and managing director of The Wealth Alliance, an investment advisory firm in Melville, New York.
Diton identifies climate change, global response, supply chain issues, labor shortages, the Ukraine war, and COVID-19 as key factors contributing to rising energy prices, according to him, oil and gas producers are experiencing record profits, and their stocks have become market leaders.
#2. The Food and Agriculture Industry:
Inflation has generally benefited the food industry, although some restaurant owners have been hit hard by the pandemic and inflation. On the other other hand, food manufacturers, like poultry processors are doing well.
High consumer prices can lead to individuals opting out of expensive food options, benefiting food manufacturers and the agricultural supply chain. Consumer staples like food are highly resistant to inflation due to their constant demand.
Agricultural companies benefit from inflation-driven higher prices, allowing agricultural stock investors to capitalize on rising prices and higher profit margins, as higher production costs are passed on to consumers.
According to Diton, “Food prices have risen over 10% in the past year due to factors like Russia and Ukraine’s war, affecting 30% of global wheat production and benefiting many food producers.”
#3. Banks and Mortgage Companies:
During high inflation, the Fed raises interest rates, impacting credit card debt and variable-rate loans, allowing lenders to increase interest collection. Rising consumer prices lead to increased spending on credit, resulting in higher credit card balances, personal loan applications, and increased demand for home equity lines of credit.
Borrowers may take longer to repay debt due to increased spending on necessities, reducing savings and repayment options. This results in lenders receiving more interest.
#4. Landowners and Real Estate Investors:
High inflation can rapidly devalue savings and other liquid assets. During volatile times, physical assets like land hold value exceptionally well, and high inflation can increase demand for real estate, thereby driving up land prices.
Landlords often increase rents during inflationary periods, and having fixed mortgages on their rental properties can increase their real income even further.
#5. Borrowers with Existing Fixed-Rate Loans:
Ahmed Rahman, an economics professor at Lehigh University, suggests that while many current and future borrowers won’t benefit from inflation, those who have already borrowed and paid back low-interest loans have some relief.
In addition to this, Rahman said that those with fixed-rate mortgages or student loans may not be celebrating inflation, but they are somewhat shielded from its more harmful effects.
The Federal Reserve’s hawkish monetary policy involves raising interest rates to discourage borrowing when inflation increases. The situation could negatively impact future borrowers, but those with fixed, low-interest loans or fixed-rate mortgages will not be affected.
Also, during inflationary periods, currency loses value, leading to lower real interest rates for borrowers on fixed-rate loans.
#6. Commodities Investors:
Commodity prices closely monitor inflation rates and are often considered indicators of inflation as they influence future prices of processed goods. Higher inflation rates can lead to increased commodity prices, allowing commodity investors to profit from selling their stocks.
#7. Collectors:
Inflationary periods can benefit collectibles like fine art, wine, and baseball cards, as investors turn to hard assets that retain value through market volatility. Collectibles, as they are not directly linked to traditional markets, maybe more secure from significant value fluctuations.
Top collectors often have a significant advantage in purchasing collectibles, as they can afford advisors, invest time in their collection, and build a comprehensive and diverse collection.
Now, let’s look at who’s adversely affected by inflation.
Inflation Losers:
#1. Renters:
During high inflation, homeowners typically maintain consistent monthly mortgage payments, unless property taxes rise or they have an adjustable-rate mortgage (ARM). However, renters face less luck as landlords can raise rent with minimal limits once leases end, depending on local laws.
High-cost cities like New York City and San Francisco are experiencing worse rent increases, with Manhattan’s average monthly rent surpassing $5,000 in July 2022, marking a 29% annual increase.
Inflation and rent increase monthly payments, leading to extra landlord revenue. As other expenses increase, people consider moving in with their parents or getting roommates, causing more expenses.
#2. Retirees:
High inflation rates may lead to wage increases, but retirees’ fixed-income retirement pots may not benefit due to increased exposure to cash or fixed-income investments. Higher inflation accelerates faster than interest rates, reducing the buying power of existing savings and those relying on interest or investment income, including retirees.
#3. First-Time Homebuyers:
During a high inflationary period, it may be necessary to delay purchasing your first home. First-time homebuyers face significant disadvantages due to rising home prices, higher mortgage rates, and currency depreciation, making it nearly impossible to buy real estate.
#4. Credit Card Borrowers
Credit cards often have variable interest rates linked to major indexes like prime rates, causing cardholders to experience rapid rate increases and higher payments.
#5. Investors in longer-term bonds:
Thoma warns that high inflation environments can lead to significant difficulties on the bond side, particularly for those living off coupon bond payments. Inflation leads to decreased bond payments and a decline in bond prices as interest rates increase, causing harm to bondholders in both ways.
McBride suggests that bond investors can mitigate inflation by utilizing shorter-term and inflation-indexed bonds, with Series I bonds being a suitable option for individual savers.
#6. General Economic Confidence:
Inflation has caused volatility in markets, with consumers concerned about higher rates, recession, and bill payments, as seen in recent social media and news sources. High inflation leads to increased uncertainty for consumers, banks, and companies, causing reluctance to invest, lower economic growth, and longer food bank lines, escalating inflation expectations.
The lack of confidence in the future of the economy can lead to significant impacts and potentially create a self-fulfilling prophecy.
How Does Inflation Work?
Inflation caused by increased prices of goods and services can be categorized into demand-pull and cost-push inflation, affecting purchasing power over time.
Who does inflation hurt the most?
Inflation significantly impacts low-income households due to their high spending on necessities like food, gas, and rent, leaving them with limited options to reduce their spending.
What are the worst investments during inflation?
BlackRock’s data indicates that the energy sector is the most profitable during high inflation, followed by healthcare and telecoms, while retail, technology, and durable goods are the worst sectors.
Is inflation good for homeowners?
Fixed-rate mortgages maintain fixed principal and interest payments despite property value increases, reducing monthly payments as the real value of each dollar shrinks.
Is inflation good for the poor people?
High inflation worsens inequality or poverty by disproportionately impacting income and savings for poorer or middle-income households compared to wealthy households.
Where can I put money with high inflation?
Top 6 inflation investments for the future include equities, real estate, commodities, Treasury Inflation-Protected Securities (TIPS), savings bonds, and gold.
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