Fighting inflation in 2023. How to counter inflation?

21 November 2023/inCrypto academy, Investing in crypto

To combat the banking and debt crisis and the corona crisis, thousands of billions of euros were pumped into the economy. This led to unprecedented growth in the money supply, with inflation in 2022 at its highest in years, at 14.5% in September 2022. But is the growth of the money supply the only cause? And what how is fighting inflation in 2023 possible? You can read about it below.

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What is inflation?

In order to come up with solutions to fighting inflation in 2023, we first have to understand inflation. Inflation, also known as currency depreciation, occurs when there is a general increase in the prices of goods and services. If the demand for a product rises, the price will rise if the supply is equal. If aggregate demand, the demand for all products in all markets in a country, increases, this will lead to an increase in the general price level. This creates inflation, or expenditure inflation.

How does inflation come about?

Since the banking and debt crisis in 2008, Central Banks have massively lowered interest rates and bought up government and corporate bonds on a large scale. They did this to stimulate the economy again after the credit crisis. This phenomenon was also continued during the corona crisis in order to prevent a ‘real’ crisis. The idea was that when interest rates were low, more would be borrowed and the economy would be stimulated.

This eventually led to a huge increase in the money supply.

According to several economists, too much money in circulation should lead to higher inflation sooner or later. We can experience this all too well today. The money supply has structurally increased much faster than the amount of tradable goods and services, ultimately leading to an increase in the general price level. In short, because there was so much extra money in circulation, it lost its value, so the purchasing power of the money has decreased greatly.

The chart below shows the annual inflation development in the Netherlands. The graph shows the development of inflation from 2002 to 2022.

Examples of past inflation events

In the past, there have been a number of events where inflation got really out of hand. Below are some examples:

Inflation in Germany

Let’s take Germany as the first example, in November 1923, where hyperinflation severely shook up the social order. At that time, more than 140 billion marks was paid in Germany for one loaf of bread. The Germans’ money was suddenly worthless.

Inflation in Zimbabwe

In January 2009 there was also hyperinflation in Zimbabwe. A hundred thousand billion Zimbabwean dollar bill was issued there, which in reality was worth barely 230 euros. Nearly everyone in Zimbabwe was then a ‘millionaire’ or ‘billionaire’, yet there was enormous unemployment and poverty.

Inflation in Venezuela

An even more recent example of hyperinflation is Venezuela. In Venezuela, the economy is heavily dependent on oil revenues. The oil price fell sharply at one point, causing the bolívar – the national currency in Venezuela – to lose a lot of its value. In the summer of 2018, a cup of coffee in Venezuela cost more than one million bolívars, while the same cup of coffee cost only 450 bolívars in 2016.

Inflation in Russia

Russia is also experiencing massive inflation at the moment. Several analysts indicate that inflation could get so out of hand there, that the Russian economy could collapse just as hard as it did in 1998, during the ruble crisis. At the time, this crisis caused a stock market crash and a sharp fall in the value of the Russian currency. The value of the Russian ruble has already fallen by more than 30% this year, and the interest rate has been raised from 9.5% to 20%.

Past inflation threats that could play a role today

Inflation is currently rising significantly worldwide. This can have strong consequences and events from the past can start to repeat themselves.

At the moment there is not only an excessive amount of money, but there is also an increase in raw material prices. A limited price increase is usually beneficial to the economy because it encourages people to buy goods before they become even more expensive. Price increases, on the other hand, do become a problem if the percentage increase becomes too high. This can eventually lead to hyperinflation.

In 1923 in Germany inflation got so out of hand that prices even rose hour by hour. This eventually led to workers being paid twice a day as prices rose too quickly. Hyperinflation can also be accompanied by a so-called ‘run on the bank’, in which people withdraw their savings en masse from the bank to invest in possible foreign currencies.

The exact causes of hyperinflation vary from case to case, but an excessive amount of money remains one of the main causes. Prices will continue to rise as long as the state does not carry out monetary restructuring and puts more and more money into circulation. This is currently happening, and could certainly get out of hand with the above threats as a result.

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Read here

Inflation and interest

Until a few months ago, the ECB had the money tap completely open. They did this so that the banks could support the companies with credit. These related support measures have led to inflation today. The markets had become addicted to free money, as it were, but that is really starting to come to an end. The Central Banks are starting to ease support gently. In short, there is less quantitative easing, which means that the purchasing policy can be quietly brought back to zero and interest rates can then be raised again. But what does such an eventual rise in interest rates mean, and can fighting inflation in 2023 be reached?

In recent years, low interest rates have been a major driver for the housing market in the Netherlands. Interest rates were so low that in reality it could only shoot up. But what does such a rise in interest rates mean for the housing market? In short, this means that the interest costs for new home buyers will also rise, so that a starter on the housing market with the same salary will still receive a lower mortgage. At the moment house prices are skyrocketing, which would mean that if interest rates rise, it will in principle become almost impossible to buy a house. The prices are simply too high. This could have major consequences on the housing market in the long run.

Inflation and investing

But is fighting inflation in 2023 possible through investing? Then we first need to know what role the European Central Bank (ECB) plays in this.

The European economy is improving and that is why the ECB will gradually reduce support in the coming months. The ECB will no longer extend the corona support program from the end of March 2022. The central bank will then no longer invest new money in government bonds and corporate bonds.

Central Bank support is gradually easing and inflation is expected to continue rising. All this with the ultimate goal of raising interest rates again. But what effect does a rise in interest rates have on investing your money?

A rise in interest rates can cause major panic in the stock market. A lot of investors invest with borrowed money, which means that they will have to pay more for a loan if the interest rate rises. These types of investors want to get rid of their shares very quickly. It is also true that high interest rates affect the share price of companies. The shares of companies with large debts will lose value in the future if interest rates rise. This has to do with the costs associated with borrowed money. Higher interest rates will depress corporate profitability, leading to lower valuations.

Inflation and crypto

It is clear that inflation affects the share price. But what can you invest to fight inflation?

In the past, people sought refuge in gold in times of inflation. Money, as can be deduced from the story above, can be created to an unlimited extent. So people want to look for something that is scarce and precious, like gold. If the demand for gold increases, the supply simply cannot grow indefinitely, because gold cannot be created to an unlimited extent.

Nowadays, many people also use a new alternative, namely crypto coins in general and Bitcoin in specific. This is also called digital gold, because Bitcoin is also scarce and expensive. Bitcoin is much more difficult to create than paper money and the production capacity of cryptominers is also very limited. So, is crypto the solution to fighting inflation in 2023?

Many people find Bitcoin even better than gold, as there is probably more gold to be found somewhere in the world. Bitcoin, for example, on the other hand, is limited to an absolute maximum of 21 million Bitcoins. So at some point it just ends.

In countries like Venezuela, Bitcoin is no longer seen as a speculative investment, but as an exit opportunity and a way to protect wealth from currency depreciation. The decentralized Bitcoin network can be a very attractive alternative in such cases, because it is a completely neutral network in which no one can make changes just like that. The Bitcoin is thus very unique as it is reliable and immutable.