After Mutti

Our new prediction model for Germany’s wide-open election

Angela Merkel’s successor could be left, right or Green



IN AMERICA presidential campaigns start soon after the mid-term elections and last nearly two arduous years. 

In Germany, by contrast, for most of this year it was hard to tell that one of the most important elections in post-war history will take place on September 26th. 

It was only in the first week of August that posters sprouted on lamp posts across Berlin, featuring both the three high-profile contenders for the chancellorship and obscure local politicians running for parliament. 

Political advertisements are at last running on television. 

The Social Democrats even broke a taboo this month by running a negative one, attacking the religious beliefs of a close aide of Armin Laschet, the conservative candidate who is a narrow front-runner to succeed Angela Merkel, who is retiring after 16 years as chancellor.

Until devastating floods inundated parts of North-Rhine Westphalia (NRW) and Rhineland-Palatinate in mid-July, conventional wisdom suggested a win for Mr Laschet, the candidate of the Christian Democratic Union (CDU) and its sister party, the Christian Social Union (CSU). 

But Mr Laschet is also the state premier of NRW, and his response to the floods has been inept. 

As The Economist launched its election-forecast model online on August 10th, the once soporific election campaign was becoming more interesting. 

The gaffe-prone Mr Laschet cancelled all campaign events last week and some TV appearances in September, ostensibly to focus on the aftermath of the flood disaster.

Meanwhile Olaf Scholz, the candidate of the Social Democratic Party (SPD), is gaining ground. 

Germans do not vote directly for their chancellor, but INSA Consulere, a pollster, found last week that when respondents were asked whom they would pick if they could, Mr Scholz (pictured, right) got 27% of the votes. 

Annalena Baerbock (in the centre), the Green Party’s candidate, drew just 13% and Mr Laschet (on the left) 14%. 

Fully 36% said that they do not want to vote for any of the three.

With Mr Scholz doing well (or at least not blundering), a genuine alternative to the conservative party’s long rule has become plausible. 

The Economist’s election model, our first ever for Germany, blends the latest polls with other predictive indicators, such as data on parties’ past performance, to come up with the most reliable guess at how many votes and seats each might win. 

It also measures the considerable uncertainty of the contest. 

The model’s projections will be updated daily until the election with the latest data.

Germany’s election system is unusual. 

Voters get two votes. 

The first is used to elect a local MP—roughly one for every 250,000 people. 

These votes are allocated using a first-past-the-post system and every winning candidate is guaranteed a seat. 

The second vote is for a party rather than a candidate. 

It is more important than the first because it determines the overall proportion of seats that each party holds in the Bundestag, the lower house of parliament. 

Candidates’ prospects for the chancellorship depend not on their personal popularity but on how well their parties do on the second vote. 

Most polls (as well as our online poll-tracker) predict that the SPD will come in third after the CDU/CSU and the Greens, or tie with the Greens for second.

Once seats are allocated, coalition talks get under way. 

As of August 10th our model predicts that the combination most likely to have a majority is that of CDU/CSU, the Greens and the free-market Free Democratic Party (FDP). 

This is known as a Jamaica coalition, after the colours of that country’s flag. 

The Greens and Christian Democrats might also go it alone in a black-green combo, if their vote share is high enough. 

Our model also spies a potential upset with an Ampel (traffic-light) coalition of the Greens, SPD and FDP. 

This would give Mr Scholz his best chance at the chancellorship, though Ms Baerbock would probably claim it if the Greens beat the SPD. 

It would exclude the CDU/CSU from government for the first time since 2005 when Mrs Merkel took charge.

The FDP has not been in government since 2013, when it failed to cross the 5% vote-share threshold required to get into parliament. 

But it would be part of two of the three most likely coalitions. 

“It’s looking good for the FDP,” says Ursula Münch, head of the Academy for Political Education in Tutzing. 

Christian Lindner, the youthful boss of the FDP, whose party is benefiting from Mr Laschet’s weakness, favours Jamaica but has not ruled out Ampel. 

Hence he risks losing some of the large majority of FDP voters who prefer Mr Laschet to Mr Scholz. 

Mr Lindner is already discussing ministerial portfolios. 

He says he would like to be finance minister—and assumes that the Greens would claim the planned environment and climate ministry.

Many pundits think the Greens and CDU/CSU chose the wrong candidates. 

Did they? 

“Jain (yes and no)”, says Olaf Böhnke of Rasmussen Global, a political consultancy in Berlin. 

The CDU/CSU should have picked Markus Söder, the CSU’s head and state premier of Bavaria, who has better political instincts and is more dynamic than the jovial, cautious Mr Laschet. 

But Ms Baerbock ticks lots of boxes, says Mr Böhnke, who adds that all women in German politics face extra grilling. 

In his view Ms Baerbock’s missteps, including alleged plagiarism in her book and embellishment of her CV, have been exaggerated by the centre-right press.

With a month and a half to go the outcome is highly uncertain. 

Since 2005 the number of undecided voters has increased drastically, says Thorsten Faas, a professor of political science at the Free University in Berlin. 

The last weeks of election campaigns have become more important than ever, which makes both our online poll-tracker and our election-forecast model especially relevant. 

Especially with new candidates for the chancellorship, old loyalties may no longer hold, says Mr Faas. 

Faithful followers of Mrs Merkel will not automatically vote for Mr Laschet’s CDU/CSU.

On August 10th Mr Laschet met his fellow state premiers to discuss covid-19 and flood responses. 

Such gatherings are important for the Rhinelander: to overcome accusations of lassitude, he must show resolve in helping flood victims and a clear strategy to fight the pandemic’s fourth wave. 

Otherwise Mr Scholz, who as finance minister has promised hundreds of millions of euros in flood remediation, will look even more promising.

The eagle and the rabbit

America, China and the race to the Moon

Half a century on, the race back to the Moon looks markedly different from the first


On july 11th, climbing through the darkling sky like a bolt of lightning in reverse, Richard Branson stole a whisper of Jeff Bezos’s thunder.

In early June Mr Bezos had garnered headlines and pageviews by announcing that when his rocket company, Blue Origin, launched a space capsule with humans on board for the first time on July 20th he would be among those passengers. 

Virgin Galactic, a company founded by Sir Richard, had already flown its rocket-plane Unity to the edge of space. 

Plans were quickly hatched to bring its next test flight forward and to put Sir Richard himself on the crew manifest (he had been planning to take a later flight). 

On July 11th Unity did its thing, and Sir Richard, returned to Earth, proclaimed a new space age open. 

Blue Origin tweeted, snarkily if accurately, that its capsule goes higher and has bigger windows.

If Mr Bezos has lost his precedence, he has kept his date. And that matters. 

July 20th is the anniversary of the first landing of a crewed spacecraft on the Moon: that of the Eagle, Apollo 11’s lunar module, in 1969. 

As such it was, for a long time, a date for retrospection. 

But now it is also a date for looking forward.

There is every reason to think that, by the time Apollo 11’s 60th anniversary rolls around at the end of this decade, American astronauts will once again be leaving footprints on the barren lunar plains. 

And while Sir Richard has no realistic human-spaceflight ambitions beyond tourist flights to the top of the atmosphere, Mr Bezos wants Blue Origin to play a big role in that next great adventure.

A place for the private initiative of Mr Bezos and those like him is one of the ways in which the plans and context for America’s return to the Moon differ from those that saw it first go there—and then stop going there—half a century ago. 

There are many others. 

One of the goals of the Artemis programme, as nasa’s back-to-the-Moon programme is known, is to highlight the ways in which America has changed in the intervening decades. 

Another is to be comparatively cheap. 

Whereas Apollo had to be a uniquely American achievement, Artemis will encourage the participation of allies. 

And rather than providing just a few brief visits, Artemis is meant to lead to the creation of permanent outposts.

One thing remains the same. 

Artemis, like Apollo, is shaped by the geopolitics of great-power rivalry—then between America and the Soviet Union, now between America and China. 

Even here, though, there are crucial differences. 

In the 1960s America was in a race, the outcome of which could not be known. 

Today it is the reigning champion, seeking merely to maintain its pre-eminence. 

But the question in the minds of the spectators is strikingly similar. 

Does the American system work better than the alternative when faced with the challenges of the future?

In the 1960s America started off on the back foot. 

The Soviet Union had launched the first satellite into space in 1957 and the first human in 1961. 

If the space race was to get into orbit, and thereby demonstrate both your remarkable technological prowess and your ability to drop a nuclear weapon onto any point on the Earth, the Soviet Union had already won. 

Part of the genius of Apollo was to redefine the race as being one to the Moon.

The fact that getting to the Moon requires a very large launcher meant that the more limited technology which had allowed the Soviet Union to take the lead in Earth orbit no longer counted for much. 

Both sides needed a fundamentally new capability. 

It was America which, through a remarkable and extremely costly effort, successfully built that capability in the form of the Saturn V.

When, at the beginning of that great drama, President John F. Kennedy told Congress that America’s eagerness to go into space was “not governed by the efforts of others” he was being less than candid; the Soviet Union’s efforts were fundamental to the programme’s rationale. 

One of the differences between that era of lunar rivalry and this one, though, is that China seems to be living up to Kennedy’s ideal. 

It is not trying to leapfrog ahead of America as America tried to overtake the Soviet Union. 

It is trying to build a similar set of capabilities—and thus catch up to some extent—and to meet its own national needs, whether defined in military and economic terms or, more nebulously, in terms of prestige.

China is capable of routinely launching satellites of all sizes which it uses for its own communications, reconnaissance and intelligence services and also makes available to third countries. 

Last year it completed a satellite navigation system, Beidou, that is a global rival to the gps system which America originally fielded in the 1980s, and to the more recent Glonass and Galileo systems developed by Russia and Europe, respectively.

The rover that China landed on Mars in May was much smaller and less capable than the most recent rovers America has sent there. 

But no other country has yet managed such a feat at all. 

Nor has anyone else landed a rover—called Yutu-2, after the rabbit who lives on the Moon in Chinese folklore—on the far side of the Moon. 

The modular space station that China is currently assembling in low Earth orbit is much more modest than the International Space Station (iss) on which America, Canada, Europe, Japan and Russia have collaborated. 

But it is a more ambitious undertaking than any of those powers other than America or Russia could field alone. 

Xi Jinping, China’s president, certainly seemed proud when he had a videocall with the “taikonauts” on board.

My spaceship knows which way to go

And China has started developing big boosters, rockets similar in size to the Saturn V. 

Officials in the Chinese space programme have said that when there is a working version, probably in the early 2030s, it will be used to put people on the Moon; recently the Chinese and Russian space agencies announced that they would work together towards such a goal. 

Again, this is a matter of catching up. 

The difference is that this time China is recreating a capability which America has let lapse.

Recreating a capability is not the same as running in a race, much less winning one. 

But for China it is just one stage in a longer drawn-out strategy which would see it eclipse America as the leading power in space sometime in the 2040s through a mixture of its own perseverance and America’s decline. 

China would be headed for the Moon even if America was not; it will go there even if, as seems likely, America gets back there well beforehand. 

China’s leaders seem to see a presence on the Moon as having a meaning which goes well beyond beating an adversary to a largely arbitrary finish line. 

There are things that great nations do which small nations cannot; there are types of grandeur reserved for nations which embody ancient civilisations of global import. 

China’s leaders think their country must be seen to share in all such perquisites. 

A presence beyond the Earth is one of them.

A truly confident America might look at these ambitions in the context of its own achievements half a century ago, say “been there, done that” and move on. Today’s America lacks such composure. 

For China to land on the Moon in the absence of an active American presence there would be a public-opinion disaster.

When making the case for the Artemis programme in May, Bill Nelson, the nasa administrator, brandished a picture of China’s Mars rover at the House appropriations committee. 

“They’re going to be landing humans on the Moon. 

That should tell us something about our need to get off our duff and get our Human Landing System programme going vigorously.”

Beating China is a simple and popular proposition. 

The Artemis programme as drawn up under Mr Trump has been embraced by Mr Biden’s administration and seems to enjoy solid bipartisan backing in Congress. 

It is an approach to making America great again which is hard to oppose in principle, even if it is not everyone’s priority.

The new administration has yet to face up publicly to the fact that it will not meet the original goal of boots on the Moon by the end of 2024 (which would have been the end of Mr Trump’s second term). 

But it seems highly likely that it will manage it sometime before the end of Mr Biden’s second term, should he serve one. 

As long as the programme remains on course to succeed before China gets off the pad, a little delay is unlikely to badly affect support.

Artemis also serves other political goals. 

The Americans put on the Moon by Apollo were all white men. 

This did not go unnoticed at the time; one of the most enduring works by Gil Scott-Heron, a black poet and musician, begins “A rat done bit my sister Nell (with Whitey on the Moon)”. 

Much has recently been done to publicise the contribution that women and people of colour made to the programme behind the scenes—this year nasa’s Washington, dc headquarters building was renamed in honour of Mary W. Jackson, the agency’s first black female engineer. 

Their role in today’s space programme is routinely celebrated. 

Wally Funk, a campaigning aviator who met all the criteria for being an astronaut in the 1960s save for her sex, will be a spacefaring guest of Mr Bezos’s on July 20th. 

Artemis, named after Apollo’s sister, is to be the means by which women and non-whites first reach the Moon.

Giant steps are what you take

What is more, it has the advantage of being comparatively cheap. 

For Apollo nasa had to create not just the Saturn V but also the command and lunar modules which it hurled aloft; the total cost is put at around $300bn in today’s dollars. 

Then, though, the size and expense of the task were not an insuperable obstacle; indeed, they were part of the point. 

The project was a signal of just how much America was willing to stake on technological pre-eminence.


Having to expend similar amounts to recreate an old capability would not send a similar message. Fortunately, it is not necessary. 

A new nasa rocket with Saturn V-like capabilities, the Space Launch System (sls), is already close to completing its development, as is a new long-duration crew capsule, Orion, that can ride on top of it. nasa also had pre-existing plans for a small space station, now known as Lunar Gateway, which would orbit in the Moon’s vicinity. 

At its simplest, all Artemis requires beyond what is already in development is a system for getting people in an Orion orbiting in the vicinity of the Moon down to the surface and back up again (see diagram).

For nasa to develop such a landing system itself would still be a pricey undertaking. 

But the space agency’s greatest achievement over the past decade has been demonstrating that it does not have to develop its spacecraft itself. 

After the last space shuttles were retired, nasa asked private companies to submit proposals for new spacecraft to get first cargo and then crews up to the iss. 

Various companies won contracts under these schemes, most notably SpaceX, the rocket company founded by Elon Musk.

Grants, milestone payments made when particular goals were achieved and the promise of long-term contracts once the vehicles were up to scratch allowed SpaceX to develop the Crew Dragon spacecraft, now used to ferry astronauts up to the iss. 

The overall cost to nasa of developing the Crew Dragon this way was $3.1bn: that is only a little more than the total cost of the most recent Mars rover mission.

It’s lonely out in space

During the Trump administration nasa decided that Artemis should take the same approach to developing its Human Landing System (hls). 

Three proposals survived the first round of bidding last year: one from a “national team” led by Blue Origin, one from a consortium led by Dynetics, an American aerospace and computing contractor, and one from SpaceX. 

It was expected that two of the three would receive contracts to build systems, just as Boeing and SpaceX had both received contracts to develop capsules to take crew to the space station (Boeing has yet to fly a crew in its capsule, but will undertake a crewless test flight later this month).

On April 16th, though, nasa awarded a single contract worth $2.9bn to SpaceX, saying it lacked the money to offer two. 

Both Blue Origin and Dynetics challenged the award, which is now being reviewed by the Government Accountability Office; its findings are expected on or before August 4th. 

Maria Cantwell, a senator from Blue Origin’s home state of Washington, subsequently sponsored an amendment to the bill authorising nasa’s budget which requires the agency to issue a second hls contract. 

The bill has passed the Senate, but as yet has no counterpart in the House.

This will probably lead to delays. 

But the competitive approach is the right one. 

When nasa builds its own spacecraft prices go sky high, not least because politicians like to see federal money spent in their home states. 

The sls is a case in point. 

Its development costs, now sunk, have been enormous; it is far too expensive for frequent flights. 

A private company could have done the job much better—as SpaceX is showing with the development of its Starship launch system, similar in capacity to the sls but much more technically ambitious. 

Its “Raptor” engines are of an advanced design that no one has previously managed to make practical. 

It is intended to be entirely reusable.

Prototypes of the sleek, stainless-steel-hulled Starship have been launching, landing and sometimes exploding at SpaceX’s plant in Texas for months as the company tests their new engines and their ability to change their orientation in mid-air. 

The next test flight will be the most ambitious yet. 

It will see the first use of a “Super Heavy” booster to launch a Starship almost into orbit (it will in fact come down about 6,000km away in the ocean off Hawaii). 

The 33 Raptors on the Super Heavy will generate twice as much thrust as the first stage of a Saturn V did. 

The eventual goal is for the Super Heavies, like the first stages of SpaceX’s Falcon boosters, to return and make a vertical landing after sending their Starships into orbit. 

There the Starships will either launch satellites and return to Earth or wait for a subsequent launch to refuel them before heading off to more distant destinations.

The SpaceX hls Moon lander is a version of such a Starship, and nasa’s selection of it over its competitors is a vote of confidence in the company’s scheme. 

If it comes to fruition, it will outcompete the sls by more or less every measure save the employment of government contractors.

Blue Origin’s plans for a booster far larger than the petard with which Mr Bezos will hoist himself next week are not yet as far along. 

But Mr Bezos has money and determination, as well as friends in Washington. 

America could have three boosters capable of supporting human missions to the Moon, two private and one public, before China has even one.

It is in such possibilities that the real promise of Artemis lies. 

The Chinese Moon programme is entirely a creature of government. 

Although there is a nascent private space sector in the country, it is not yet capable of anything so ambitious. 

(Nor is it entirely clear that the government is; the engines a booster big enough for Moon duty requires are far more sophisticated than anything it has yet built.) 

In this, China’s programme will resemble in form, if not in scale, America’s huge, centralised Apollo programme. 

One of the great ironies of the first space race was that at the peak of its efforts to stop the Moon from turning communist America was devoting more than 4% of government spending to a 400,000-worker planned economy entirely run by government officials.

The stars look very different today

This time round, it is possible that America will instead get to the Moon by supporting the aspirations of brilliant and determined—if sometimes petty—entrepreneurs and harnessing the capabilities they provide. 

It promises to be a more effective mode of exploration. 

It could also be the beginning of something more. 

While Mr Musk dreams of his Starships taking settlers to Mars, Mr Bezos talks of using resources from the Moon to build new industries in space (such as power-generation, asteroid mining or the production of exotic new materials). 

It is a vision shared by Chinese space enthusiasts such as Lieutenant-General Zhang Yulin, who works in a part of the People’s Liberation Army devoted to space- and cyber-operations. 

Its realisation, should it come to pass, may offer a truly dramatic answer to the question of which system can better respond to the challenges of the future. 

China is still a long way from being a superpower

Beijing may lack the ambition needed to develop a global military presence that rivals the US

Gideon Rachman 

         © James Ferguson


Does China want to be a superpower? 

In the White House, at least, there seems to be little doubt. 

Rush Doshi, director for China on President Joe Biden’s National Security Council, has just published a book in which he argues that Beijing is pursuing a “grand strategy” to “displace American order” and become the world’s most powerful nation.

Superpower status is a source of national pride and brings significant economic and political benefits. 

But it also involves costs, risks and burdens. 

Just last week, nine Chinese nationals were killed in a terrorist attack in Pakistan, a country now firmly in Beijing’s sphere of influence. 

The call for reprisals in nationalist circles in China echoes the American reaction when terrorists have targeted US citizens.

The Chinese, like the Americans, are upset and confused that their efforts to bring peace and development, as they see it, have been met with violence. 

It is all faintly reminiscent of the lament of Rudyard Kipling, a poet who celebrated British imperialism but warned of, “The blame of those ye better/ The hate of those ye guard.”

Becoming a superpower is a complicated business. 

It poses a series of connected questions about capabilities, intentions and will. 

To use a sporting analogy, you can be an extremely gifted tennis player and genuinely want to be world champion but still be unwilling to make the sacrifices to turn the dream into reality.

It is in the military domain that the distinction between capabilities, aspiration and will is most important. 

In recent years, China has transformed its war-fighting potential. 

The Chinese navy now has more vessels than the US one. 

Some senior American military officers openly doubt whether the US would prevail in a battle over Taiwan.

President Xi Jinping’s government is fond of displaying military might in parades in Beijing, and there is plenty of warlike, nationalist rhetoric on the internet and in the press. 

Chinese troops engaged in a deadly skirmish with Indian ones in the Himalayas last year. Nonetheless, Evan Medeiros, Asia director in former president Barack Obama’s White House, argues that it is unclear that China is willing or able to take on the burdens of being a US-style global military power.

China has not fought a war since it clashed with Vietnam in 1979 and boasts of its “peaceful rise”. 

Unlike the US, Beijing has also historically been very reluctant to promise to defend its friends and allies. 

China has only one overseas military base in Djibouti in east Africa, compared with hundreds of US military facilities overseas.

If the Chinese government or people are reluctant to go to war, that is doubtless to their credit. 

But wars have tended to be the means by which new superpowers emerge and remake the world order, from Britain in the 19th century to the Soviet Union and the US in the 20th century.

China’s economic weight, as the world’s largest trading power and manufacturer, gives it significant political leverage internationally. 

Countries that are dependent on Chinese trade or investment are often reluctant to clash with Beijing — which partly explains the muted global reaction to China’s policies of mass internment in Xinjiang.

But Beijing’s economic power is not always politically decisive. 

Although China is the largest trading partner of Japan, South Korea and Australia, these countries have defied Beijing on occasion. 

The South Koreans allowed the US to deploy a missile defence system on their territory; Japan has refused to yield in territorial disputes; Australia infuriated Beijing by calling for an inquiry into the origins of Covid-19.

The Japanese, South Koreans and Australians are all democracies that are wary of being drawn into the political orbit of an authoritarian, one-party state. 

They are also treaty allies of the US and have US military bases on their soil — which may give them the confidence to push back against China.

China sometimes hints that America’s security guarantees cannot be relied upon. 

But the credibility of the US alliance system would only collapse if Washington failed to intervene after China had attacked a US ally. 

Fortunately, there is no real evidence that China is yet prepared to take that risk — even with Taiwan, which does not have an unambiguous US defence guarantee.

Rather than trying to undermine America’s global network of alliances and bases, China could try to build up its own alternative system. 

The White House’s Doshi argues that China is gearing up to expand its global military footprint — perhaps by adding a military component, alongside the civilian port facilities that it has been buying or developing all over the world. 

But that expansion, while plausible, has not yet happened. 

Even if China were to develop a naval presence in ports such as Gwadar in Pakistan or Hambantota in Sri Lanka, it seems unlikely that Beijing would offer the security guarantees that have made so many countries willing to welcome American troops and bases. 

The US is committed to defend its 29 allies in Nato and has also offered military protection to roughly 30 other countries, including Japan, Australia, South Korea and much of Latin America.

If China is unwilling or unable to achieve a global military presence that rivals that of the US, it may have to find a new way of being a superpower — or give up on the ambition.

What Rising Inflation Means for Stock Investors


With rising inflation in recent months, stock market investors have been using long-held street wisdom to find hedges, or protection, in commodities, REITs or real estate investment trusts, as well as stocks and equity mutual funds. 

But while those asset classes provide hedges against energy inflation, they do not offer protection against core inflation, according to a new research paper by experts at Wharton and the University of Hong Kong titled “Getting to the Core: Inflation Risks Within and Across Asset Classes.”

“The key takeaway from our research is that you have to look at what is known as core inflation separately, excluding food and energy items,” said Wharton finance professor Nikolai Roussanov, who co-authored the paper with Xiang Fang and Yang Liu, both assistant professors of finance at the University of Hong Kong. 

“A lot of the discussion in the popular press on different asset classes in their relation to inflation tend to miss this distinction.”

Core inflation tracks prices of goods and services including shelter, household furnishings and operations, apparel, transportation, medical care and recreation. 

The indexes for core inflation, along with those for food and energy inflation, make up the consumer price index, or headline inflation. 

The consumer price index for urban consumers in June 2021 rose 5.4% (before seasonal adjustments), representing the largest 12-month increase in 13 years, according to the latest labor department report. 

Within that, core inflation rose 4.5%, the largest 12-month increase since November 1991, and energy inflation rose 24.5%; the food index rose 2.4%.

“[Conventional wisdom that] commodity futures, for example, are good protection against inflation because commodity prices will go up is not necessarily true,” said Roussanov. 

Commodity futures do provide a hedge against energy inflation, “but energy is not always the important component of inflation,” he added. 

“It just so happened that in the last 20 years, inflation has been subdued overall and energy being its most volatile part really kind of stood out. 

A lot of movement of inflation has been obscured by high energy prices, oil in particular being the most powerful.”

Key Findings

“We argue that decomposing inflation into core and non-core components (with a particular focus on energy) is important as it sheds new light on the nature of inflation risks,” the paper’s authors stated. 

“First, core and energy inflation have sharply different statistical and economic properties. 

Second, inflation-hedging properties of conventional ‘real assets,’ such as stocks, currencies, and commodity futures, are largely confined to energy inflation, while they provide almost no protection against core inflation risk. 

Third, core inflation carries a significantly negative price of risk, while the risk price associated with energy inflation is in most cases indistinguishable from zero.”

In their study, the authors examined returns in seven major asset classes between 1963 and 2019: U.S. stocks, Treasury notes/bonds, agency bonds, corporate bonds, currencies, commodity futures, and REITs. 

The data had varying starting points between 1963 (for stocks and treasuries) and 1983 (for energy).

These were their key findings:

The conventional wisdom that stocks, currencies and commodity futures are real assets is incomplete: They only hedge against energy inflation. 

A long position in none of these seven asset classes can hedge against the core inflation.

The cost of hedging against inflation – or the price of these inflation risks – of headline and energy inflation are indistinguishable from zero. 

However, core inflation carries a sizable negative price of risk. 

In other words, insuring your portfolio against core inflation is potentially costly due to foregone returns.

Among commodities, precious metals, especially gold, are the most well-accepted assets to preserve value. 

Gold and platinum have positive core inflation betas (volatility and therefore risk) that are statistically indistinguishable from zero and they strongly hedge against energy inflation. 

These precious metal futures have relatively low returns and high volatility, so their ability to protect against core inflation risk is far from assured.

New Paradigms

Inflation dynamics have also changed in the aftermath of the pandemic. 

“Post-Covid, core inflation or prices of goods have been going up across wide swathes of the economy, not just energy costs,” Roussanov said. 

Higher prices of commodities push up costs elsewhere in the economy, too, he added. 

“Those two components of inflation – core inflation and energy inflation – often do not go in tandem. 

But when they do and they both rise, they’re going to in some sense reinforce each other.”

Apart from commodities, most other asset classes too “don’t provide good protection” against core inflation, he added. 

Markets across the board are revising assumptions about assets that were hitherto considered decent hedges against inflation — cryptocurrencies like bitcoin, gold and other precious metals, and treasury inflation-protected securities, or TIPS, whose values are adjusted for changes in the consumer price index. 

Bitcoin prices, for instance, have been falling steadily from their March 2021 peak.

The relationship between stocks and bonds is also set to change, according to Roussanov. 

“Over the last 20 years, [a combination of stocks and bonds] has proved a very robust portfolio because in good times, stocks outperform and bonds are more or less safe,” he said. 

“And in bad times, the Fed cuts interest rates so bond yields go down, which is good for bond prices. 

So even though stocks fall, say in the Great Recession or even in March 2020 with Covid, the prices of Treasury bonds actually shot up because of the cuts by the Fed, which compensated investors with these types of portfolios to a certain extent.”

“We might see a break in this negative relationship between bonds and stocks,” Roussanov continued. 

“When we have a pickup in inflation, it will be bad for stocks, and it will be bad for bonds at the same time.” 

That new equation played out around February 2021, “when there was this increasing worry about inflation, with bond yields going up and stock prices starting to sputter as well,” he noted. 

“This is the paradigm that we should potentially get accustomed to. 

Now, we might actually see that both stocks and bonds will go in the same direction, which, of course, magnifies the risk for an investor’s portfolio.”

Options for Investors

What then are the dependable inflation-hedging options in the current scenario for investors? 

“Sit tight. 

There will be very few things in that basket as far as we have been able to find so far,” said Roussanov. 

“Some of the precious metals such as gold and platinum do seem to have some inflation-hedging potential. 

But they are not very reliable or very strong in the sense that those are pretty volatile.” 

He noted that while bitcoin or other cryptocurrencies are seen by some market watchers as an option, he and his coauthors refrain from recommending them because their relative nascency doesn’t offer sufficient historical data to make any inferences; he also pointed to their recent price volatility as a negative.

TIPS, however, are always an option for investors, according to Roussanov, “TIPS offer a reliable [option] for those who want to protect their portfolios against inflation; TIPS are the safe haven. 

They’re not particularly attractive – they have negative yields precisely because inflation expectations have increased.”

Demand for TIPS has been surging, and they drew a record $36.3 billion in new investments in the first half of 2021, another Wall Street Journal report said, citing data from Morningstar. 

After inflation adjustments, TIPS rates have trended at below 1% for most of the past decade and gone negative in recent years, with the tradeoff being the protection against inflation for the principal amount.

Of course, continued high inflation is not necessarily set in stone, and much depends on how the Fed responds to the recent spikes. 

Federal Reserve Chairman Jerome Powell said last week in a House testimony that recent inflation was uncomfortably above the levels the central bank seeks, the Wall Street Journal reported. 

In June, Powell had noted that he expected inflationary pressures to be transitory because many goods and services have seen one-time price increases after the reopening of the economy, such as air travel and hotel rates, or new and used cars.

“We will have to wait and see whether the view of the Fed is right that this pickup in inflation is truly transitory, and we’ll get back to where we were a couple of years ago,” said Roussanov. 

“It is certainly not a foregone conclusion that we are going to see a continued pickup in inflation. 

I would not expect anything close to what people worry about — the nightmare scenario of the 1970s with great inflation. 

I don’t see the conditions for that.”

That outlook offers hope for investors. 

“If [the current trend] in inflation is transitory and fairly mild, a well-balanced portfolio that has a well-balanced combination of stocks and inflation-protected bonds should do reasonably well in the near to medium-term future,” said Roussanov.