We Are All Affected By Inflation. Read What To Do!

What is Inflation?

The term inflation can be defined as a persistent increase or rise in the general price level of goods and services in the economy over a specific period of time. It can also be seen as the long term rise in the prices of goods and services as a result of the devaluation of currency.

History of Inflation

There has been a rapid rise in the overall money supply in many different societies throughout history, varying with diverse forms of money. For example, when gold was the currency in use, the government could assemble coins of gold, melt and mix them with other metals such as silver, lead, or copper and issue them again at the same actual value. Thus, the government could issue more coins without raising the sum of gold used to make them by diluting the gold with other metals. Such a practice will usually increase the supply of money, but at the same time lower the relative value of each coin. As a result of the lowered value of the coins, consumers would issue more coins to acquire the same goods and services as they used to. 

These goods and service would experience an increase in price as a result of the reduction in coin value. To create fiat currency, Song Dynasty China brought about the practice of paper money printing. At the time of the Mongol Yuan Dynasty, a great deal of money was spent by the government fighting civil wars, which resulted to printing more money ultimately leading to inflation.

 For fear of the inflation that plagued the Yuan Dynasty, the Ming Dynasty initially refused to make use of paper money; instead, they reverted to the use of coins made of copper. History reveals that large infusion of precious stones such as gold and silver into an economy also resulted in inflation. 

Western Europe experienced a main inflationary cycle from the second half of the 15thcentury to the first half of the 17thcentury referred to as the price revolution, where prices on average rise maybe six fold over 150 years. Largely, this was as a result of the sudden influx of gold and silver coming from the new world into Habsburg Spain.  The silver extended all over Europe which has been previously cash-starved, thus causing widespread inflation.  

Three factors that can cause the rise or fall in price of goods:

1) Change in the production cost of goods

2) Change in the price of money

3) Depreciation of currency due to over supply

After the proliferation of private banknote currency printed at the time of the American Civil War, inflation started to emerge as a straight reference to the currency depreciation that happened as the quantity of exchangeable banknotes outstripped the quantity of metal accessible for their recovery. During this period, inflation referred to currency devaluation, rather than a rise in the price of goods. 

Early classical economists such as David Hume and David Ricardo noted the connection between the over-supply of banknotes and the depression that followed as a result. They would go on to examine and debate the effect of currency devaluation on price of goods and services. This was termed price inflation, and later just inflation. 

By the time more countries adopted fiat currency from the 18thcentury forward, much larger variations in money supply was possible. From that point, hyperinflation has occurred as a result of huge rise in the supply of paper money in a number of countries. 

How to Monitor Inflation

The various ways to monitor inflation can be viewed under three sub-headings

1.    Monetary Measures

These measures are used to monitor the supply of currency and credit in the economy, they include:

·     Quantitative measures: open market operations, stationary reserve requirements, and bank rates

·     Qualitative measures: margin requirements, and moral suasion.

The government takes away liquidity from the economy by selling securities in the open market. This reduces the balance in bank vaults, thereby lowering their power to supply credit or lend money for the purpose of investment. 

2.     Fiscal Measures

These are measures taken by the government as regard taxation, public borrowing and expenditure. A well organized tax policy will avoid tax cuts. The purchasing power of the people can also be reduced by an increase in tax rate, thus reducing the pressure of demand on price.

3.     Control Over Investment

The original investment leads to a rise in revenue and outlay and the demand for both capital and consumer goods speedily goes up. Thus, it is very important to have a control over investments and be watchful to ensure that the resources of the community are used for investment which has no effect of rising inflation.

How Inflation Affects Us

Some of the main effect of inflation can be viewed through the following sub-headings;

1.     Debtors and Creditors

During inflation, creditors lose while debtors gain. The rise in price leads to a fall in the value of money. The debtors will however return the same amount of money, but they pay less in terms of goods and services. This is because the value of money has reduced compared to when they borrowed. 

2.     Salaried Persons

These set of people such as clerks, teachers and other white collar persons lose as a result of inflation. This is because their salaries do not rise in regards to the rising prices.

3.     Wage Earners

Depending on the speed with which wages adjust to price, wage earners may gain or lose. If they have a powerful union, they may easily get their wages linked to the cost of living index. Thus, they may afford to guide against the negative effect of inflation.

4.     Equity Holders or Investors

During inflation, the people in possession of shares and stocks in companies gain. Because an increase in price leads to an increase in business activities, which means the companies records profit. Increase in profits means an even increase in dividends on equity at faster rate than prices.  But those who invest on securities, debentures, bonds etc. with fixed interest rate lose during inflation due to the fact that they receive fixed sum while there is a fall in the purchasing power.

5.     Businessmen

During periods of rising price businessmen such as producers, real estate holders, and traders gain. Take producers for instance, when prices are rising, the value of their goods in stock rise in the same proportion. So they make more profit when they sell their stored merchandise.

Ways to Protect Against Inflation

It is very vital to understand how to invest and plan in such a way to make sure that your assets uphold its purchasing power. Below are approaches you should take into serious consideration as ways of protecting against inflation.

1.     Invest in Stock

Though people express lack of confidence about stocks, it is good to own some equities as it can be a very good way to protect against inflation. You may think a business is comparable to a household, and if a company fails to properly spend in projects that will yield returns above its cost, then it’s possible that it will also fall victim of inflation. Basically, corporations will trade their goods at higher prices, which will result in higher revenues, income and unavoidably, stock prices. It is wise to seek out the lowest-cost producer. Sort out businesses that possess the strongest profit margins. During periods of inflation, never underestimate the value of dividends, it increases the total return of portfolio.

2.     Invest in a Home

Real estate is a huge venture when done for the correct reason. In as much as many real estate investors are able to find hidden values in properties, it is advisable for individuals to focus on purchasing a home with the aim of keeping it, even if for some years. This is because it usually doesn’t just take weeks or months; extensive waiting period is required in order for value to swell. Instead of holding money in a savings account, which will lead to a major loss in purchasing power at your retirement, real estate investment has a rather opposed outcome.

3.     Invest in Yourself

To a large extent, the best way to deal with the uncertainty of the future that may come with higher prices is to invest in yourself. Nothing supersedes the fight against inflation than increasing your future earning power by investing in yourself. This begins with quality education, and continues with a constant interest to acquire new skills that will equal the most sorted after in the future.  Bear in mind, the higher one’s level of education, the higher pay they receive and the greater their chances of getting employed. Besides protection against inflation, education also helps protect against recession. Beyond stocks, bonds, or houses, the easiest and most effective way to fight inflation and any form of economic turmoil is investing in oneself.

Written by:
Alex Lopez
Posted on:
June 12, 2018