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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Real Asset Investments as a Hedge Against Inflationary QE

Stock-Markets / Inflation Apr 20, 2012 - 06:46 AM GMT

By: Submissions

Stock-Markets

Best Financial Markets Analysis ArticleAdam Waldman writes: Since the financial crisis and the “Great Recession” began in 2008, western  central banks have responded in a number of different ways.  The one method linking all of these central banks activities together has been the use of Quantitative Easing, or QE as it is more commonly called.


The aim of QE is to stimulate the real economy, and it is considered so-called “Unconventional “
Monetary Policy.  Generally speaking, a central bank will try to boost economic growth by cutting interest.   In theory, lower interest rates will encourage businesses and consumers to increase their economic activity by borrowing money at lower interest rates. 

In the post-World War 2 era, lowering interest rates have sufficed to lift western economies out of economic recessions.  Since the financial crisis started, however, lowering interest rates has not been sufficient to boost economic activity across western economies.  Since 2009 however, interest rates in the European Union (EU), the UK and the US are all one percent or lower, meaning they are at or near the so-called “zero-bound” where they cannot be lowered further, and hence central bankers have turned to QE instead.

The process of QE is best explained by providing a rough overview of the steps involved in its implementation:

  1. First, a central bank will create new money.  In the past, this meant literally printing money; today however it simply means creating new money electronically.
  2. Next, a central bank will use this newly created money to buy more conservative bond investments – generally government or government-guaranteed bonds – directly from financial institutions such as banks, pension funds and insurance companies.
  3. This purchase of government bonds by the central bank should lower the interest rates that these bonds pay to financial investors.  This is based on simple supply and demand.  Large purchases of bonds by a central bank will increase the price of these bonds, which lowers the yield the bonds will pay (when it comes to bonds, their price and yield is inversely proportional).
  4. The hope is that these financial institutions – especially banks – will respond to lower bond yields by lending money to consumers and businesses in the real economy to achieve a higher rate of return.
  5. Then, once the economy recovers, the central bank will sell the bonds back into the marketplace, thereby recovering the new money it created in the first place.

Just to give one example of what the scale of QE has been, to date the UK’s Central Bank, the Bank of England or BOE, has implemented QE  to the tune of £325 billion (or US$517 billion).  Meanwhile, the American central Bank, the Federal Reserve (FED) has used QE to purchase approximately US$2 trillion of bonds in the marketplace.

The major question that central banks’ QE has created in investors’ minds is whether all of this new money will lead to high inflation.  Some analysts have argued that because consumers and businesses are not borrowing and banks are not lending, that the risk of inflation is small because the proceeds from QE are just sitting on financial institutions balance sheets rather than reaching the real economy.

An excellent recent article by Liam Halligan in the UK’s Daily Telegraph, however, notes that inflationary risks of QE are very real.  Mr. Halligan argues the following:

"Future inflation, not disinflation, is the problem the UK faces. For now, most of the QE “proceeds” are sitting on the balance sheets of banks pretending to be solvent...What happens to inflation when that massive increase in base money is leant out? What happens when the mask slips and the markets focus on “currency debasement”, which then pushes up imports prices as sterling falls?" 

Whilst Halligan’s article focuses on the UK, the same question could be asked of the US FED or any central bank which has implemented QE. 

One question investors might ask themselves if they believe that high inflation at some point down the road is a real possibility is “what type of investments would I want to protect my investment portfolio and retirement security from the substantial inflationary risks created by QE?” (whether in the UK or any nation where QE has been implemented).

We believe that the best type of inflation hedge for investors are so-called real asset investments real asset investments as their value generally rises in conjunction with inflation.  A "real asset" in the investment world generally refers to a tangible asset such as timber investments or farmland investments that have an inherent economic  value.  The advantage of investing in the right real assets is that they frequently pay good current income and can also act as an excellent hedge against inflation.  Just to take the example of farmland, we pointed out in a previous article that the long-term rationale for farmland investment is compelling, as global arable land is decreasing whilst global population continues to rise inexorably.  The good thing for retail investors is that real assets such as farmland investments are no longer the preserve of the wealthiest investors such as the legendary Jim Rogers (who is a huge proponent of farmland investing), but are now also accessible by individuals due to a number of innovations in the market.    

Whilst many commentators often discuss the merits of hedging against inflation through the use of commodity Exchange-Traded Funds or ETFs, we believe that commodity  ETFs are driven heavily by financial speculation and hence do not provide the true stability of the real assets themselves.  Nevertheless, there is certainly an argument to be made for at least splitting one’s real asset investments between the tangible assets such as farmland investments and commodity ETFs, especially if one chooses an ETF that follows a well-balanced commodity index. 

Finally, it is worth noting that no matter how keen an investor may be on real asset investments as a hedge against inflation, they are still best used as a complement to a more traditional portfolio as opposed to being one’s sole investments.  As with any investment, including in real assets, there are no hard and fast rules, and investors should analyze their own situation and ultimately make choices with which they feel most comfortable.

Adam Waldman is the Marketing Director at GreenWorld BVI.  GreenWorld specializes in real asset alternative investments such farmland and forestry.   All of GreenWorld’s investments have low enough minimums that they are accessible by individual investors.  The aim is to allow retail investors to access such stable, "hard asset" alternative investments that pay high current income and also offer excellent opportunity of long-term capital gains.

© 2012 Copyright Adam Waldman - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


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