Flight to real assets

Definition

Flight to real assets refers to the investment strategy where individuals and institutions move their capital from financial assets, such as stocks and bonds, into tangible assets like real estate, commodities, or precious metals during periods of economic instability or hyperinflation. This shift often occurs as investors seek to preserve their wealth, maintain purchasing power, and reduce exposure to currency risk that may arise in uncertain economic environments. In hyperinflationary economies, the depreciation of currency erodes the value of financial assets, prompting a stronger inclination towards real assets that can retain or increase in value.

5 Must Know Facts For Your Next Test

1. In hyperinflationary economies, currencies lose value rapidly, leading investors to seek safety in real assets that are less susceptible to inflation.
2. Real assets like gold and real estate tend to hold their value better than financial assets during periods of significant economic distress.
3. The flight to real assets can create increased demand for commodities and real estate, potentially driving their prices up further amidst scarcity.
4. Investors often perceive real assets as a hedge against inflation since they can appreciate in value as the cost of living rises.
5. This trend can also lead to decreased liquidity in financial markets as capital is diverted away from stocks and bonds into physical assets.

Review Questions

• How does the concept of flight to real assets help explain investor behavior during hyperinflation?
  • During hyperinflation, investors often experience a loss of confidence in the local currency and financial markets due to rapidly rising prices and uncertainty. This leads them to engage in a flight to real assets as a means of preserving their wealth. By investing in tangible assets like real estate or commodities that are likely to retain value despite currency devaluation, investors aim to safeguard their purchasing power against inflation.
• Analyze the implications of a widespread flight to real assets on the economy of a hyperinflationary country.
  • A widespread flight to real assets can exacerbate the challenges faced by a hyperinflationary economy. As investors pull money out of financial markets and divert it into tangible assets, this creates decreased liquidity in those markets and could lead to further instability. Additionally, rising demand for real assets can cause price surges in commodities and property, making them less accessible for the average consumer while worsening economic inequality.
• Evaluate the long-term consequences of sustained flight to real assets for both individual investors and the overall economy during times of hyperinflation.
  • Sustained flight to real assets can significantly impact both individual investors and the overall economy during periods of hyperinflation. For individual investors, while it may provide short-term protection against currency depreciation, it can also limit investment diversification and long-term growth potential. On a broader scale, when capital flows into tangible assets persistently, it can lead to asset bubbles and further economic distortions. Over time, this may inhibit recovery efforts once stability returns, as resources are tied up in illiquid investments rather than being reinvested into more productive economic activities.

Related terms

Hyperinflation: A severe and rapid increase in prices, typically exceeding 50% per month, leading to a drastic decline in the purchasing power of a currency.

Tangible assets: Physical assets that have intrinsic value due to their substance and properties, such as real estate, machinery, and precious metals.

Wealth preservation: Strategies and practices aimed at maintaining the value of an individual’s or institution's financial resources over time, particularly during economic downturns.