Let’s be honest – most of us don’t really understand inflation. The dictionary defines inflation as:
1“a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services.”
In a nutshell, inflation is when prices go up. But why is that bad? And why should we care? In the US, we haven’t seen high inflation since the 70s and 80s (some 30-40 years ago!). In recent weeks there has been more chatter about inflation because President Biden is proposing large domestic spending plans as part of his agenda. Some economists have expressed concern that the Biden plans may create higher than normal inflation. The Biden administration has maintained that their plans may lead to short term inflation, but that long term inflation would remain at modest levels.
To help you understand the concept of inflation, here are some of the top costs of inflation2:
- Money erosion: Your cash can buy fewer goods. As such, many people try to put their wealth into physical goods (ie property) instead of fiat money (ie cash).
- Income redistribution: Inflation redistributes wealth in an unequal fashion. During a high inflationary period, it’s good to be a borrower (you can pay back the debt with higher valued/inflated dollars) and bad to be a lender (you’re paid back less than what you originally lent out!). Generally, people with assets are able to better hedge themselves against inflation while individuals without many assets are left behind (Imagine a person trying to buy their first home and the house goes up 10% in value from inflation. The result is that the house gets more and more out of reach for that first time homebuyer).
- Unemployment: As labor costs rise, employers may seek alternatives to labor (such as increased technology).
- Higher menu costs: As inputs rise, restaurants may have to regularly re-price menu items to maintain their profit margins.
These are just a few potential costs of inflation, but hopefully it more clearly paints a picture of what a high inflationary environment might look like.
Note: Staying in a well-diversified portfolio can help you to weather a high or low inflation environment. If you have questions about inflation and/or your portfolio please don’t hesitate to reach out to us.
1 https://www.merriam-webster.com/dictionary/inflation 2 https://www.economicsonline.co.uk/Global_economics/Inflation.html