Bank runs, buying gold, 17% interest rates, rising prices… the days of high inflation seem to be long gone in these economic times. Once viewed as a normal economic circumstance requiring constant vigilance, Australia hasn't even come close to being threatened by high inflation in over a decade.
Not since Wayne Swan declared the 'inflation genie was out of the bottle' back in 2007 anyway (the genie was put back in the bottle by the GFC soon after, if you were wondering).
But could we be forgetting about one of the most dangerous forces in the economy? A force that has the potential to destroy investing returns? After all, the inflation 'genie' hasn't gone away, it never will. And even though we haven't seen its face for over a decade, forgetting its presence could be a grave mistake.
What causes inflation?
There are two types of inflation that our economy has experienced over the last 50 years. The first is 'traditional inflation', caused by an overheating economy. This is when the resources of an economy can't keep up with economic growth. We saw this in the late 1980s as well as just before the GFC.
The second is 'stagflation', which is rare in these times, but was last seen during the oil shocks of the 1970s. Stagflation involves high inflation with zero or negative economic growth and was caused by the economic rigidity that our economy had before our exchange rate was floated and other modern reforms were implemented.
Could we see inflation again soon?
It's impossible to say. It looks as though the traditional causes of inflation are not present in our economy today. But the effects of the unprecedented, decade-long money-printing stimulus program that the US government has undertaken, known as QE (or Quantitative Easing), are still unknown. Our own Reserve Bank of Australia has stated that they are prepared to go down this road if they have to. And no one knows where that road ends.
What does inflation mean for investing?
Inflation makes investing that much harder. Ever rising prices puts enormous pressure on companies because they have to keep up by charging more for the products they sell, just to keep even. Warren Buffett has said in the past that high quality stocks like the Coca-Cola Co (NYSE: KO) are the best protection against inflation because they can easily pass on costs to their loyal consumers.
Foolish Takeaway
Although I don't think we will see high inflation soon, it's something that we should not treat with apathy. If inflation does come back, it will help to separate the wheat from the chaff, as they say. You just want to be holding 'wheat' stocks like Buffett's Coca-Cola when that happens.
