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The other day, an investment professional was telling me of a pressing problem. He handles wealth management at a big investment bank and the main worry for his super-rich clients at present is inflation. They expect him to arrange protection against it. But how do you do that?
It is, as they say, a very good question. Before we try to answer it, we should clarify what kind of inflation we are talking about.
Some will say the problem is confined to commodities in actual shortage: food, metals and so forth. So the simple answer is to buy those commodities.
This puts investors rather in the position of a hamster on a wheel - scrabbling to keep up with the effects of their own exertions. But if it means staying on the same spot, well and good.
Then there are those who believe the problem is transient -that, since it is the product of economic growth, it will go away when the growth does. According to the latest fund manager survey from Merrill Lynch, most institutional investors are in that camp at present.
They are, on balance, more worried about recession than inflation. So, logically enough, they have reduced their weighting in basic materials - in effect, commodities.
If you find that a somewhat sanguine view, Merrill for one would agree. And this brings us to the third category - those who believe that inflation is in the process of broadening out from commodities to the wider world and to wages in particular.
Main threat
The main threat seems to come in emerging markets - if only because many of them were still command economies when inflation was last a problem. In China, according to Merrill's Asian economist, TJ Bond, wage inflation is running at 18 per cent. Meanwhile, he reckons the rate of appreciation of the renminbi in recent months is faster than at any time since the People's Republic was founded in 1949.
If wage inflation is the product of labour shortage, food price inflation risks making it worse. For the main supplier of spare labour in China is, of course, the agricultural sector. The more food prices rise, the more sense it makes to stay on the farm. And so food inflation feeds through to manufactured goods.
Once more then, what to buy? Not bonds, for sure. Treasury yields have been falling as a result of the credit crisis and the flight to quality. They, therefore, risk a double hit - first from a rising inflation premium, then from a recovery in real yields as the credit shock subsides. Inflation-linked bonds are one obvious answer. But the world stock of those is only some $1,500 billion, which is scarcely enough to go round. At the short end in the US, real yields are still negative - the hamster is going backwards.
Real estate might seem to offer a longer-term solution; but, at the tail end of a gigantic mortgage boom, the timing is scarcely ideal.
As for equities, long-run experience suggests the sectors likely to do best are consumer staples. But again, they look pretty expensive already.
There is a wider worry about equities. As David Bowers, of Absolute Strategy Research, points out: if inflated prices from developing countries hit recession-bound countries such as the US, companies may not be able to pass those prices on.
In other words, corporate margins may have to act as a buffer. How fortunate, then, that those margins are still at a record high.
This brings us down to the bedrock - cash and gold. The problem with cash, for the true bear at any rate, is what bank you pick to deposit it in.
As for gold, there is only so much of it around. The amount actually available for purchase - the free float, as it were - is a matter for surmise. But annual production, at $1,000 an ounce, is worth only some $50 billion. Even with the help of derivatives, that is not going to solve everyone's problem.
There is one way out, but only on a miniature scale. Some time back, I put as much as possible of my own modest savings into UK government inflation-linked savings certificates. At the time, they offered a real tax-free yield of 1.35 per cent, which grossed up for tax and inflation is about nine per cent - not bad for a riskless inflation-proofed security.
Two snags: first, the most an individual can buy in one year is about £60,000 ($120,000) - loose change for the super-rich. Second, demand is evidently on the rise. The latest issue carries a real yield of only 0.25 per cent.
No easy answers, then. But the root effect of inflation has always been to transfer wealth from savers to borrowers. So maybe the trick is to borrow as much as possible. If the banks will let you, that is.
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