We will discuss the three different types of inflation that can occur and how it can affect you personally. We will also review some ways you can fight back against inflation by looking at deflationary assets.
What is inflation?
Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage means that a unit of currency effectively buys less than it did in prior periods.
In order to simplify understanding inflation, we will discuss three types of inflation:
- Demand-Pull Inflation
- Cost-Push Inflation and
- Built-in Inflation
There will be more detail given about the three types of inflation later in the article. For now, we will discuss how inflation can affect you when you buy something. There are many simple ways to understand inflation. But here is one true story that may help you understand how inflation affects you on a personal level.
In the Piggy Bank Coins article entitled, “How Much Was a Dollar Worth in 1960?” we discussed the purchasing power. The purchasing power of a Dollar in 1960 was compared to that of 2020. We shared the story of Mike Maloney’s father who bought a home in the late 1950s at a price that was equivalent to his annual salary.
As an example, Mr. Maloney displays his father’s 1955 tax return. His father was an auto parts store manager in Salem, Oregon during this time. He earned approximately $9,600 per year.
What’s interesting is the average home cost during this time period in comparison with his [Maloney’s Father’s] salary. According to US Census Bureau data, the median price for a single-family home in Oregon ranged between $6,800 in 1950 and $10,500 in 1960. Moreover, his father’s annual salary was almost equal to the median home price during this time. Now, consider the average salary today and the price of homes. In contrast, could you purchase a home with your annual salary? Clearly things have changed and Americans are becoming poorer.-Piggy Bank Coins article entitled, “How Much Was a Dollar Worth in 1960?”
Basically, in 1960 the cost of a simple home was equal to a manager’s salary. We all know that you can’t buy a home today on a manager’s salary! This is the power of inflation.
One thing that significantly affects inflation and purchasing power is money printing. When the US Treasury and the Federal Reserve Bank coordinate to print large amounts of money, it causes inflation. Inflation is simply an increase in the money supply. The bigger the money supply, the less the money in your wallet is worth. Moreover, inflation is a hidden tax. As a result, money you have in your bank account loses purchasing power when money is printed by the government.
On March 23, 2020, it was announced that the US Government would be giving out stimulus checks to Americans. In addition, they planned to give money and loans to businesses hurt by the COVID-19 epidemic. Almost overnight, approximately $2 Trillion in loans and grants were printed out of thin air. As a result, the internet went viral in creating money printing memes. One of those memes was the now infamous “money printer go brrrr” meme.
Consumer Price Index
According to the US Bureau of Labor Statistics, the consumer price index has increased 1.3% in the past 12 months (before seasonal adjustment).
“The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Indexes are available for the U.S. and various geographic areas. Average price data for select utility, automotive fuel, and food items are also available.”-The US Bureau of Labor Statistics, Definition of Consumer Price Index (CPI)
A consumer price index value of 1.3% seems reasonable for 2019-2020. If inflation or the CPI were only 1% per year, that means that in 100 years one US Dollar would lose about half its purchasing power. For example, $100 in 1920 would only purchase $50 worth of goods in 2020. However, real inflation for items we buy every day is much higher. In addition, we’ll soon see what the real inflation values are, and they are not pretty.
The United States Federal Reserve Bank Aims For 2% Inflation
The Federal Reserve Bank believes that we must have inflation to promote stability and predictability in the economy. Their goal is to have 2% inflation each year.
The Federal Open Market Committee (FOMC) judges that inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Federal Reserve’s mandate for maximum employment and price stability. When households and businesses can reasonably expect inflation to remain low and stable, they are able to make sound decisions regarding saving, borrowing, and investment, which contributes to a well-functioning economy. – Federal Reserve Website
The Federal Reserve’s Tools of Inflation: Money Printing and Interest Rates
The Federal Reserve Bank’s most powerful tool for creating inflation is a two-pronged approach. First, they have the power to raise and lower interest rates. Increasing or decreasing interest rates has the effect of accelerating or decelerating the American economy. If they raise interest rates, people tend to borrow less and it becomes more expensive to do business. As a result, there is a chilling effect on the economy; however, if the Federal Reserve lowers interest rates, individuals (and businesses) find it easier to get capital to do business, and the economic machine is powered up, so to speak.
The other powerful tool that the Federal Reserve has is to print money. Typically, when they print more money, there is more money in the economy. The velocity of money increases and people tend to have more money. With more money in the system, the economy is stimulated.
The US Dollar Has Declined in Purchasing Power Since 1913; The Stated CPI Does Not Reflect Real Price Increases
In addition, the US Bureau of Labor Statistics provides a handy Inflation Calculator. Using their calculator, you can estimate what purchasing power (based upon inflation) is today compared with years past. For example, $10 in 1960 is equal to $88.71 today. That means that in the 60 years prior to 2020, the dollar has suffered 887% inflation over time.
Since the Federal Reserve Bank was formed in 1913, the dollar has been in steady decline. The dollar’s purchasing power has decreased dramatically since 1913. Using the US Bureau of Labor Statistics CPI calculator, the US Dollar has lost approximately 96% of its purchasing power since 1913. This is an alarming statistic.
How Inflation is Measured by You
Sometimes when we think about inflation, we think of what can be purchased directly with our national currency. For example, we might notice that last week fuel cost only $3/gallon, whereas, this week a gallon of fuel increased to $3.50. This is how consumers most often notice inflation. However, don’t get too caught up in measuring inflation by just using currency.
Three Types of Inflation
As stated earlier in the article, there are three types of inflation: demand-pull inflation, cost-push inflation and built-in inflation. These types of inflation are provided as a generalized example so that you can better understand the types of inflation. However, economists and financial experts have other names for types of inflation. Let’s talk about these three types of inflation.
One of the types of inflation is called Demand-Pull Inflation. This kind of inflation happens demand for goods and services outpace the production capacity. In effect, a gap is created between supply and demand in the economy, which puts stress on the price. As a result, prices go higher following the demand from people or businesses who want a good or service. This leads to price inflation.
Another one of the types of inflation is called cost-push inflation. When prices increase in the production process, it forces people to spend more and leads to inflation of money. For example, imagine a bakery that uses sugar to make cookies. If the price of sugar doubled in a short period, it would cause the bake to have to increase the price of the cookies she sold dramatically to maintain profitability. This is one of the most common types of inflation.
Finally, one of the last types of inflation is called built-in inflation. When the price of products or services increases, workers want to increase their wages. For example, if it cost a worker more to drive to work because of high gas prices, and it cost more to buy clothing for work, then a worker will want to earn more money at his job.
How Do You Win Against Inflation?
Seek Shelter in Deflationary Assets Such as Gold, Silver, Bitcoin and Real Estate.
There are some investments and things that you can own that weather inflation better than currency. For example, for hundreds of years, owning gold and silver has been a way to avoid currency inflation. Gold and silver both have a long history of maintaining their value when currencies became inflated.
Another alternative to gold and silver that many consider inflation-proof is Bitcoin. In the past few years, many have begun to use bitcoin like gold – a store of value. In fact, Bitcoin has many of the positive properties that gold has. It is a store of value, it can be a medium of exchange, it can be a unit of account, there’s a limited supply, it is uniform, acceptable, divisible and portable, etc.
Both Bitcoin and gold have a finite, limited supply. As a result, this means that they cannot be subject to inflation. If there is only so much gold, silver and bitcoin, it is by definition, deflationary. Being deflationary means that as the supply of the commodity dwindles, the value and demand for each increase. This is not true of currencies like the US Dollar.
Even something like real estate can have a deflationary affect when compared to US Dollars. Real estate has a long history of maintaining its value over time as compared to the Dollar. However, choose wisely; many believe that there is currently a bubble in the United States real estate market. Prices for real estate in many cities today are considered to be over-priced and inflated.
Final Thoughts on Inflation
As you can see, inflation is a real phenomenon that can affect your personal finances. There are three types of inflation that can occur. Each of these scenarios can quietly steal money from your savings. As a result, it is important to have a plan to address inflation and a place to invest to fight back against the types of inflation.
Disclaimer: It is important to note that Piggy Bank Coins does not provide financial advice. We don’t endorse or recommend any financial investments. Instead, we provide information for educational purposes to those seeking knowledge regarding personal finance. However, in the spirit of transparency, note that the author is an investor in cryptocurrencies, precious metals and some equities.
In addition, The Federal Trade Commission (FTC) requires that Piggy Bank Coins disclose to readers that we may receive commissions when you click our links and make purchases. However, this does not impact our reviews and comparisons. Moreover, we try our best to keep things fair and balanced, to help you make the best choice for you.