Inflation and How It Keeps You Poor

We’re going to talk a little bit about inflation. More importantly, we're going to talk about how inflation makes you poor. Scary, right? The simple reality is that inflation is an ever-present phenomenon in our economy, and nothing affects your money and its value more than inflation.

Inflation comes in various forms and it's kind of like the Goldilocks effect where too much is bad and too little is bad. It needs to be just right, but the goal, and this is important to understand, is to not get rid of inflation. No one is targeting to have zero inflation, in fact the targets for inflation are somewhere around 2.5 to 3 percent. That is the government's target, and the government does this for a few reasons.

Real quick, let's just walk-through what inflation is. In general, it's important to keep in mind that inflation is the price of goods and services as they go up. Inflation makes the value of the dollar go down. We've all heard of this happening in places like Venezuela where it costs millions of Venezuelan dollars just to buy a loaf of bread. That is inflation, because as the price of goods and services go up the value of money drops to the point where money is worthless and that is something that is really scary for economists. It is also scary for our government. It was one of the biggest threats in 2008 because once the government starts borrowing and printing more money and injecting mass amounts of money (by lowering interest rates and other methods), they increase the money supply. Money, like all things is affected by supply and demand. When the money supply inflates, you get worried that money is not going to be worth as much. It will cost more to buy basic goods and services. As prices skyrocket, the economy can't keep up with it and suddenly it gets out of hand which leads to “runaway inflation” and it cost thousands of dollars to buy a loaf of bread which will devastate and destroy an economy.

The other side of inflation is something called deflation. A lot of people are a little more worried about deflation than inflation, the reason being is that deflation is almost never good. Deflation is the opposite. Deflation is when you have assets, and the price of physical investments were all going down. We all saw deflation in 2008 when stock markets and housing costs went down, all your investments went down with it and money became worth more. So, it's this inverse of inflation, but deflation can erode with some of the most fundamental building blocks of our economy and deflation leads straight into economic depressions. That's why deflation is scary. You don't want any deflation, but inflation is something you want a little bit. It's a balancing act. This balancing act is something that the government plays with through the use and tools of monetary policy through the levers that they have available to them such as interest rates.

That's all great, and now that we’ve covered the basics, we're going to go into why inflation makes you poor. Remember inflation is when the price of goods and services go up and the value of money goes down. This is important. For example, if you have $10 it doesn’t mean much today. But, $10 in the 1950’s was very different from the 2000’s. That $10 is not the same. Why? Because the value of it has changed because of the prices of goods and services. But as the price of goods and services goes up like everything does from the 1950s and from the beginning of time until now, as the value of money deteriorates and those prices in services go up that means your $10 is worth less every single year and a lot less if they are targeting 3 percent inflation. That means your money is dropping at 3percent a year and in just 10 years, your $10 is no longer $10. You’ve lost 3 percent and your $10 is now $7. Therefore, inflation can make you poor. This is one of the fundamental reasons why saving money is the best way to lose money. It’s just a losing game because saving guarantees you that you will lose money due to inflation and decreasing money values. It's guaranteed.

the way to offset that loss of value is through investing and most people are investing simply to offset inflation. If inflation is 3 percent and the stock market goes up every single year by 6 percent that doesn't mean you made 6 percent. That means you only made 3 percent. When you start looking at it like that, you realize that's not a lot of gains, so there's a lot of different ways that the wealthy use to offset that differential.

You must remember how inflation makes you poor is through money, but inflation also has another separate event. Inflation can make you rich and that is what we're going to talk about in our next article.