What is Inflation? It is not that scary

What is inflation | Definition and Meaning | Capital.com

What is inflation? Inflation, while important, is often used as a marketing board in the financial industry. Before selling your fixed deposit, insurance, funds, or even buying stocks, you will first move out of the inflation threat.

In fact, apart from stocks, there are many financial products that are not necessarily anti-inflationary. In particular, there are some financial products with low returns and even far more dangerous than inflation, and they will use inflation as a marketing slogan.

All in all, if you know inflation, it’s actually not that scary.

At the moment of writing, toilet paper has recently risen by 30%, and some people are starting to say “the inflation monster is coming” and so on. In fact, this statement is very strange: Inflation has always been there.

Inflation refers to the continuous increase in general prices, which simply means that the purchasing power of your money has shrunk year by year.

If inflation is 3%, that means the purchasing power of your currency shrinks by 3% per year.
Is 3% a lot or a little? An analogy can be drawn:
If a hamburger is now $100 and inflation is 3%,
After 24 years, your $100 will only get you half a hamburger (a quick calculation can use the rule of 72).

24 years is a long time right, the global average inflation rate is also about 3%, but in theory wage growth will offset inflation (note that it is theoretical). For example, the salary level also increases by 3% per year, which completely offsets the impact of inflation.

The actual global inflation is mostly between 1 and 2% per year.

But why does it say that the average is 3%?

Because large-scale disasters such as wars or oil crises occur every few decades on the earth, the annual inflation at this time is likely to be 20% to 50%. In the long run, these extreme values will raise the overall average inflation.

Inflation is a composite data and does not reflect the rise of every commodity.

It is worth noting that inflation is a composite index of multiple commodity prices and is a concept of an average. While most things go up in price because of inflation in the long run, the increases are not the same.

The price of hamburgers and the price of real estate are not necessarily similar over time. It is not easy to estimate the impact of a single commodity, and we will only use the inflation rate to make an estimate.

How does inflation happen?

People’s purchasing power becomes lower. It could be that too much money is printed, reducing the value of the currency (the traditional definition of inflation), or it could be that all the necessities of life have become relatively expensive (aka rising prices).

There are many possibilities for a decrease in the value of the currency. The more common reason is that the government is printing money. The government uses public spending to invest in public construction or debt repayment, so that money flows into the private market. When the total amount of money increases, its value slowly decreases.

There may also be political instability in the country due to war or disaster. Because the money in this era is not gold, but metal coins or paper money. They have no real value. Therefore, the value of money needs to be legally guaranteed by the government. When the government is unstable or the country is in jeopardy, the law naturally cannot guarantee the value of money. Inflation at this time may reduce the purchasing power of the currency by 50% or even 1000%. This is called hyperinflation and is prone to occur in some extremely volatile countries.

For example, Zimbabwe once issued 100 trillion yuan banknotes due to political turmoil. But 100 trillion Zimbabwe dollars can only buy half a loaf of bread.

Hyperinflation in Zimbabwe - Wikipedia

Who does inflation affect?

Those most negatively affected by inflation are those who hold a pile of cash or deposits.

For example, say you have saved a bunch of money and plan to spend it slowly in retirement. At that time, the purchasing power of this money will gradually shrink over time.

Assets that are not resistant to inflation include:

  • Fixed deposit
  • Bond
  • Savings insurance
  • National Pension
  • Labor Insurance Annuity
  • Foreign currency assets
  • Cash in hand

These assets, you can collectively refer to as “monetary assets”

The most doubtful one should be bonds. The reason is very simple:

for example, a bond promises to give you 10,000 yuan in interest every month in the future. This 10,000 yuan will not increase due to the increase in inflation, so the purchasing power will also shrink over time, saving Commodities with fixed interest rates, such as insurance or time deposits, are also incapable of fighting inflation unless they have a special mechanism.

And the least affected are those who hold valuable assets.

Because only money has become lower in value, the value of relative item assets has not become lower. Whether it is housing real estate, stocks, stock funds, gold and silver, it can continue to maintain its value under inflation.

This is also the reason why wealthy people mostly hold many real assets.

It’s worth mentioning that “debt” itself is usually also anti-inflationary.

Inflation usually reduces the impact of debt. Because it means that the current borrowing is more valuable, and the future repayment is less valuable. The premise is that you use debt to buy assets, otherwise debt is just debt.

Note here: not all assets that can store value mean that you should hold it!

If it’s a commodity with a low rate of return, or a commodity that doesn’t consistently appreciate in value, it won’t necessarily improve your finances even if it’s not affected by inflation.

The return on an asset is subject to inflation, but that doesn’t mean you should accept low returns in order to fight inflation.

Simply put,

  1. The more cash and deposits, the more inflation hurts.
  2. The higher the proportion of non-cash entity assets, the smaller the impact.
  3. Inflation affects the richer the more.

As for those who have accumulated a certain amount of assets, anti-inflation is a topic you must face. The bigger the asset, the bigger the inflationary impact.

Will inflation be reflected in wages?

The economics textbook is telling you that, because the profits of business operations are theoretically anti-inflation, the salaries paid to employees should not be affected by inflation.

But in reality, if you open a newspaper from 20 years ago, people’s salaries didn’t go up at all, they went down.

It should be noted that the inflation index is only an “average”

As mentioned earlier, the inflation index is comprehensive data.

Because not everything rises the same, the inflation index only reflects the overall average. Maybe the inflation index shows 2%, but consumer goods or real estate related to our lives rose 5% to 10%, which is still a huge impact.

How does the government control inflation?

For the people, if these necessities of life are too expensive, it will be very painful. For the benefit of the people, it will naturally become the responsibility of the government to control inflation not too high. (It’s not so much a responsibility, it’s better to control prices so that the government will not be overthrown by riots)

There are usually two schools of thought about government intervention in the economy. One school advocates that the government should intervene in the economy, expand spending to increase demand, and use demand to drive supply, which is called the Keynesian school. Another school advocates that the government should not intervene in the economy, and that supply and demand will gradually balance in the long run, which is called the classical school of economics.

In terms of government intervention, “lowering interest rates” and “increasing government spending” are considered to be ways to stimulate the economy.

There are two ways the government can control inflation:

Reduce public sector spending
In this way, the supply of money circulating to the private sector will be reduced. When the supply of money is small, the value will naturally decrease slowly or even increase. If the inflation rate is negative and less than 0, such as -3%, it is called deflation.

Conversely, if you increase public spending, more money will reduce the value of money and inflation will increase.

Raise interest rates
An increase in interest rates means that the interest on borrowing and saving money will increase. The interest on depositing money rises, so people deposit money in circulation in the bank, and there will be less money in circulation. The interest on borrowing money has risen, and people don’t want to borrow money because the interest will become more expensive, and the currency in circulation will also decrease. Through this method, it is possible to compare the overall suppression of the amount of currency in circulation.

Conversely, lowering interest rates will increase inflation.

But I think government intervention is not necessarily useful, it is just a mainstream policy under political correctness.

more inflation joe biden

Asset allocation to fight inflation?

For some institutions that manage tens of billions of dollars, the annual impact of inflation can be as high as hundreds of millions of dollars. Therefore, there is a link in asset allocation, which is to add anti-inflation effects to the investment portfolio.

There is usually a certain proportion of anti-inflation assets (stocks, real estate REITs, raw materials, gold, anti-inflation bonds, etc.) in the assets as an anti-inflation configuration.

Conclusion: Understanding inflation is important for investment and financial management, but inflation has little impact on your life

Why does inflation have little effect on your life?
The reason is simple: because it’s bound to happen, it’s no use worrying

Just like you will get old, not only you but others too, modern people, ancient people too.
And inflation, like getting old, is bound to happen. You just need to be ready to allocate your assets to the best investment. As long as it is not a large proportion of cash assets, there is no need to be afraid of it at all.

Simply use numbers to prove that you don’t need to be afraid of inflation

If I tell you:

“In 24 years your salary will be double what it is now.”

You will definitely say: “It’s only twice! Too little, right?”

Same:

“Prices will double in 24 years.”

24 years also doubled, not much, right?

I think the reason a lot of people react so strongly, other than media rendering, is because humans are inherently loss-averse. We hate increasing losses more than decreasing profits. So every time prices go up, people will naturally react violently, that’s all.

Inflation Definition

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