The world has been at a party since the credit crises. Bottomless booze, fanciful foods and blaring music have fuelled the exuberance. It has kept us going, kept spirits up and turned our stories into fantastical tales. But now the food, dancing and booze has run out, bright lights have been switched on and we face the morning tired and hungover. The party is over.
We’ve been partying on easy money as authorities have been fuelling economies with low interest rates and cash. They have been acting like indulgent parents helping their children out of financial difficulties. Even when the pandemic struck, they doubled down to get us out of the economic doldrums caused by a global lockdown.
So why are we now facing inflation? Why are the prices of input costs and essentials rising, with nearly everything becoming more expensive?
When the money is easy, spending is easy. In this instance, the excess, the easy money, eventually found its way to property and share prices, and new asset classes like cryptocurrencies. And while investment is good, this excess cash pushed up asset prices beyond reasonable expectations.
At the same time, successive shocks in the pandemic and the war in Ukraine constrained the supply of raw materials like oil and gas and other inputs like agricultural materials and microchips. And in the USA, the world’s largest economy, a shortage of skilled labour (at a time when people are rethinking their priorities) is pushing up wages. For the first time in a long time, the American people have the power of corporates – they are the price-makers for wages, and they are demanding more to work.
The result is rampant inflation.
Monetary authorities are now forced to end the easy money party by raising interest rates fast to choke demand. If they don’t, the expectations of higher prices and higher wages will become entrenched. It will lead to an economic slowdown, possibly even a contraction.
What does this mean for our own money? Only a foolishly brave person predicts the outcome of interwoven shocks to a system. Although we may be right in predicting what is likely to happen, how it will impact financial markets is not a direct outcome. It has rarely been wise to change a long-term investment strategy in anticipation of a recession. If any changes must happen, they are best made by those who are constructing portfolios rather than the end investor.
While we should not tamper with our investment strategies, we should however consider the other elements of our financial plans. I suggest three steps: take control of your cash flow, ensure you have cash available and rein in your credit appetite.
Start with improving control of household spending. At a time of rampant inflation, spending can easily escalate, as you may have already noticed. Know your budget and where you can cut.
If you have liquidity or cash available to tie you over - should the economic slump affect your business or earnings - you will be able to sleep easier. Plan to build up cash for emergencies if you do not have a cash pool already. Bear in mind that it may be difficult or detrimental to cash in investments so don’t bank on that for quick access to cash.
With interest rates on the rise, you do not want to be trapped with unaffordable, escalating interest payments on credit. There is a strong possibility that interest rates may have to rise fast and long to curb inflation. Review whether your finances can withstand such an interest rate rise. Limit your credit appetite.
In short, keep your long-term investment focus but review your personal financial behaviour. While the money party may be over, life can still be good. The best things are free!
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