Inflation: the slow devaluation of money

If you've ever listened to your grand-parent talking about their youth, you may have been surprised to learn how cheap everything was. A bus ride would cost 5 cents, you'd get a bag of candies for pennies... and your take-home pay would be less than 300$ per month.

How is that possible? What terrible event occurred between then and now where the cost of money exploded? Just slow, very slow inflation.

Inflation measures the increase in the price of various consumer goods and services. It tries to approximate the general increase in the cost-of-living of the general population in a country. In other words, a 2% inflation means that buying the exact same thing you bought last year would cost you 2% more.

How does that affect me?

Not that much. At least not in the short term. Being an average measurement based on a variable set of goods and services, your spending could get more or less affected depending on your own spending patterns. Not everything increases at the same pace, and in most developed countries it takes a long time for the cost of money to skyrocket.

At the current inflation pace of 2-3% per year, it would take about 35 years for the cost of money to double. That means that if we stay at the same inflation rate, a 20$ restaurant meal would cost 40$ in 2054. Thankfully, salary tends to more or less follow inflation, so all else being equal your salary would also increase as time goes by.

That's all very theoric though for two reasons. First, inflation is an average. That means that depending on how different your spending patterns are from the "typical" set of goods and services used to calculate inflation (and it probably is), the effects it has on you will vary. If ice cream increases in price by 10% and chocolate stays the same price, a family buying only ice cream would feel the effect a lot more than a family buying only chocolate.

Secondly, the past is not an indication of the future, so while we got an average of 2-3% most years since the world wars, inflation could be higher or lower going forward.

But what causes inflation? There are 2 main reasons. The first is when the demand for goods and services increases, the second is when the price of production for these goods and services increases.

Is inflation good?

Most modern economists agree that a little inflation is good, and that's what most countries' central bank targets. While you don't have much say over this, it's good to remember the effect it can have on you.

Since salary tends to increase with inflation, you don't have to worry too much about losing your spending power over time.

It's another story for any money you have saved though. If you leave it in the bank collecting dust, you may be losing some of its spending power yearly. Even if it's in a saving account collecting 2% per year, with a 3% inflation you'd actually be losing money over time!

How can you counter this? Simple: just invest it! Since the cost of goods and services increases with inflation, owning a little bit of the companies creating those will save you from inflation.

Deflation

What happens when inflation goes negative? That's called deflation, and countries try to avoid it. The reasoning is that if money is going to be worth more tomorrow than today, why would you spend it? This creates a feedback loop where people hoard their cash rather than invest it (since it will be worth more in the future if you keep it).

Less investment means less production, which exacerbates the deflation further.

What happens when inflation goes out of control

The worst that can happen is when shit hits the fan and inflation hits an all-time high. While a 2-3% inflation rate won't change much for you in the short-term, higher level of inflation can destroy any saving you have in the bank quickly.

Now, before you panic, remember than hyper-inflation is rare and is usually a symptom that things have gone south. You'll probably see some signs before-hand, and at that point, inflation may very well be the last of your problem.

Nevertheless, it does happen sometimes. The most recent situation comes from Venezuela, where their national currency, the Bolivar, suffered a 1,300,000% inflation rate between December 2017 and November 2018. To give you perspective on this huge number, imagine a coffee cost 1 Bolivar in December 2017. A year later, the same coffee would cost 13,000 Bolivar.

What's the point of all this?

Now that you're aware of what inflation is, what can you do about it?

Invest in stocks

While companies are also affected by inflation, stocks usually increase more than inflation over time. Owning stocks from many different countries will further alleviate the risks.

Invest in real estate

Over time, real estate tends to follow the inflation rate. Since real estate price follows what people are able to afford (or borrow), just as salary increases over time, so does real estate value. Just make sure you don't buy more than you can afford, and don't invest all your money in a single house.

Invest in yourself

Investing in yourself can be a great way to future-proof your life if it helps you increase your earning power. You could decide to go back to school to get a higher paying job, start a business or a side-hustle. Not only would this increase your salary long-term, but it will also help if things go south by giving you more options.

So basically just invest, and don't keep too much cash on the side... besides an emergency fund of course!