We examine the conditions that have led to increasingly high levels of inflation. 

Key points

  • Since the 2008 global financial crisis, the West has demonstrated greater concern for national self-interest, and frictions between nations have been rising, leading to a more fragmented world.
  • Russia’s invasion of Ukraine has presented a more definitive end to globalisation, given the financial sanctions imposed by the West and the halting of trade.
  • There has been a clear shift towards a greater role for fiscal policy, in an attempt to reduce inequality and ease inflationary pressures.
  • The combination of these factors is leading to higher interest rates, lower leverage and more challenging financial markets, but we believe that active investment will benefit in this environment.

Defining inflation

Before understanding how inflation reached this point, it is first useful to define inflation. Prices can rise or fall owing to ‘shocks’ to the system – a bad corn harvest, a pandemic that disrupts global production, or the closure of the Straits of Hormuz are examples of supply-side shocks. In the case of demand-side disruptions, such as the 1997 Asian financial crisis, prices may decline and remain depressed, despite aggressive monetary-policy easing. These resulting price shocks are often considered inflationary or deflationary, though in our view they are ultimately not, given that they tend to mean-revert.

It is important to distinguish between changes to price brought about by these ‘shocks’, and those that stem from inflationary (or deflationary) policy. We believe that inflationary conditions, characterised by a sustained acceleration of price increases, are a function of a government adopting policies that expressly try to lower the value of money, and a currency’s value will keep falling until the central bank changes its stance. As Milton Friedman argued, “inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”.

We believe that consumer price index (CPI) measures are residuals – the more important question is: why is this happening? If CPI measures of inflation peak out, it does not mean the underlying causes of inflation have necessarily gone away, and these can have a greater impact on asset prices.


Prior to the 2008 global financial crisis, globalisation was generally considered to be a positive force, in which free trade and the free movement of capital, labour and knowledge resulted in a more efficient world that was generally judged to be mutually beneficial. This narrative in Western populations has steadily changed since then, as persistently weak economic growth in the West contributed to growing scepticism around whether globalisation really is in their best interests. This has been exhibited by a spark of populist politics: Donald Trump was elected as US President with his ‘America First’ vision, and the UK left the European Union following a referendum. A similar theme has also played out throughout Europe and China.

As the West has demonstrated greater concern for national self-interest, frictions between nations have also been rising, most notably between the US and China. Both countries have implemented restrictions on the other for the import and export of goods, in particular in the technology sector. The extent to which the West relies on China’s manufacturing base, especially for strategically important components, has raised fears, and is encouraging nations to become increasingly self-sufficient.

Russia and Ukraine

While this trend of deglobalisation started long before Russia’s invasion of Ukraine, we believe that the subsequent financial sanctions imposed by the West and the halting of trade with Russia and its allies has presented a more definitive end to globalisation.

Russia’s invasion of Ukraine has revealed the heavy reliance of Europe on Russian energy, and the associated risks. The European Commission has announced that the EU’s dependency on Russian gas will be cut by two-thirds by the end of 2022, and the UK has shared plans to phase out imports of Russian oil in the same time frame.1 In addition, the US has completely banned Russian oil, gas and coal imports.2 The situation in Ukraine is therefore likely to encourage Western governments to invest in the onshoring of manufacturing and the rebuilding of their industrial base and strategic industries, particularly where there are concerns about national security.

Whatever views the West might hold regarding globalisation, its result is a more efficient global system. In a world where fewer goods, capital and ideas cross borders, we believe that the outcome will inevitably be lower productivity growth and higher costs of production.

Shift in policy

Since the onset of the Covid pandemic, there has been a clear shift away from dominant monetary and recessive fiscal policy, towards a greater role for fiscal policy. A balkanised world is a less efficient one, and with higher prices and pressure on the cost of living comes increased fiscal stimulus. The US Congress has been considering rebates of USD $100 for Americans, given the soaring gas prices,3 and in the UK the government is providing a council tax rebate of £150 to approximately 20 million households, to ease the impact of the increase in energy costs.4 The unintended result of this, however, is that this fiscal stimulus is monetised – by giving people more money, the underlying price pressures will only be exacerbated.

While the inequality that has been felt over the last 30 years in mature economies may decline through the use of fiscal policy, it could in fact rise between developed and developing nations. Countries with weaker institutions that are not part of the global order are unable to use fiscal policy in the same way to help ease inflationary pressures.

What next?

All of these factors in combination are not only leading to higher inflation, but also to a higher interest-rate environment than we have been accustomed to in recent times. Over the last 40 years, we have witnessed lower highs and lower lows in terms of rates, and this is likely to have come to an end. Along with higher interest rates come lower levels of leverage, which until now have been accommodated by monetary policy. Generally, against this backdrop, a significant portion of returns has come from capital appreciation rather than from income. However, we believe that is likely to change – we expect to see a greater focus on income from now on.

One example of where we see opportunity in this environment is commodities. As countries continue to reduce their trade linkages and focus on domestic production, there will be a requirement to build more infrastructure, in particular as governments seek to ‘green’ the economy and onshore their renewable energy resources. Commodities that constitute the raw materials of production processes have historically had a more reliable relationship with inflation.

Investing in a disinflationary world has been a relatively straightforward affair. Both equities and bonds have been in structural bull markets for 40 years. We think that financial markets will be more challenging to navigate from now on, and we believe that the ‘beta wave’ that carried bonds and equities for a long time is over. It is in this environment that active investment has a particular opportunity to demonstrate its purpose.


  1. Reuters, Britain to phase out Russian oil imports by end of 2022, 8 March 2022
  2. BBC, Russia sanctions: Can the world cope without its oil and gas?, 31 May 2022
  3. CNBC, Some lawmakers want to ease the pain of high gas prices with direct payments to Americans, 24 March 2022
  4. GOV.UK, Households urged to get ready for £150 council tax rebate, 23 February 2022


Brendan Mulhern

Brendan Mulhern

Global strategist, Real Return team


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