Inflation: How To Best Protect Your Money!
Despite its continual authority within our economy, precisely what inflation is is still unclear to many people. However, it is an economic factor that affects, without exception, everyone who relies on money to live. From this article, you will learn what inflation is, how to calculate it, as well as how to maintain the value of savings as much as possible despite its effects.
Reporting of inflation
The concept of inflation is of Latin origin, more specifically inflatio – a word meaning flatulence or bloating. However, in economics, it has a different meaning: In this way, it means the permanent deterioration in the value of money. In practice, inflation is a single, sustained increase in consumer goods and raw material prices.
To illustrate a simple example: if a litre of milk cost $1 last year and today it costs $1.10, then the milk is now 10% inflated. However, if only the price of milk has risen, it cannot yet be called inflation on a global scale. Inflation can only be suggested as the cause when a large proportion of products present in the economy become more expensive, all at the same time. So if we can now only buy for $50 less than we could 1-2 years ago, we would be experiencing the effect of inflation, that is, the permanent deterioration of the money.
Types of inflation
Inflation types are grouped according to several criteria. However, we will take a closer look at only two discernable types – those grouped by rate and those grouped due together because the inflation period’s cause. Let’s see the schedule first.
Slow inflation
Slow inflation is when inflation is at levels of around 2-3%. This kind of inflation is the most favourable for the economy, as it positively impacts economic growth.
Walker inflation
Inflation falls into the ‘Walker range’ when its rate ranges between 3% and 10%. Here many goods and services may not be available to everyone. This reduced accessibility happens because wages will, most likely in this case, no longer fully cover living costs. However, despite this, the balance of the economy can still be maintained.
Galloping inflation
If inflation rose above 10%, we would then be in a period of what is called ‘Galloping inflation’. Unfortunately, with this type, we would be on the brink of economic disaster. Wages are now clearly unable to cover general living expenses, due to how quickly the value of money is deteriorating. This factor alone, in turn, can lead to both investors and consumers having a loss of confidence. In the case of galloping inflation, a Government crisis and public distrust of political leaders is not uncommon.
Hyperinflation
Hyperinflation occurs when the rate of monetary deterioration exceeds 50%. From here it isn’t inconceivable for the inflation rate to then potentially jump by hundreds of per cent! This phenomenon is particularly rare, especially in countries with war situations or unstable political backgrounds. Typically the economy is usually destabilised extraordinarily in this situation. To make it worse, this will only be reversed with a series of government decisions and strict austerity. Hyperinflation has been seen recently in Zimbabwe, among other places.
After the Second World War, Hungary experienced an example of this. The value of the Pengő, the currency of that time, fell by 207.19% per day. The Pengő hyperinflation is considered by many to be the worst devaluation in global history to date, so much so that it is regularly used as a point of reference.
Deflation
Simply put, deflation is just the opposite of inflation. In the case of this phenomenon, the value of inflation turns in a negative direction. In practice, this entails huge price drops, which seems optimistic at first glance, whereas it can be a warning signal of an extremely worrying economic situation. If there is deflation in a country, it slows its economy, leading to economic depression, which can cause significant social problems in the long term.
Causes of inflation
According to the economic definition, inflation occurs when the amount of money in circulation exceeds the economic growth of the country, respectively. This is indicated by the original meaning of the word inflation.
For a long time, the value of money was adjusted to the value of some precious metal, more oftenly gold. Fiat currency was then integrated into the market in the second half of the 1900s. Regulatory money value is determined lawfully instead of using this method of ‘balancing’. History shows that printing more money has financed high public debts, unstable economic conditions, liquidity problems and war costs. At the time of printing the money, new banknotes were placed into the market, i.e. the amount of money was “bloated”.
And when economic growth could not keep up with the increase in cash volumes, prices soared. That’s because there’s more money cost per every unit of merchandise.
Nowadays, though, the causes of inflation are more difficult to accurately determine since there are so many theories to consider. According to many, the causes of monetary deterioration today are found in real economic processes rather than just in money printing. The real economy is the part of the economy that is able to remain independent of the financial sphere in the medium or long term.
In the modern age, inflation can develop for two main reasons. Due to the increase in demand (Demand Inflation) and the increase in the cost of producing goods (Supply Inflation otherwise known as Cost Inflation).
What is demand inflation?
In demand inflation, an analogy can be found between the money printing discussed earlier. In the event of low unemployment in a country, a stable economic situation and high wages, consumption patterns increase. At this time, society prefers to sacrifice consumer goods and save less. Thus, as a result of the increase in demand, prices in the economy increase.
What is supply inflation?
Supply, or cost, inflation occurs when the price of products is not due to an increase in demand, but instead due to increases in production costs. The cost of production may increase as a result of both raw material costs and worker wages rising simultaneously. At this time, as demand remains unchanged, traders will make back the excess cost of production from the consumer price, at which point there will be a general price increase.
How is inflation calculated?
The most popular indicator used to calculate inflation rate is the Consumer Price Index (CPI). This value shows the change in the price of goods purchased by the general public and the services used. Most statistical centres, such as the Central Statistical Office, use cpi to calculate the inflation rate.
When calculating the CPI, a so-called consumer basket is defined. This cart includes all products and services whose price changes are tracked. This typically includes basic food, clothing, spirits, tobacco products, cultural services and many other goods.
They calculate the general consumer price index by the weight of the following main product groups.
Food: 26,401 %
Spirits and tobacco: 10,272 %
Clothing: 3,795 %
Durable goods: 7,703 %
Household energy: 6,538 %
Other wares, fuels: 17,976 %
Services: 27,315 %
It is important to note that they calculate several different consumer baskets. There is also a consumer basket for pensioners and a basket used to calculate core inflation. In these categories, the above categories are weighted in a different way.
What’s wrong with the Consumer Price Index?
Consumer baskets show only an average value. In the second and third quarters of 2021, the rate of English inflation was averagely 5.25% per quarter*, you can see this below.
This does not show the actual value of the deterioration of money. For example, generations Y and Z consume more electronics and, because of the popularity of food ordering, they will usually buy fewer food ingredients. In most cases, they rent an apartment because they are yet to buy their first home. Therefore, they may experience inflation up to 10-20% higher than the consumer basket measured. If you’re running your expenses on a monthly basis and on a budget, you can look back and easily work out how much your monthly spending has changed.
It’s the inflation in your consumer basket that shows you best.
Who could fail as inflation rises?
Inflation affects everyone who makes a living on money. However, some are less at the mercy of the harmful effects of general monetary deterioration. Those who keep their savings in cash are typically the worst affected by inflation. Even those who have put their money into investment vehicles, whose rate of return could potentially not exceed inflation, should not feel safe.
Let’s take a closer look at both scenarios:
Savings committed in low-interest government securities
Most classic government securities have a fixed interest rate. If the inflation rate exceeds these typically low fixed interest rates, the value of our money invested will also decline. To prevent inflation, there are types of low-liquidity government securities that will follow the inflation rate. These can be good solutions, especially in an environment of rising inflation.
Savings committed in bank deposits
The situation with savings committed in bank deposits is similar to that of government securities. The interest rate on standard fixed-term deposits in 2021 ranges from 0.01% to 3%. At an inflation rate of 5%, it is not even enough for our savings to retain their value.
Unbound savings in cash
However, the above methods are still, on some level, more favourable than keeping your money sewn into a pillow or just leaving it in a bank account. In this case, savings are entirely exposed to inflation, and our money is constantly losing value at the relative inflation rate.
How can we protect ourselves against the effects of inflation?
One of the most effective ways can be to avoid the effects of inflation is to invest your savings wisely.
If you decide to invest, putting our savings in assets that are more likely to yield above inflation would be better.
In the case of investments, it is a golden rule that it is not worth putting everything on a single page, i.e. it is more worthy of our time to consider as many assets and sectors as possible. This spreading of investment is called diversification, which also helps to reduce the possibility of risks associated with investing.
For example, if you only buy fixed-rate government securities, you may not gain anything in case of high inflation. In fact, in this case, you may not even keep the value of your savings! You may even lose some of it. But a balanced investment portfolio, which includes stocks, bonds and other assets, is more resistant to inflation.
Would you like to start investing? We’re here to help!
Inflation is an economic factor that everyone should consider. It is essential, especially those planning to embark on a long-term savings plan, to pay close attention to this. In most cases, fixed-rate government securities and bank deposits aren’t pro against inflation. And the only way to lose more money is if we don’t invest our savings at all.
If you want to make your savings valuable and enjoy the returns on your investments, you should put your money in a well-structured investment portfolio. Since creating such a portfolio requires a high level of expertise, it may be important to get more comprehensive help in getting started.
If you are not sure where to start your long-term financial planning journey, please be sure to execute adequate research of your own first (We are not financial advisers!). We only help you gain more understanding, knowledge and approach intuition so that you can make the most suitable forms of investment for you, so that your wealth can be a secure, value-proof foundation for many years to come.
Read more from Us
