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What lies ahead… inflation or deflation?

Europe, Japan and the US are mired in debt and adding more each day. They have little choice unless they face up to major austerity adjustment and all the unpalatable social upheaval that would bring. So, they opt for the muddle through scenario to stir their economies back into life and global interest rates have not been so low for over 60 years.

Many investors fled to cash and deposits after the GFC to protect their capital amid all the uncertainty. More confident investors kept a diversified portfolio, though more conservative than previously. In Australia we’ve been fortunate that cash and deposits produced a reasonable income for retirees but this is slowly changing with lower interest rates caused by slower mining and the desire for a lower A$.

So, what lies ahead? Will we have deflation like Japan has endured since 1989? If so, then secure investments like cash and deposits will be attractive, though their income may be underwhelming. Perhaps instead we’ll eventually have higher inflation arising from the prolonged period of extraordinarily low interest rates? If high inflation does occur, then ‘growth’ assets like shares, property and even gold should fare best. A diversified portfolio of income and growth assets allows you to ‘sit on the fence’ until the outcome becomes clearer.

But let’s ponder the motives that face the world’s decision makers. Most are relatively rich as well as powerful. As individuals, inflation is a more palatable option because the long term, growth assets they typically own (properties, business) tend to prosper with inflation. In such periods you can make money if you have money and thus the capacity to readily borrow more – remember the 70s and 80s?

Inflation also has the effect of bringing your debt problems down to size. This also makes it the preferred choice for most nations too – an attractive solution for western leaders now bogged in debt (US, UK, Europe and Japan). Though Australia doesn’t have much government debt, our citizens do. But this inflationary motive may not be so attractive to China, which has huge foreign reserves, having loaned their savings to the US and others. So, the geo-political outlook may prove interesting.

Regardless, it seems plausible that inflation would be the favoured course for global decision makers – even though it may take a while to come about. If so, it seems prudent to have a diverse portfolio that includes some growth assets (shares and property). An inflationary environment is ruinous for savings held in cash, deposits and bonds unless they’re inflation-linked. In Australia as interest rates come down, the pressure to re-think shares and property post GFC is growing. What is the balance point for you?

Disclaimer: All information in this article is intended to be general in nature for discussion purposes only. So you should not rely on it and seek personalised professional advice before making any decision.