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The Silent Thief: How to Protect Savings from Inflation

Kieran Smith
April 23, 2020

How can you protect your savings from inflation?

Horror stories of the prices of bread and milk spinning out of control have fixed the concept of inflation firmly in the public imagination. These hark back to the worst cases, like in the Weimar Republic where shoppers were forced to buy loaves of bread with wheelbarrows full of bills, and diners would pay for meals in advance because prices would have risen by the time they finished eating. Monthly inflation reached almost 29,500% at the peak of the Weimar Republic crisis in 1923, with prices doubling every 3.7 days. But even the 2% inflation rates of the modern day will destroy the buying power of your bank balance faster than you might think…

In 1913, USD $500 could buy you a state-of-the-art Ford Model T Runabout. Since then, that same $500 has lost 96% of its purchasing power through inflation, leaving you with enough value to scrape the rent in a small city — never mind buying a brand new car!

Few people live long enough to see such a decline in purchasing power, but even over the last 20 years the effect of inflation is still very noticeable.

During the last two decades, the U.S. dollar has experienced an average inflation rate of 2.04% per year. This might sound small, but it compounds to a staggering 50%. So to get what would have been $100 worth of groceries in the year 2000, you will need to pay $150 in 2020.

In many European countries inflation has been even more extreme, with UK inflation averaging 2.8% between 2000 and 2020 — a rate that compounds to 70% over two decades.

So how can you protect your funds against this silent thief?

Protecting savings from inflation with gold

In the classic example of the Weimar Republic, the devaluation of the currency left citizens sweeping worthless bank notes into sewers and returning to a barter economy where goods and services were swapped directly. Eventually, the government restored the gold standard and the economy stabilized, but the scars that were left eventually led to the rise of the third reich.

If you had held gold instead of cash during the turmoil, you would not only have survived, but suddenly become extremely wealthy compared to your cash-holding neighbours.

But while gold would have protected you against hyper-inflation, would it still guard against the “silent thief” of the lower inflation rates that we see in more modern times?

Let’s take a trip back through the last fifty years to see how gold held up against inflation in the final decades of the twentieth century…

“The Great Inflation” of the ’70s

As the swingin’ sixties drew to a close and President Nixon dropped the gold standard, the West entered a period of sustained currency devaluation.

Inflation ratcheted up through the 1970s and hit a massive 14% in 1980. Most economists attribute this to loose monetary policy, which Wharton professor Jeremy Siegel famously called “the greatest failure of American macroeconomic policy in the postwar period.”

Meanwhile, gold took centre stage, delivering more than 1700% returns over the decade, and peaking at $850 in January 1980. This surge outpaced inflation and made gold the star of the seventies.

But some of the stellar performance can be put down to the artificially low starting price of $35 — as set by the United States Treasury from 1934. And although gold acted effectively as a hedge against inflation, the sudden spike in 1979 and 1980 is more commonly attributed to uncertainty over the Russian invasion of Afghanistan, and unconventional policy actions from the Fed, rather than inflation. 

The price of gold (nominal) plotted against the Consumer Price Index from 1970 – 1980 (First gold futures shown which started trading only in the mid-seventies).

The ’80s

By the early ’80s, inflation had persisted at 3% or more for 15 years, with prices more than doubling in ten years.

But after sitting above $700 for a couple of weeks in 1980, gold returned to trade between $300 and $500. Then as the new decade got under way the demand for gold dropped, and even though inflation continued to ramp up, the price of gold didn’t follow.

If you had chosen to hold gold as a hedge against inflation in the 1980s, you would have lost money to inflation, and watched as the stock market ripped higher.

Gold (nominal) plotted against the Consumer Price Index from 1980 – 1990

The ’90s

As the cold war thawed and Kurt Cobain played on MTV, the world witnessed a period of strong economic growth, low inflation, and relative stability.

Gold’s performance during this period was lackluster, to say the least. The metal ranged for the early part of the decade, before dropping in 1997 and not stopping until 1999. Gold only found a footing in the new millennium, and eventually surged skywards on the recession of 2000 and 2001. 

Gold (nominal) plotted against the Consumer Price Index from 1990 – 2000

Gold: A hedge against inflation the fear of inflation

As shown by gold’s performance during these three decades, the metal’s inverse correlation with inflation is far from perfect.

Gold is not bound to keep up with inflation, and it often doesn’t — like in the 1980s when inflation surged and gold dropped, and the 1990s when gold fell amid steady inflation.

Against slow and steady inflation, gold doesn’t seem to offer any protection. But, the fear associated with high levels of inflation does push up the price of gold.

This was seen in the 1970s when experimentation with monetary policy — along with oil shocks, war, and economic troubles — led to lots of uncertainty and doubt: The perfect recipe for making gold rise.

So although gold doesn’t act as a direct hedge against inflation, it does act as a hedge against the fear and uncertainty associated with it.

As most investors suggest, a well-diversified portfolio, including gold alongside other assets like stocks and bonds, is the best way to protect your savings from inflation in both the short-term and the long-term.

Disclaimer: This content is for informational purposes only and should not be construed as investment or financial advice.

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