UNDERSTANDING INFLATION AND RISING PRICESBy MARY LYNNE DAHL , Certified Financial Planner ™
March 29, 2021
(SitNews) Ketchikan, Alaska - If you shop for food, buy gas for your vehicle, pay utility bills, medical bills and educational expenses for your child or yourself, you have no doubt noticed that the prices for these expenses have gone up. A lot, in many cases. This is due to inflation, the ongoing and silent thief that steals your hard-earned money continuously. If you are working and get raises periodically, you may not worry about this too much. But if you are retired, or out of work due to the pandemic, you probably are at least aware of inflation, since you do not have a rising wage to help offset the increase in prices of ordinary goods and services that you require. In addition, if inflation is rising faster than your income for any reason, the money that you do have just does not buy as much as it used to. So why is this?
This is because inflation is a general increase in prices that causes a decline in the purchasing power of money. How does this work? Let’s use an example: if 10 years ago a loaf of bread cost $2.00 and now that same loaf of bread costs $3.25, your cost for bread has increased by 5% per year. That is inflation. The result is that you need more money to buy the same things now that you bought in the past for less. Inflation is experienced by rising prices and loss of purchasing power. So, what are the causes of inflation and is it bad or is it good?
According to the US Federal Reserve Bank, which has a lot of control over the rate of inflation in this country, it is good for inflation to average around 2% - 2.5%. The Fed reasons that this small rate of inflation stimulates the US economy to grow at a reasonable rate and is manageable. However, they want to control it in order to avoid high rates that can be bad for the general US economy, so they watch it carefully. At this date (March of 2021), the Fed is voicing some “concerns” about inflation that could potentially rise above a reasonable rate in the coming year, so a lot of people are watching it carefully, including myself.
In the past, the US has had several periods of time when inflation did, indeed, rise to dangerously high levels. During the late 1970’s into the early 1980’s, before the US became oil self-sufficient, oil prices were controlled entirely by OPEC, led by Saudi Arabia. At that time, inflation rose to about 20%-21% and did a lot of damage to the economy of this country, causing a lot of people to stop saving money entirely, while running up their credit cards simply because they could not afford to pay them off monthly. In addition, real estate prices rose to levels that made it hard to qualify for home loans, and for anyone who did borrow money, the interest rate on the loans were in the range of 15% - 20%. As you might expect, it was pretty hard to pay off a loan at such high interest rates, so not many people were able to borrow except on their credit cards. America was awash in personal debt as a result. Naturally, savers were able to get higher rates on their savings accounts, generally in the range of 15%-18% but even that was not enough to offset the effects of inflation. So, long story short is that once inflation rises above a certain level for some period of time, it gets labeled “bad”. Even worse than just “bad”, experts say that if it rises 50% or more for several months in a row, it has become “hyperinflation”, which is what happened in the 1970’s. This kind of inflation is, in fact, catastrophic to any economy,
The goal for anyone who is concerned about staying afloat financially is to earn a wage that rises annually at a rate higher than inflation, and to save/invest at average annual returns higher than inflation. Failure to do these things gradually erodes your lifestyle by reducing your purchasing power slowly but surely. Doing better than inflation is crucial for long-term investors, but is also important to wage earners. For a retiree, it is even more important, since a retiree no longer has a wage that he or she can use for saving and investing.
What are the signs of rising inflation, and why is the Federal Reserve Bank becoming more concerned about it at this time? Several factors are signs of rising inflation, such as rising energy prices. Back in the early 1980’s, oil prices rose so fast and so much that the US had long lines at the gas pump and people were limited to how many gallons they could buy. Another example, more currently, is lumber; in the US it has doubled in consumer price this last 12 months, making new home construction prices jump significantly.
The Federal Reserve is aware of this, and other price increases, which it views as a “signal” of potential (maybe/maybe not) threat of inflation in the coming year. The Fed watches it while also watches prices on other key goods and services, to see if they also are rising. If it becomes widespread, the Fed has to decide if and what they should do about slowing inflation down and preventing hyperinflation from even getting started. Many other nations do essentially the same thing through their own central banks (like our US Federal Reserve).
What are some reasons why inflation starts to rise to unhealthy levels? Are there signals to watch for? Yes, there are. When Americans save all of their excess income instead of spend it, that is a signal to watch. Recent analysis of this factor indicates that over the last 12 months, Americans are saving at a rate of 30% as compared to their previous rate of about 7%. This is a very significant increase in the savings rate. It means that people are saving rather than spending. Considering that we are in a pandemic, this is understandable and wise. However, it does slow down growth. It will be interesting to watch if/when the savings rate drops and whether economic growth will pick up as would normally be expected.
Another factor is the money supply. This is when too much cash is available (called “money supply”) it can slow down economic growth, because when there is so much money floating around, the value of cash falls and prices rise. Dollars become worth less than they were previously. This does make sense, since anything that is easy to get is less valuable than something hard to get. It is the “supply vs demand” scenario. Some experts are concerned today that the amount of cash that is being pumped into the US economy via government stimulus, as a result of the pandemic may have created too much money supply, which could trigger a rise in inflation that is hard to reduce. I think we need to wait to see if this is or is not the case, but it is worth watching.
Another signal to watch is the rate of employment/unemployment. At some point when employment is on the rise, wages become the center of attention and the demand for higher wages becomes widespread. Current unemployment is pretty high compared to prior to the pandemic, so this could also be a factor in an upcoming increase in the rate of inflation in the US (and probably worldwide as well).
Economist and financial folks use for (4) common labels for the reasons why inflation starts an upward trend. When these factors are moderate, inflation is considered ok and under control. If they become extreme, however, inflation is hard to manage and price increases become a real problem for ordinary people.
One is called “Demand – Pull inflation”. This is when the demand for something is greater than the supply. It creates higher prices just because buyers want it and may not be able to buy it. This is why Bit Coin and other cyber currencies are in such demand right now, even though they have absolutely no intrinsic value. It may just be that some people want to speculate, thinking (wrongly) that this is their chance to make a lot of profit fast. However, as the saying goes, if it looks too good to be true, it usually is too good to be true.
Another label is “Cost – Push inflation”. This is when the cost of producing widgets goes up and has to be passed along to buyers. If you make and sell widgets at a cost to you of $25.00 and the parts you buy to make those widgets rises to $30.00, you have to raise the price of your product. That is pretty easy to understand.
A third label often referred to is “Built – In inflation”. This is inflation that pushes wages up as a direct result of rising prices of goods and services.
Finally, the fourth label is called “Stagnation”. This is when prices are rising, unemployment is high and there is too much money supply in the economy. This results in an economy that is not growing, but has increasing costs for producing goods and services and also has too many unemployed people. This last type of inflation may be the reason why the central bank of the US (the Fed) is somewhat concerned right now, since the situation in the US is similar to this scenario, although not exactly.
All of these things can lead to inflation going up too much, too fast. The Federal Reserve is keenly aware of the money supply numbers, the employment/unemployment numbers, wholesale and consumer prices, the rate of savings of ordinary citizens, the levels of personal debt of ordinary people and the erosion of the value of the US dollar. All of these things have an impact on inflation.
By now you may correctly be saying to yourself that this whole subject is too darn complicated to understand. That may be true, and there is no point simply worrying about it. That is not why I have written this article for you, however. My point in writing this article is to say that when you know that inflation steals your money because it devalues your hard-earned dollars over time, your job is to make sure that your investments earn more than the rate of inflation. You can do this by staying informed of the annual rate of inflation and your average annual investment returns. The information is available on your smart phone, in the papers, in most media and from your financial advisor if you have one. Search or ask for it and do a comparison. If you are not earning as much or more than inflation on your invested dollars over 5 – 10 periods of time, consider making some changes. If your wages are not rising at least by the rate of inflation, develop a plan to correct this. A new job, more education, extra jobs, whatever it will take to stay above water. If you are retired and your pension is not increased by a cost-of-living adjustment (COLA), make a plan to address that with higher investment returns (if you have investments), budget cuts if necessary or part-time work, if you are able.
Once you understand inflation, the silent thief that steals everyone’s money, you can succeed in spite of it. There is no better time than now to get started.
On the Web:
Representations of fact and opinions in comments posted are solely those of the individual posters and do not represent the opinions of Sitnews.
E-mail your news, photos
& letters to email@example.com