Inflation is the rate of increase in the price level over a period of time. Like other prices, the consumer price index (CPI) tends to rise over time because of various reasons but especially as a result of “economies of scale” and productivity.
Inflation is a hidden tax that raises the price of everything: the cost of food, clothing, healthcare, education, and even your house. It’s a slow and long process of raising the prices of goods and services in a country. When you think about it, inflation is something that is almost unavoidable in the markets.
Inflation is a big topic, but I intend to make it easier for you by covering crucial information: basics of inflation, causes, different types, and ways to handle it. There are things that you can do now to protect your wealth from this persistent condition that does not seem to be going away anytime in the near future.
Basics of Inflation
Inflation by definition is a sustained increase in the general price level of goods and services. In short, this means that prices of the same products in money terms are now higher than they used to be in the past.
For example, in 2019 if you’ve $100 in your bank account or anywhere else and you get 2% interest but the inflation rate is 3% per year. Then your money value is decreasing by 1% per year. It means a product with a value of $2 in 2019 will cost you $3 in 2020 and so on (interest – inflation).
This is a continuous and persistent increase in the volume of currency and credit relative to available goods and services, caused by an increase in the total amount of money in an economy.
Inflation can also happen when there is increased government spending, increased taxes, wars, higher tariffs on imports, manipulating lending rates to cause a cycle of boom and bust (i.e. the dot-com bubble).
Understanding inflation is a bit more complex than just knowing what is going on with the rise in prices of items you frequently buy. Inflation is a systematic decrease in purchasing power over time.
According to Statista, the inflation rate of the USA in 2020 was 1.25% and in Canada, it was 0.72%. Meanwhile, the projected inflation rate in the USA is 2.26% for 2021 which is 80% higher.
Have you ever wanted to know how to profit from inflation? In this article will discuss how to exploit inflation to your favor financially.
These are some factors that highly affect the inflation rates:
- Technological advancement, faster communication, and shipping mean more goods and lower prices for everyone.
- Government regulations can respond quickly to price rises, for example, by introducing tariffs or taxes on certain goods.
- Supply and demand: as more people buy something, there are fewer available alternatives and prices rise accordingly.
This means that although the price of items may go up, their ability to purchase these items will go down. The inflation rate is a very important indicator of the state of an economy. It is primarily used for pricing, savings, investments, and credit.
How Inflation rate works
The inflation rate is usually quoted as a percentage which means that the price of a good or service is going up. It occurs when prices of goods and services are kept set by the government or another entity. But wages or prices of products are allowed to rise or fall based on demand.
This is an annual increase in the price of goods and services. Inflation is sometimes seen as an inevitable part of living in a developed country. It is reduced when there are policies in place to control inflation, and it is increased when there are shortages of some goods or services.
In the 1980s, many countries in Europe implemented tight monetary policies to fight inflation and encourage economic growth. This began a period of rapid economic growth in Europe and North America, but unfortunately, this also resulted in higher prices.
Although there are multiple ways to quantify inflation, these are two commonly used methods to rank inflation:
The Consumer Price Index (CPI)
The Consumer Price Index (CPI) is the most widely used measure of inflation. This is an inflation calculation based on the consumer price index for all urban consumers aged 15 and over. It tracks the amount of money a typical person has to spend to buy a basic basket of goods and services.
The Producer Price Index (PPI)
The Producer Price Index (PPI) measures the change in the price of a product as it changes in relation to population and wages. It is an important price measurement because it affects families’ spending patterns, spurring economic growth. The PPI is derived from a twelve-factor model that considers factors such as productivity, profitability, demand, labor demand, taxation, and inflation.
Types of Inflation
Inflation is an increase in the levels of price for goods and services. It can instantly change our lives. It raises the prices of products on our shelves, it influences wages and salaries.
This can be expressed as a country’s annualized percentage, which occurs when there is more than one type of inflation. These are the main types of inflation:
- Creeping: Creeping is a strange phenomenon that increases about 3% or less. According to the Federal Reserve, when prices increase 2% or less, that’s a good signal because it is very helpful for economic growth. It’s the increase in the price of goods and services over time. While prices are creeping up, they’re not increasing by much.
- Walking: Walking Inflation is when prices increase by 3-10% per year. Walking inflation deceives consumers into buying more than they need, which overloads our economy and carries the country further from real economic progress. This inflation is cumulative, making it seem that the dollar will never become more valuable.
- Galloping: Galloping inflation is a type of inflation that occurs when the inflation rate is at 10%. Businesses can’t pay their workers and ordinary people can’t survive. After a short period, the prices increase quickly, this effect causes rapid decreases in the value of the money.
- Hyperinflation: Hyperinflation isn’t the same as regular inflation when prices go up slowly. In hyperinflation, prices go up so fast that it’s hard to keep track of how much things cost. Prices start rising to 50% a month in some cases. As a result, everything starts to become out of control and worthless.
How inflation affects the market
Inflation, or the increase in prices of goods and services, has a significant impact on the stock market. The topic that is hotly debated among economists and finance experts is the effect of inflation on different types of investments. While there were suggestions from some analysts that all assets would be affected equally, others think that inflation would have a greater impact on some assets than others.
Well, Inflation affects all asset classes, especially junk bonds, equities, and cash will be at risk. Still, there are some moves that can protect investors’ money and even take advantage of it.
How does inflation affect stocks?
Stock prices rise and fall every day; however, inflation can increase the effect on the prices’ fluctuations due to possible raise of interest rates. In general, inflation has a negative effect on stocks.
Value stocks can make better choices during inflationary times than growth stocks, mostly because these companies are in industries such as financial or consumer staples that are hit less hard by inflation, and they are already well established and have more pricing power.
Some companies that have benefitted from rising commodity prices also have a very good chance of keeping pace with inflation. They have historically kept pace with inflation over the long haul.
How inflation affects fixed income instruments:
For people who are looking to preserve, and grow their wealth, rising inflation can make it harder due to the increasing required rate of return over time and decreasing purchasing power.
Fixed income instruments effectively stand to lose the most as they are not keeping pace with inflation due to the inverse relationship with interest rates.
Investment instruments linked to inflation
As we mentioned, investing in bonds may not seem to be the logical choice because of inflation. But there is one solution to counteract this additional increase in inflation: purchasing TIPS (Treasury Inflation-Protected Securities). It is treasury security that is designed to provide protection against inflation by the U.S. Government. TIPS adjusts in price to maintain their real value based on changes in the Consumer Price Index. They provide attractive inflation protection and, like other Treasuries, offer the safety of the U.S.
Other hedges to inflation
Real estate and commodities appear to be a good hedge against inflation because they rise in value along with goods prices.
Inflation is something that affects everyone, even if you don’t realize it. That’s because inflation is a measure of how quickly the prices of goods and services go up. It affects the way the government measures your income, and it means that the money you earn from your job will buy you less and less over time.
This is a hot topic, not only for the American economy but also for the world economy. We are truly excited to see how all of the different variables will impact the way that we live and work. If you have any questions or concerns about inflation, please let us know.