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Effects of Inflation on an Economy

We will discuss the effects of inflation on an economy, the causes of inflation and the possibility of hyperinflation in the United States. We will also discuss how you can fight back against inflation by looking at deflationary assets.

In short, owning assets like gold, silver, Bitcoin and real estate have been traditionally safer investments during an inflation crisis. Currently, many of these assets may be a smart choice for weathering the inflation storm that is ongoing in the United States. Furthermore, we believe that the inflation trend will continue for the foreseeable future and smart investors will take precautions, doing what they can to learn about the effects of inflation on an economy.

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.” –Investopedia

Understanding 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. But could hyperinflation in the United States happen?

Currency 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. Additionally, this could be the start of hyperinflation in the United States.

Clearly, the out-of-control money printing in the United States is probably the biggest reason to learn the effects of inflation on an economy now. Learning about the effects of inflation on an economy now could critically change your financial situation for the future by protecting your wealth and putting you ahead of the game.

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. As a result, this may be the beginning of hyperinflation in the United States.

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. However, the problem is that many experts believe that inflation is much higher than 2%. This is why it is critical to learn about the effects of inflation on an economy.

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

However, despite the inflation values touted by the Federal Reserve Bank, real inflation is likely much higher. You notice the difference when you buy groceries, pay for items or buy a car. Prices are clearly increasing significantly each year. But is this the start of hyperinflation in the United States?

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. As a result, policies that involve greater and greater money printing can easily cause hyperinflation in the United States. Printing money is the catalyst that is making inflation worse. As a result, it is critical to learn about the effects of inflation on an economy today.

Inflation Calculator

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 that may be a harbinger of hyperinflation in the United States.

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.

Could Hyperinflation in the United States Happen Now?

Employee pushing wheelbarrow of mutilated currency, US, circa 1910. Source: Library of Congress Images

Well, hyperinflation has famously happened in other places in the world in the recent past. For example, hyperinflation famously struck Weimar Germany in the 1920s. Hyperinflation has also occurred in Zimbabwe, Argentina and Venezuela. Furthermore, hyperinflation has occurred quite a lot throughout history.You have probably heard famous stories of citizens pushing wheelbarrows full of cash to the bakery to buy a loaf of bread.

Hyperinflation in Argentina

Argentina is frequently studied as a case history for inflation problems. Since Argentina became an independent country in 1816, it has defaulted on its debt nine times over the years. Many of these defaults lead to hyperinflation and economic destruction for Argentinians. Furthermore, the debt defaults have caused currency devaluations (money becomes worth less). In addition, inflation in the country has reached levels as high as 5,000%!

Argentina was known as the Switzerland of South America throughout the 20th century. It is a large, independent country with significant natural resources, a delightful climate and strong historical economic growth. However, beginning in the 1980s, increased debt and import issues caused the country to see excessive inflation of the currency. Later, Argentina staked the Argentine Peso to the US Dollar in hopes of economic recovery. However, a recession led to a default on debt and inflation hit again.

As the currency in a country like Argentina loses buying power, more currency is required to pay for the same things. For example, one day groceries may cost $50; however, during hyperinflation, you might return to the grocery store the following day and spend $100 to buy the same groceries that cost only $50 the day before.

What is Hyperinflation?

“Hyperinflation is a term to describe rapid, excessive, and out-of-control general price increases in an economy. While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.” –Investopedia

In order to simplify understanding inflation, we will discuss three types of inflation:

  • Demand-Pull Inflation
  • Cost-Push Inflation and
  • Built-in Inflation

Effects of inflation on an economy in the United States

Seek Shelter in Deflationary Assets Such as Gold, Silver, Bitcoin and Real Estate.

There are some investments and things that you can own that hedge against inflation and hyperinflation in the United States. For example, for hundreds of years, owning gold and silver has been a method for hedging against the effects of inflation on an economy. Gold and silver both have a long history of maintaining their value when currencies became inflated.

Gold and Silver: Maintain Value, Secure, Private and Real Money

Real money is resistant to inflationary forces and has a value that is based on demand. First, silver and gold have a long history of maintaining their value against the currency of the day. No matter what the value of a dollar is, a one-ounce silver coin is always equal in value to one ounce of silver. In addition, silver and gold maintain a special balance with the value of gold, which fluctuates.

Silver and gold are real money, which is tangible and is backed by something of value. Moreover, you can hold it in your hand. Silver and gold cannot be taken from your bank account, like cash. In addition, hackers cannot steal silver from your computer, like Bitcoin. Finally, silver and gold can be kept safely and privately in a secure location.

Bitcoin

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. As a result, Bitcoin may be a great way for avoiding the effects of inflation on an economy.

Bitcoin Price ForecastBoth 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.

Real Estate

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. Owning real estate is a great way for hedging against the effects of inflation on an economy. Furthermore, it can be a source of passive income for you.

Equities Market

This may be counterintuitive, but owning equities such as stocks can be a way of tapering the effects of inflation on an economy. With the current trend in the United States of printing money and handing it out to individuals through stimulus checks, obviously inflation is rising. Many people are spending the stimulus money quickly. Furthermore, some people are taking their money and buying stocks or trading equities. As a result, the stock market has been trending higher. However, note that the rising stock market trend cannot last forever. In addition, when the market reverses, it may be ugly. At this point, a smart investor will move their money out of the stock market and into safer assets that can weather the storm.

Other Assets

There are many other examples of assets that can be a method for avoiding the effects of inflation on an economy. For example, owning art, vintage cars, collectibles, and high demand items that serve a purpose can all be hedges against inflation. When buying assets, stick to what you know. Furthermore, if you know a lot about vintage baseball cards, then buy those with currency. In addition, try to own assets that have liquidity, meaning you can buy and sell them on the market easily. An example of an illiquid asset would be buying a Picasso painting. A Picasso may be a good store of value over time, but you may have to wait for years until you can sell it in a special auction.

Final Thoughts on Effects of Inflation on an Economy

As you can see, learning about the effects of inflation on an economy is not rocket science. Furthermore, inflation and hyperinflation are real phenomenon that can affect your personal finances. There are different types of inflation that can occur. Each of these scenarios can quietly steal money from your savings. In addition, if hyperinflation occurs, significant destruction of the economy can occur. 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.

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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.

 

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