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The risks of inflation and fiat currencies

Inflation is healthy for the economy when it is controlled. But what happens when it gets out of control?

11/09/2022


With inflation reaching record levels in France and Europe, our purchasing power is eroding day by day. Will the ECB's rate hike be the solution? In any case, the returns on our traditional savings products are not likely to protect us.


What is inflation?


In simple terms, this is the general price increase. It is calculated over a year and is usually expressed in %. When inflation is higher than 0% from one year to the next, the purchasing power of each euro will be lower than the previous year.


For example, when inflation is 2%, a baguette that cost 1.00 euro will cost 1.02 euro the following year.


Inflation is stimulated by the European Monetary Policy aiming at a rate of 2% per year, which is considered optimal by the European Central Bank (ECB).


It is easy to think that inflation is bad for the economy, but this is not the case.


Inflation stimulates the economy


The advantages of inflation:

  • Businesses can anticipate price increases and are therefore stimulated to make investments ;
  • Households are encouraged to invest their surplus income to avoid losing purchasing power ;
  • Interest rates are low: households and companies can easily borrow.


However... it is not so simple when inflation exceeds the recommended rates.

Inflation is healthy for the economy when it is controlled and moderate. However, for the year 2022, it is estimated at 5.5% in France by INSEE! This means that your purchasing power will decrease drastically. And thanks to the anti-inflation shield put in place by our government, France is doing well compared to our European neighbors. Indeed, in August 2022, the price increase was 9.1% in Europe.


When inflation is too high


Over the year 2022 we could see inflation exceeding the optimal rates and reaching almost 6% in France! This represents a risk for your purchasing power but also for fiduciary currencies such as the euro.


The strength of a fiduciary currency is mainly the trust we have in it. Periods of high inflation tend to weaken it because we do not have confidence in the euro's ability to cope with this type of economic crisis. This is exactly what we are seeing with the euro right now!


The euro is at its lowest level since the last 20 years, 1 euro is currently exchanged against 1 dollar, a depreciation of nearly 20% in the space of a year!

In addition to suffering from the rising cost of living, your assets are losing value against other fiat currencies such as the dollar.


What is the ECB doing to fight inflation?

In order to limit the rise in prices, the only recourse of the Central Banks is to increase the key rate. Indeed, by increasing the cost of credit, the quantity of money in circulation is brought down; leading to a slowdown in inflation.


After an initial increase of 50 basis points in July 2022, the European Central Bank's main interest rate has recently increased to 1.25%. This 0.75 point increase is a first in the history of the euro!


Unfortunately, by seeking to lower prices, we will see a slowdown in activity in the Eurozone. This could have a negative impact on growth and unemployment.


What are the solutions to protect yourself from the risks of inflation?


The first idea that comes to mind is to use a Livret A? Yes, you are right! It is in fact partly to fight against inflation that this famous bank savings account was created in 1818. With more than 350 billion euros of outstanding savings, this makes it the favorite savings product of the French.


And good news! Faced with the surge in prices that we can observe lately, the Livret A has doubled its rates on August 1, 2022 from 1 to 2%. This seems very interesting, but... With an estimated inflation of 5.5% for the year 2022, you LOSE by leaving your savings on your Livret A.


Fortunately, there are solutions, such as investing your money in different asset classes: real estate, gold, equities, ETFs, crypto... And when it comes to crypto, the Ambrosia teams are here to help!

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