Recently, while looking into Taiwan's recent inflation wave, I realized that many people's understanding of inflation actually has quite a few misconceptions. Everyone gets scared when they hear about inflation, but the benefits of moderate inflation are seriously underestimated.

Let's start with the basics: inflation means money is becoming more and more diluted. The 100 yuan you have today might only buy 80 yuan worth of goods after some time—that's a decline in purchasing power. Over the past two years, prices in Taiwan have skyrocketed, and the central bank has raised interest rates five times because of this. Many people don't understand why interest rates need to go up, but the logic behind it is quite simple.

The purpose of raising interest rates is to discourage people from borrowing money. When borrowing costs increase, people tend to save more in banks rather than spend, reducing market demand, and naturally bringing down prices. The U.S. followed this approach in 2022: CPI rose 9.1% year-over-year, hitting a 40-year high. The Federal Reserve raised rates seven times in one go, from 0.25% to 4.5%. As a result, the S&P 500 fell 19%, and the Nasdaq dropped even more—33%.

But there's an interesting point here: while raising rates can curb inflation, it also leads to higher unemployment and economic slowdown. So, the real goal of central banks isn't to bring inflation down to zero but to keep it within a reasonable range of 2% to 3%. Why? Because mild inflation is actually beneficial to the economy.

Think about it: if prices keep rising, people will spend in advance. When businesses see increased demand, they will expand investments and produce more goods, leading to economic growth. China experienced this in the early 2000s: CPI rose from 0 to 5%, and GDP growth jumped from 8% to over 10%. This is a manifestation of the benefits of inflation at the economic level. Conversely, if inflation turns negative—deflation—people start hoarding money. Japan in the 1990s suffered from this: after the economic bubble burst, they entered a period of contraction, with negative GDP growth, leading to what is called the "Lost Thirty Years."

Beyond the national economy, the benefits of inflation are also very tangible for individuals, especially those with debt. For example, if you borrowed 1 million yuan to buy a house 20 years ago, with a 3% inflation rate, that 1 million would only be worth about 550k after 20 years—meaning you effectively paid back only half of what you borrowed. So, during periods of high inflation, those who use debt to acquire assets benefit the most.

What about investment? That gets a bit more complicated. During low inflation, hot money tends to flow into stocks, but during high inflation, government tightening policies tend to suppress stock prices. However, it’s not that there are no opportunities during high inflation; energy stocks, for example, tend to perform well. In 2022, the U.S. energy sector returned over 60%, with Western Petroleum up 111% and ExxonMobil up 74%.

If you want to allocate assets during inflation, traditional inflation-hedging assets like gold, real estate, and the US dollar are worth paying attention to. Gold tends to perform inversely to real interest rates—the higher the inflation, the better gold does. Real estate is attractive because, with ample liquidity, excess money often flows into the housing market. The US dollar appreciates due to the Fed’s hawkish rate hikes. Diversifying your investments across these assets allows you to benefit from stock growth potential while hedging inflation risks with gold and the dollar.

So, looking at this from a new perspective, the benefits of inflation are actually quite substantial. The key is to find the right balance. Low inflation promotes growth; high inflation damages the economy. The job of the central bank is to keep inflation within an optimal range. For investors, understanding the logic behind inflation and then strategically allocating assets is the correct approach.