This summer Americans drove less than the summer of 2020 when many office goers were working from home and the economy was partially shut down. The situation is no better in Europe. Higher fuel and food cost is driving the cost of living higher in most of the world, significantly disturbing the household budgets.
Many emerging and underdeveloped markets were struggling with higher inflation even before the pandemic. But pandemic and adverse weather conditions in the past two and half years have made the situation worse.
Whereas many emerging markets, especially in Africa and Latin America, have been struggling with higher inflation and rise in the cost of living for a couple of decades, it is a relatively new phenomenon for the post 1980s developed western economies. The present generation in these economies had gotten used to cheap and easily available money and marginal food and fuel inflation in the past two decades. For them this sudden and sharp rise in basic cost of living is nothing less than a major shock. Most of them may not be financially sufficient, economically trained, socially skilled and/or mentally prepared to deal with this problem.
On the other hand, the modern asset pricing models may also not be suitable to the situation where interest rates are rising at record pace. Many valuation models used for making investments in "startups" - having very long payback period in terms of conventional asset pricing techniques; not differentiating between revenue and capital cashflows for operating purposes; usually funded by professional private equity investors with little own skin in the game; and having high leverage debt as the ultimate source of funding – may not work at all in a scenario where USD is depreciating and cost of USD borrowing is running in excess of 6%.
The current spike and persistence of inflation has been
attributed to the logistic constraints due to the pandemic; adverse weather
conditions; Russia-Ukraine war and fiscal support extended by various
governments to mitigate the hardships faced by the citizens. Initially most
central bankers believed that the inflation is transitory and will wane as
these conditions change. However, in the past six months a realization seems to
be dawning upon them that the trillions of dollars in new money, printed over
the course of the past 2yrs, may also have a key role to play in this episode of
high inflation. Apparently, it took 215yrs for the US government debt to reach
US$7trn. It has added the same amount in just the past 27months.
Inarguably, the problem of inflation has many more dimensions. Hiking rates and withdrawing quantitative tightening will take more than 25yrs to reach a sustainable level of debt. Manufacturing a recession by sharp hikes will only destroy demand for various commodities and weaken the inflation. However, the inflationary forces will keep coming back, much stronger than now, as and when the growth begins to revive.
A sharp USD and EUR devaluation could perhaps be one of the more viable solutions left to (i) reduce the public debt materially in a short period of time; (ii) complete restructuring of the global terms of trade; (iii) rationalization of the global commodity prices especially energy; (iv) catalyze a new investment cycle led by US and European exports.
The investors in USD denominated assets would obviously suffer tremendous losses. No wonder large investors like the Chinese government have materially reduced their holdings of US treasury and USD. India is also trying hard to diversify its trade to include other currencies like Ruble, Riyal and Yuan, to contain its exposure to USD.
The questions that beg answer are:
(a) What shall be the safe haven in case of a sudden USD decline. Whether it would be the traditional asset like Gold; a new age asset like digital currencies or traditional safe havens like CHF, CNY, SGD etc.?
(b) Is there any actionable for a small investor, if this speculation does come true?
