There is a big wave of inflation all over the world. Nor has it spared the European Union, where every month of this year has come with a new inflation record. However, there are large differences in the magnitude of the inflation wave across countries. In April, annual inflation or an increase in consumer prices in Latvia was 13%, which was the fourth highest indicator in the European Union. Only the other Baltic countries and the Czech Republic grew even faster. At the same time, in April, annual inflation in the Scandinavian countries was only around 6% to 7%. Why is it?
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One of the reasons is that the income level of the population in Latvia is significantly lower than in northern Europe, so most of the spending is on basic needs such as food, the cost of housing-related services and, especially in the regions, fuel, goods and services. In Latvia, about 40% of the population’s wallet is allocated for these needs, but in the Scandinavian countries it is almost halved. Latvians are rightly worried that high inflation will eat up this year. However, the situation is likely to improve in the coming years.
The ability to buy money melts like Olaf in the animated film “Ice Heart”
Last year, the average salary in Latvia grew by less than 12%, and the old-age pension by less than 7%. It was significantly faster than 3.3% inflation. Last year was the 11th year in a row when the purchasing power of the Latvian population increased. However, this year will be different. The rise in income will not be accompanied by a huge jump in prices. Real wages, an indicator that takes into account inflation, fell by almost 3% in the first quarter of this year. The value of money held in bank accounts and under the pillow has also begun to melt rapidly. If you forgot eight ten euro banknotes in the drawer last year, now one of them is relatively melted. At today’s prices with 80 euros we can buy as much as a year ago with 70 euros. Entrepreneurs are also facing difficulties. Raising wages at a rate comparable to inflation in many cases means losses for the company. The alternative is to pass on costs to the buyer, ie to raise the selling price of your product or service and risk a drop in domestic sales or a loss of competitive advantage in export markets. On the other hand, without raising wages enough, we can once again experience people going to work in richer European countries, thus putting even more pressure on the already tight labor market.
High inflation can be explained both by the tensions caused by the pandemic in global supply chains and high demand, and by the not-so-generous crop yields in the world last year, but the recent rise in prices is driven by the war in Ukraine, including sanctions against Russia. In addition, the highest point of inflation is still ahead in many places, including Latvia. Not only the public is concerned about high inflation, but also the central banks of many countries, whose job it is to ensure price stability. To achieve this, central banks pursue monetary policy by influencing interest rates and the money supply in the economy through a variety of instruments, which in turn help drive aggregate demand and, at least, demand-side inflation. In order not to add oil to the fire of inflation, European Central Bank (ECB) has begun to limit its support for the economy. It is gradually reducing the pace of “money printing” by narrowing its asset purchase programs and plans to start raising interest rates under its control. Such decisions along the chain are increasingly affecting and will also affect the borrowing costs of individuals, businesses and governments and, consequently, the appetite of financial markets. Interest rates have been at historically low levels for several years, and it is clear that the period of extremely low interest rates once had to end. At the same time, high uncertainty and news of an economic slowdown will encourage the ECB to remain cautious. Although interest rates will rise, they are unlikely to rise sharply and long. What can people do to not lose the value of existing savings in such circumstances.
There is still room to outpace inflation when investing in financial markets
In the conditions of such high inflation, of course, those who started investing their free money 5 or even 10 years ago are in a better situation. For example, the return of an investment fund or exchange traded fund (ETF) that passively follows the MSCI World Index has risen to 38% in the last 5 years and even 112% in 10 years. This shows that long-term investment can outpace inflation. A less positive picture could be for those who started investing relatively recently, for example, 1 year ago, because due to the geopolitical situation and inflationary measures of central banks and other events, the value of their investors’ investments has decreased by about 9%. However, it should be noted that there is nothing new in the crisis and adjustment markets, as financial markets have experienced various turbulences over the last 20 years, such as the 2008 financial crisis and the recent Covid-19 crisis, but in the long run they have recovered .
As a result, experienced investors are less worried about the current downturn in financial markets and high inflation than less experienced investors who are worried about continuing to invest or sell their shares. Others have a question – is this a good time to start investing? There is no single right answer, as the big stock market records seem to be coming to an end in times of both market downturns and ups and downs, and there is a worry at the bottom of the market that we may have to wait, as the market may still fall. Even now, looking at the so-called Fear and Greed Index, which reflects investor sentiment, we can see that it is at its lowest point since March 2009, which was basically the end of the Great Depression before the markets started to rise again.
Naturally, rising inflation, war, supply chain problems, a potential energy crisis and a reduction in central bank monetary policy support are a source of fear for investors and are having an impact on financial markets. In principle, there are currently few safe places to take refuge to protect your money from market downturns and inflation, as most stocks are experiencing a decline in bonds, gold and speculative investment solutions such as cryptocurrencies. Peer-to-peer investment could also expect more difficult times in the future if the scenario of rising unemployment or uncontrolled consumer prices continues to materialize. In such a scenario, the result may be that borrowers may not be able to cover part or all of their liabilities to the creditor. This trend is particularly pronounced for loans to developing countries.
Oil and energy companies and producers of various raw materials are currently showing good results, but it should be noted that in the long run, investors’ money is still flowing out of fossil and renewable energy sources. But is it wise to jump on an already running train and rush into investing in industries that are showing profits right now? Rather no! Because we have already seen a similar trend in the 1970s, when we experienced so-called stagflation, which is a combination of high inflation, extremely low economic growth and high unemployment. Although we cannot yet say that we are in stagflation, as Europe and the United States are still experiencing positive labor market developments, a few regularities have since been highlighted today. Shares of oil and energy companies and commodity prices are showing phenomenal results, but looking back to the 1970s, their performance was not long-lasting, as their economies returned to normal as their economies returned to normal. That is why investors today need to be careful not to lose more capital in addition to inflation by making cautious investments.
In general, with the current high cost of living, it is becoming increasingly difficult for middle-income families to find money to invest in, and choices have to be made. The wise choice is to get rid of any high-interest loans as quickly as possible, most often short-term or so-called quick loans. You can then consider investment opportunities that, in the long run, by investing regularly and with patience, can build your wealth as well as cover today’s and tomorrow’s inflation.
As Nathan Meijer Rothschild, a 19th-century banker, put it, “It’s time to buy when there’s blood on the streets.” This quote reveals an important truth about market psychology. When prices fall and markets shake, the brave can make a big profit. As markets fall, it is possible to buy more shares for a certain amount. In other words, it’s like shopping during the summer sale. Not in vain Warens Buffets just bought billions of dollars worth of shares.
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