What does inflation mean? The investment defense battle in an era of rising prices

In the past two years, prices have risen sharply, prompting the central bank to raise interest rates five times. Some ask, what exactly does inflation mean? How does raising interest rates relate to inflation? How can we find opportunities in this market cycle? Today, I will explain it all clearly.

What is inflation: Money devalues, prices soar

Inflation, simply put, is a period during which prices continuously increase. Conversely, it means your money becomes less valuable — the same 100 dollars used to buy 5 jin of rice, now only buys 3 jin.

The most direct indicator of inflation is the Consumer Price Index (CPI). The CPI increase reflects how much your purchasing power has diminished.

How does inflation happen? Three main drivers

Demand-driven: When everyone wants to buy things and supply can’t keep up, prices rise. Companies earn profits and spend more, further increasing demand, creating a spiral. This type of inflation boosts GDP growth, which many countries favor.

Cost-push: Rising raw material costs directly push up product prices. During the Russia-Ukraine conflict in 2022, Europe’s oil and gas imports were disrupted, energy prices increased tenfold, and the Eurozone’s CPI annual rate exceeded 10%, a historic high. This kind of inflation hampers economic growth and gives countries headaches.

Money supply expansion: When governments print too much money, too many currencies chase too few goods. Taiwan experienced this in the 1950s, when to cover deficits, they printed money wildly, and 8 million francs were only worth 1 US dollar.

Expectations rising: When people believe prices will keep rising, they rush to buy and demand higher wages, prompting businesses to raise prices, creating a vicious cycle. This is what central banks fear most because once inflation expectations rise, it’s hard to bring them down.

How does raising interest rates curb inflation?

When inflation spirals out of control, central banks raise interest rates. The principle is simple: Higher interest rates mean higher borrowing costs.

Previously, a loan at 1% interest on 1 million dollars would cost only 10,000 per year. When rates rise to 5%, borrowing the same 1 million costs 50,000. Who still wants to borrow then? Most prefer to deposit their money in banks.

Market liquidity decreases, demand for goods drops, and businesses are forced to lower prices to attract buyers, causing inflation to naturally subside.

But what’s the cost? Companies stop hiring or lay off workers, unemployment rises, economic growth slows, and a recession may occur. That’s why raising interest rates is a double-edged sword.

Moderate inflation can actually be beneficial

Many people fear inflation, but moderate inflation is actually good for the economy.

When people expect prices to rise, their consumption appetite increases. Strong demand encourages businesses to invest more, production rises, and GDP grows. For example, in early 2000, China’s CPI rose from 0 to 5%, and GDP growth accelerated from 8% to over 10%.

The opposite example is Japan. After the economic bubble burst in the 1990s, Japan fell into deflation (prices not only stopped rising but declined). Since prices were falling, people preferred to save money rather than spend. Eventually, GDP contracted negative growth, and Japan entered the “Lost Thirty Years.”

Therefore, most central banks aim to keep inflation between 2% and 5%, avoiding deflation on the low end and excessive harm on the high end.

Who benefits from inflation?

High-debt individuals. Inflation devalues cash, but the debts owed also shrink in real terms.

For example, borrowing 1 million dollars at 3% inflation 20 years ago to buy a house means that after 20 years, that 1 million is only worth about 550,000 in real terms, greatly reducing repayment pressure. During high inflation periods, those who buy assets (real estate, stocks, gold) with debt benefit the most.

How to invest during high inflation?

Low inflation benefits stocks, high inflation hurts stocks.

The reason: High inflation → central bank raises interest rates → corporate financing becomes difficult → stock prices fall. The US in 2022 is a typical example. CPI hit 9.1% (a 40-year high), the Fed raised rates 7 times, from 0.25% to 4.5%. As a result, the S&P 500 fell 19%, and the Nasdaq plunged 33%.

But there are opportunities. Energy stocks often perform well during high inflation. In 2022, the US energy sector returned over 60%, with Western Petroleum up 111% and ExxonMobil up 74%.

( Asset allocation during inflation

) Practical tips: Diversify your portfolio

If you have 100,000 in capital, you might allocate as follows:

• 30% in stocks (preferably energy-related)
• 30% in gold or precious metals
• 30% in USD or US bonds
• 10% in cash for emergencies

This way, you can enjoy stock growth potential while protecting value with gold and hedging inflation with USD.

Why act during inflation?

If you do nothing, cash in the bank erodes 3%-5% annually due to inflation. Leaving it there is equivalent to losing money.

By properly allocating assets—investing in stocks, gold, forex, or other inflation-resistant assets—your wealth can be preserved and even outpace inflation.

Summary

Inflation means rising prices and devalued money. Low inflation promotes growth, while high inflation requires central banks to raise interest rates. Although rate hikes can curb inflation, they also harm the economy.

Investors should avoid passively holding cash. Properly diversify into stocks, gold, forex, and other assets to protect wealth and seek opportunities during inflation. Especially in high inflation periods, assets like energy stocks, gold, and the US dollar tend to perform strongly and are worth close attention.