What's the effect of high inflation (in a developing country) when you hold all assets outside the country

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andrew99999
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Joined: Fri Jul 13, 2018 8:14 pm

What's the effect of high inflation (in a developing country) when you hold all assets outside the country

Post by andrew99999 » Fri Dec 07, 2018 9:58 am

If a westerner goes to live in a developing country, and that country has a period of higher inflation than the low inflation of the west, but all assets are held outside that country in a global portfolio, what is the real effect of the inflation for that person purchasing power?

Is it essentially a zero sum since the buying power of the local currency goes down but the exchange rate compensates for it so that relative to a global portfolio, the cost of living would overall be unaffected by the inflation aspect beyond the inflation on their own global portfolio?

pdavi21
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Re: What's the effect of high inflation (in a developing country) when you hold all assets outside the country

Post by pdavi21 » Fri Dec 07, 2018 10:16 am

If we are talking US dollars, (EUROs, Yen, Yuan, Pounds), in a country with a small currency market, probably. The reason is US dollars are everywhere because of businesses and people like your hypothetical. When local prices inflate, you are still willing to buy local goods for the same price in your currency which affects the exchange rate.

...but good luck getting your money into the country for cheap...scammers and gov't officials will take the opportunity to wet their beaks.

AlohaJoe
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Location: Saigon, Vietnam

Re: What's the effect of high inflation (in a developing country) when you hold all assets outside the country

Post by AlohaJoe » Fri Dec 07, 2018 10:27 am

andrew99999 wrote:
Fri Dec 07, 2018 9:58 am
If a westerner goes to live in a developing country, and that country has a period of higher inflation than the low inflation of the west, but all assets are held outside that country in a global portfolio, what is the real effect of the inflation for that person purchasing power?

Is it essentially a zero sum since the buying power of the local currency goes down but the exchange rate compensates for it so that relative to a global portfolio, the cost of living would overall be unaffected by the inflation aspect beyond the inflation on their own global portfolio?
No, it is not essentially a zero sum. I am a Westerner who lives in a developing country. Anyone who tells you differently is simply too lazy to look at actual data. I'll just repost something I've posted in the past:
Typically high local inflation is offset by falling exchange rate vs the US dollar. Local money buys less, but dollar still buys same amount.
I feel like a broken record but....a lot of people have made similar replies so let try to make a fuller reply.

The short version: your theory doesn't fit the empirical facts in the real world and there are alternate theories about how exchange rates work; even professional economics don't agree.

First, let's take a look at the real world:

Here's Vietnamese inflation since 2012:

2012: 9.1%
2013: 6.6%
2014: 4.09%
2015: 0.63%
2016: 2.67%
2017: 4.37%
And here are the Social Security COLA increases

2012: 1.7%
2013: 1.5%
2014: 1.7%
2015: 0
2016: 0.3%
2017: 2%
On January 1st, 2012, the exchange rate was $1 got you 21,030 Vietnamese Dong (VND).

Given those Vietnamese inflation and those Social Security COLA changes, the exchange rate today would need to be 25,135 VND to stay even.

Except it was actually just 22,703 VND on January 1, 2018. That's a more than 10% difference. Someone relying on Social Security lost 10% of their purchasing power over the past 6 years.

A dollar doesn't buy the same amount.

The theory you describe is the purchasing power parity theory of exchange rates. From one 2016 paper surveying how exchange rates are taught in introductory economics textbooks they conclude:

Empirical evidence would have taught readers that strong deviation [from the Purchasing Power Parity theory] is the rule, and compliance the exception, at least on the deepest forex markets, the dollar-yen and the dollar euro market (cp. Priewe 2016). Periods of deviation are often long. This need not imply that Purchasing Power Parity is a false theory per se – it could be a sensible target, but floating exchange rates are driven by other factors.

Those periods of long deviation are long effect to materially affect the life of a retiree.

And not everyone even thinks your theory is correct. There are other theories.

[Blanchard & Johnson's textbook] follow also the Interest Rate Parity theory which is considered key for the short and medium term. Purchasing Power Parity theory is briefly mentioned but rejected as it cannot explain empirically observed exchange rates

andrew99999
Posts: 115
Joined: Fri Jul 13, 2018 8:14 pm

Re: What's the effect of high inflation (in a developing country) when you hold all assets outside the country

Post by andrew99999 » Sat Dec 08, 2018 11:52 am

Hmm I wonder what it looks like over longer periods.
I have heard that emerging markets tend to have higher inflation than developed markets as they "catch up" and the gap closes, which is why I wonder if this is true and if so does that mean that what AlohaJoe noted is what is expected for developing markets where the purchasing power of a global currency basket would actually be lowered over time in these markets.

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