What exactly does inflation mean? Master these tips to make money even during soaring prices

In the past two years, prices in Taiwan have risen sharply. The central bank has raised interest rates five times in an attempt to cool down the economy, but many people still don’t understand what inflation really is, let alone how to respond. Actually, understanding the meaning of inflation is not difficult; the key is to find investment opportunities during periods of rising prices.

What exactly is inflation? A simple one-sentence explanation

Inflation means that prices continue to rise over a period of time, while the actual purchasing power of your money depreciates. In other words, things that cost 100 yuan last year might only cost 80 yuan this year.

The most commonly used indicator to measure inflation is called CPI (Consumer Price Index), which countries use to monitor price changes.

Why do prices go up? The three core reasons you need to know

The fundamental cause of inflation is that there is too much money circulating in the market, but the supply of goods does not increase accordingly, leading to too much money chasing too few goods.

Demand surge drives prices up

When demand for goods suddenly increases, businesses will raise prices accordingly. As corporate profits rise, they will further increase consumption, creating a cycle. This demand-driven inflation, while pushing up prices, also promotes economic growth (GDP growth), so governments generally welcome it.

Raw material costs soar

Rising prices of raw materials like crude oil and natural gas directly increase production costs, leading to higher prices for goods. During the Russia-Ukraine war in 2022, Europe was unable to import Russian energy, causing oil and gas prices to surge tenfold. The CPI in the Eurozone increased by over 10% annually, reaching a record high. Cost-push inflation like this can lead to economic recession, which governments want to avoid.

Government printing money recklessly

Most hyperinflations in history stem from governments excessively increasing the money supply. In Taiwan during the 1950s, to cover post-war deficits, the central bank printed大量鈔票, leading to soaring prices. At that time, 8 million banknotes were only worth 1 US dollar.

Changing expectations fuel inflation

Once people expect prices to keep rising in the future, they will spend in advance and demand higher wages. Businesses, seeing increased demand, will also raise prices. This inflation expectation becomes self-fulfilling and difficult to shake.

Why do central banks raise interest rates? Can this really reduce inflation?

When price increases spiral out of control, central banks usually raise interest rates—making borrowing more expensive. Suppose the loan interest rate rises from 1% to 5%. Borrowing 1 million yuan would mean paying 10,000 yuan in interest annually at 1%, but 50,000 yuan at 5%. Naturally, people will be less inclined to borrow and prefer to deposit money in banks.

This reduces the liquidity in the market, leading to decreased demand for goods. When products are unsold, businesses are forced to lower prices, gradually bringing down the price level, and inflation is slowly contained.

However, raising interest rates is not without costs. When demand weakens, companies may lay off workers, increasing unemployment, slowing economic growth, and potentially triggering an economic crisis. That’s why central banks tread carefully when fighting inflation.

Low inflation is actually good, but high inflation can be deadly

It may seem that inflation is worthless, but moderate inflation is actually beneficial for the economy.

When people expect future prices to rise, they are motivated to spend. Increased demand encourages businesses to invest, leading to higher production and economic growth. China in the early 2000s is an example: when CPI rose from 0% to 5%, GDP growth accelerated from 8% to over 10%.

Conversely, when inflation drops into negative territory (deflation), people prefer to save rather than spend, causing economic decline. Japan experienced a bubble burst in the 1990s and fell into deflation, losing a full thirty years of economic growth opportunities.

Therefore, most central banks aim to keep inflation within a reasonable range. The target for developed countries like the US, Europe, and Japan is 2%-3%, while other countries often set it between 2%-5%.

Who benefits most from inflation? Debtors are laughing

Inflation causes cash holdings to depreciate, but it is a huge boon for those with debt.

Suppose you borrowed 1 million yuan to buy a house 20 years ago. With an average inflation rate of 3% per year, after 20 years, that 1 million yuan is effectively worth only about 550,000 yuan. You only need to repay roughly half of the original debt. So during periods of high inflation, investors leveraging assets like real estate and stocks benefit the most.

Is inflation good or bad for the stock market? It depends on how high inflation is

During low inflation, hot money flows into stocks, pushing prices higher.

During high inflation, central banks tend to implement tightening policies to cool down the economy, which can suppress stock prices.

The US stock market in 2022 is a typical example. That year, the US CPI soared to 9.1% (a 40-year high). The Federal Reserve began raising interest rates in March, with a total of 7 hikes throughout the year, pushing rates from 0.25% to 4.5%. As a result, borrowing costs for stocks increased, valuations were pressured, and the S&P 500 fell by 19% for the year. The tech-heavy Nasdaq dropped even more, by 33%.

However, high inflation periods are not entirely without investment opportunities. Energy stocks are an exception—historical data shows energy companies tend to perform well during high inflation. In 2022, the US energy sector returned over 60%, with Western Petroleum up 111% and ExxonMobil up 74%.

How to allocate assets during inflation to preserve and grow wealth?

During high inflation, holding cash alone becomes increasingly disadvantageous. The smart approach is to diversify your assets.

Assets that perform well during inflation include:

• Real estate: Increased liquidity during inflation drives capital into the housing market, raising property prices.
• Gold and silver: Gold has an inverse relationship with real interest rates (real interest rate = nominal rate - inflation). The higher the inflation, the more valuable gold becomes.
• Stocks: Although volatile in the short term, long-term returns often outpace inflation.
• Foreign currencies (like USD): When interest rates rise, foreign capital flows in, causing the currency to appreciate.

A simple allocation plan: Divide your funds into three equal parts, investing 33% in stocks, gold, and USD. This way, you participate in stock market growth while hedging against inflation through gold and USD appreciation, and your overall risk is more diversified.

If opening multiple accounts feels too cumbersome, consider trading tools like Contracts for Difference (CFDs), which allow you to allocate assets across stocks, gold, and forex in one platform, saving time and effort.

Conclusion: Understand inflation, see the opportunities clearly

Inflation means rising prices and depreciating cash. Moderate inflation promotes economic growth, while excessive inflation damages the economy.

In the context of central banks raising interest rates to combat high inflation, holding onto cash will inevitably lead to losses. Smart investors should appropriately allocate assets that can hedge against inflation—such as stocks, gold, and USD—allowing participation in economic growth while protecting wealth from erosion.

The key is to recognize the trend early and make strategic arrangements, rather than waiting until inflation spirals out of control and regretting it too late.