How to Protect Your Money in the Era of Inflation? The Truth About Rate Hikes, Investing, and Wealth Growth

Inflation has become a global consensus, with Taiwan experiencing persistent high inflation in recent years, prompting the central bank to raise interest rates multiple times. But what exactly is inflation? Why does it have both disadvantages and advantages? How can investors capitalize on inflation? These questions deserve in-depth exploration.

The Essence of Inflation: Money Depreciation

Inflation, simply put, is a period during which prices continuously rise, leading to a decrease in the purchasing power of your cash holdings. In other words, the same amount of money can buy more goods today than tomorrow.

The most common indicator used to measure inflation is the Consumer Price Index (CPI). When CPI rises, it indicates that the average prices of goods are increasing; when CPI falls, it indicates that prices are decreasing.

How Does Inflation Occur? Four Main Drivers

The fundamental cause of inflation in an economy is that the amount of money in circulation exceeds the actual economic output—too much money chasing too few goods. Specifically, there are several triggering mechanisms:

Demand-Pull Inflation

When consumer demand increases, both the production and prices of goods rise, and corporate profits grow accordingly. Profits are reinvested and spent, further boosting demand, creating a positive feedback loop. Although this type of inflation pushes prices up, it also contributes to GDP growth, which is why governments try to stimulate demand through various means.

Cost-Push Inflation

Inflation caused by rising raw material costs is the most destructive. During the Russia-Ukraine conflict in 2022, Europe lost energy supplies from Russia, causing crude oil and natural gas prices to surge over 10 times, with the Eurozone CPI annual rate exceeding 10%, reaching a historic high. This type of inflation can lead to decreased social output and GDP contraction, which central banks aim to avoid.

Excess Money Supply

Unrestrained money printing by governments is a primary culprit of hyperinflation. A convincing example is Taiwan in the 1950s—faced with post-war deficits, authorities issued大量货币，最终800万法币仅值1美元。

Rising Inflation Expectations

Once people expect prices to keep rising, consumption increases, workers demand higher wages, and businesses raise prices accordingly, forming a self-fulfilling inflation cycle. Once inflation expectations are established, they are very difficult to change, which is why central banks always emphasize their determination to bring inflation down.

How Do Rate Hikes Combat Inflation? The Economics Behind It

When inflation spirals out of control, central banks typically raise interest rates. How does raising rates curb inflation?

The core logic is simple: Higher interest rates → More expensive borrowing → People less willing to borrow → Reduced market liquidity → Lower demand → Falling prices

For example: Borrow 1 million yuan, with interest rates rising from 1% to 5%, annual interest jumps from 10,000 to 50,000. As a result, people are less inclined to borrow and prefer to deposit money in banks to earn interest. Reduced demand forces businesses to lower prices to stimulate sales, leading to a decline in price levels.

However, raising rates also has costs—reduced demand can lead to layoffs, increased unemployment, slower economic growth, and even recession. Therefore, rate hikes are a double-edged sword: they can suppress inflation but may harm the economy.

Hidden Benefits of Inflation: Why Moderate Inflation Is Good for the Economy

When discussing inflation, many react with concern. But in fact, moderate inflation can be beneficial to the economy.

When people expect prices to rise, consumption motivation increases → Demand rises → Business investment increases → Output increases → Economic (GDP) growth

Data from China in the early 2000s best illustrates this: as CPI rose from 0 to 5%, GDP growth accelerated from 8% to over 10%.

The opposite example is Japan. After the burst of its economic bubble in the 1990s, Japan fell into deflation (CPI below 0). When prices are nearly stagnant, people prefer to save rather than spend, causing GDP growth to turn negative, leading Japan into the “Lost Thirty Years.”

Therefore, global central banks aim for moderate inflation. The target inflation rates in the US, Europe, the UK, Japan, Canada, and Australia are around 2%–3%, with other countries generally setting targets between 2% and 5%.

Inflation is especially advantageous for certain groups, particularly those with debt. Although cash holdings depreciate, debtors’ repayment obligations also effectively diminish. For example, if you borrowed 1 million yuan to buy a house 20 years ago, with a 3% annual inflation rate, the real value of that debt after 20 years shrinks to about 550,000 yuan. During high inflation periods, those who purchase assets (real estate, stocks, gold, etc.) with borrowed money tend to profit the most.

The Dual Impact of Inflation on the Stock Market

Conclusion first: Low inflation benefits the stock market, high inflation harms it.

During periods of low inflation, excess market liquidity flows into stocks, pushing prices higher. During high inflation, central banks tighten monetary policy, leading to falling stock prices.

The 2022 US stock market is a textbook example. US inflation rates soared, with CPI rising 9.1% year-over-year in June, a 40-year high. The Federal Reserve began aggressive rate hikes from March, raising interest rates seven times in total by 425 basis points, from 0.25% to 4.5%. Higher rates made corporate financing more difficult, and stock valuations were compressed. As a result, the US stock market in 2022 had its worst performance in 14 years, with the S&P 500 down 19% and the Nasdaq dropping 33%.

However, this does not mean there are no opportunities during high inflation. Historical data shows that the energy sector performs particularly well in high inflation periods. In 2022, energy sector returns exceeded 60%, with Western Oil up 111% and ExxonMobil up 74%. Rising energy costs directly boost profits for oil companies, making them winners in high inflation times.

Investment Strategies in an Inflationary Era

In an inflation environment, proper asset allocation is crucial. Investors need to identify assets that can both hedge against inflation and generate growth, building a diversified portfolio.

Which assets perform better during high inflation?

The ideal allocation is diversified: 33% in stocks to capture growth, 33% in gold for preservation, and 33% in USD for hedging. This approach leverages stock market potential, the stability of gold, and the inflation-hedging properties of the dollar, reducing risk while providing steady returns.

After choosing the assets, selecting the right trading method is also important. Contracts for Difference (CFD) are popular due to their wide variety of assets and ease of operation. Through CFDs, investors can trade stocks, gold, forex, and more on a single platform without the need to open multiple accounts with different institutions.

Summary

Inflation is the continuous rise in prices and the decline in the purchasing power of money. Moderate inflation can promote economic growth, but excessive inflation damages the economy. To control inflation, central banks often raise interest rates, which is effective but can also trigger recessions.

In an inflationary era, investors should actively respond by allocating assets such as stocks, gold, and USD to hedge against currency depreciation. Understanding inflation mechanisms, grasping the characteristics of various assets, and adopting scientific allocation strategies are key to safeguarding wealth and achieving steady growth during inflation.