Investment Opportunities Under Inflation: A Complete Guide from Rate Hike Policies to Asset Allocation

Why Do We Need to Understand Inflation?

In the past two years, rising prices have become a global economic theme. Taiwan’s central bank has raised interest rates five times, the Federal Reserve has increased rates seven times within a year, and governments worldwide are fighting inflation. But few truly understand: What is inflation? Why does it happen? And how can one profit from it?

Rather than passively accepting the decline in purchasing power caused by inflation, it’s better to actively understand its mechanisms and find ways to respond. This article will help you clarify the essence of inflation, the central bank’s response measures, and most importantly—how to build a resilient investment portfolio during inflationary times.

The Nature of Inflation: Imbalance Between Money and Goods

Inflation, simply put, is a phenomenon where prices continuously rise over a period, leading to a decrease in the purchasing power of money. In other words, the money in your pocket becomes less valuable over time.

Economists measure inflation using the CPI (Consumer Price Index). When CPI continues to rise, it indicates that you need to spend more to buy the same items.

How Does Inflation Occur? Four Main Drivers

First: Demand-Pull Inflation

When demand for goods suddenly increases, businesses raise prices, which drives prices upward. Increased demand → higher production → business profits → further investment → further demand stimulation. This creates a positive feedback loop. Interestingly, demand-pull inflation, while pushing prices up, also promotes GDP growth, which is why governments try to stimulate demand.

Second: Cost-Push Inflation

Rising raw material prices directly increase production costs. A typical example is during the 2022 Russia-Ukraine conflict, when Europe couldn’t import Russian oil and natural gas, energy prices soared tenfold, causing the Eurozone CPI to exceed 10% annually—hitting record highs. Cost-push inflation is the most concerning because it can lead to decreased social output and GDP contraction.

Third: Excessive Money Supply

Governments print money without restraint, leading to an oversupply of liquidity. In Taiwan during the 1950s, to cope with post-war deficits, large amounts of currency were issued, eventually making 8 million dollars worth only 1 US dollar. All hyperinflations in history are backed by reckless central bank money printing.

Fourth: Inflation Expectations

When the public expects future prices to rise continuously, they preemptively spend and demand higher wages, prompting businesses to raise prices. Once these expectations form, they are hard to break. Therefore, central banks worldwide actively manage inflation expectations and express firm resolve to suppress inflation.

Why Can Raising Interest Rates Suppress Inflation? What Are the Costs?

When central banks raise interest rates, borrowing becomes expensive. Suppose rates go from 1% to 5%; borrowing 1 million dollars now costs 50,000 dollars annually in interest instead of 10,000—this discourages most borrowers. People prefer saving in banks rather than risking investments or consumption.

Market liquidity decreases → demand for goods drops → businesses are forced to lower prices to stimulate sales → price levels fall. That’s the power of rate hikes.

But the costs are significant: When demand weakens, companies lay off workers to cope with declining sales, unemployment rises, economic growth slows, and recession may ensue. The 2022 US stock market is a stark example—The Fed raised rates by 425 basis points to curb CPI, leading to a 19% drop in the S&P 500 and a 33% plunge in the Nasdaq.

Low Inflation Is Good; High Inflation Is a Disaster

Here’s a counterintuitive truth: Moderate inflation is actually healthy for the economy.

When people expect future goods to become more expensive, they are motivated to spend, increasing demand. Demand-driven investment boosts production, GDP grows. China in the early 2000s is an example—CPI rose from 0 to 5%, while GDP growth jumped from 8% to over 10%.

Conversely, when inflation rates fall into negative territory (deflation), disaster strikes. People hesitate to spend, preferring to save, causing GDP to shrink. Japan in the 1990s fell into deflation, leading to an economic bubble burst and entering the “Lost Decade” of stagnation.

Therefore, the consensus among global central banks is to keep inflation in a moderate range—around 2%-3% (US, Europe, UK, Japan, Canada, Australia) or 2%-5% for most countries.

Who Benefits from Inflation? Those with Debt

On the surface, inflation erodes the value of cash holdings. But from another perspective: If you have debt, inflation can actually be advantageous.

For example: If you borrowed 1 million dollars to buy a house 20 years ago, with a 3% inflation rate, after 20 years, that 1 million is only worth about 550,000 in real terms—you only need to repay roughly half the original debt. That’s why experienced investors leverage assets during high inflation periods.

These assets include real estate, stocks, gold, cryptocurrencies, etc. Borrow to acquire assets, enjoy appreciation, and repay debt with devalued currency—this is a classic inflation hedge.

The Dual Impact of Inflation on the Stock Market

In summary: Low inflation benefits stocks; high inflation harms stocks.

In low inflation environments, hot money flows into equities, pushing stock prices higher. But when inflation surges to dangerous levels, central banks are forced to take strong measures, often causing stock markets to decline—this was evident in 2022.

However, high inflation periods also present investment opportunities. Energy stocks performed remarkably well. In 2022, the US energy sector returned over 60%, with Occidental Petroleum up 111% and ExxonMobil up 74%. The logic is simple—rising energy prices directly boost energy companies’ profits.

How to Build a Defensive Investment Portfolio During Inflation?

The key is diversified asset allocation. Spread your funds across different asset classes to enjoy growth while hedging risks.

Quality assets during inflation:

Practical allocation suggestion: Divide your capital into three equal parts—33% each in stocks, gold, and USD. This mix allows you to benefit from stock growth while using gold and USD to hedge against inflation.

But the challenge is: to hold these assets, you need accounts with brokers, futures firms, and forex brokers—complex procedures. Is there a one-stop solution?

Yes, there is: Contracts for Difference (CFD). CFD trading offers a wide range of assets (stocks, gold, forex, digital currencies), with leverage up to 200x, enabling you to control larger positions with less capital. For example, with 100x leverage, investing in gold requires only about $19.

Summary: The Mindset for Investors in an Inflationary Era

Inflation is a normal part of the economy, not a disaster. Low inflation promotes GDP growth; high inflation warrants caution. Rate hikes can suppress prices but also slow down the economy.

The smartest approach is: Understand inflation mechanisms, then build a diversified asset portfolio, balancing stocks, gold, and USD. Use moderate leverage tools (like CFDs) to amplify gains and diversify to reduce risks.

In this way, you are not a passive victim of inflation but an active investor seizing opportunities.