Inflation Matters

Why does the money in your wallet buy less over time? Understanding inflation reveals who gains, who loses, and how you can prepare.

1. What is Inflation?

Inflation occurs when the prices of goods and services rise consistently, and the purchasing power of money decreases. This means that over time, a dollar, euro, or yen buys less than what it used to. Inflation is a complex phenomenon tied directly to both monetary policies and human behaviors.

Imagine an economy with only ten gold coins shared among five bakers and five brewers, each selling their bread and beer. When ten extra gold coins are discovered and added, yet production doesn’t increase, people compete for limited goods, and prices double. This illustrates how inflation stems from a larger money supply without corresponding growth in production.

In modern economies, inflation often arises from central banks printing more money or private banks issuing loans. Historical examples like Germany’s Weimar Republic show how excessive money creation aimed at paying debt led to hyperinflation, causing massive spikes in prices—examples illustrating how inflation can spiral out of control.

Examples

• During the Weimar Republic, hyperinflation saw prices skyrocket by 29,500% in 1923.
• Central banks influence money supply with new currency issuance.
• Private banks create money when offering loans, which increases currency circulation.

2. Inflation and the Money Supply

Inflation is closely connected to changes in the money supply but happens differently in the short, medium, and long term. When money enters an economy, people don't immediately spend it. Banks also often channel new money into assets like real estate rather than goods, slowing inflation's immediate impact.

Over time, however, the increase in money demand and supply creates a competitive push for limited goods leading to higher prices. John Maynard Keynes explained that factors like demand outstripping supply and inflationary habits like wage increases also propel prices.

In the long term, global population growth places more demand on resources, amplifying inflation. Between 1950 and 2013, the world population tripled, coinciding with the most significant surge in global prices, highlighting the link between demographics and inflation.

Examples

• Individuals save initial money influx instead of spending immediately.
• Banks divert new money into longer-term assets, like housing.
• From 1950 to 2013, population growth coincided with record-high global inflation rates.

3. Inflation's Wave-Like Pattern

Inflation rarely climbs steadily; instead, it follows a wave pattern described in the book as Inflationary Wave Theory. Over approximately 100 years, inflation rises gradually before culminating in dramatic price fluctuations and then stabilizing.

David Hackett Fischer observed that long phases of price stability often trigger more positive perceptions of life, leading to population growth. This growth creates competition for resources, setting the next inflation wave into motion. Economic history shows recurrent cycles where stabilization eventually yields to inflationary pressures.

Governments, central banks, and businesses are often unprepared for the turbulence and crashes when inflation waves peak, making it difficult for average citizens to safeguard their savings effectively during these transitions.

Examples

• Inflation waves build over a century before turbulence disrupts equilibrium.
• Fischer’s theory correlates inflation onset with population growth following price stability.
• The post-WWII increase in prosperity set a foundation for rising prices by the 1970s.

4. Who Wins and Who Loses in Inflation?

Inflation benefits some while hurting others. Governments often gain due to reduced debt burdens, the so-called "hidden inflation tax," where rising revenues ease national debt. People holding assets like property, stocks, or commodities also benefit, as these tend to rise alongside overall price levels.

On the other hand, savers and middle-income earners relying heavily on cash experience losses. Their monetary savings become worth less each year, eroding the value of their labor and savings. This unseen wealth transfer often leaves average citizens poorer.

Inflation motivates consumption, as money’s future purchasing power drops. This cycle can drive economic activity but at the expense of people unaware or unable to protect against invisible losses.

Examples

• UK savers lose approximately £2.50 per £100 annually due to inflation.
• The government uses above-zero inflation targets to ease its debt obligations.
• Asset owners (homes, stocks, gold) thrive during inflationary periods.

5. Aging Populations Could Counter Act Inflation

While inflation seems unrelenting, trends like declining population growth may signal a shift. Global population growth has slowed, with high-resource-consuming regions like Europe experiencing population declines. Lower birth rates in countries like Japan and Germany mean fewer young consumers putting demand pressure on resource prices.

Additionally, older populations consume fewer resources after middle age. This demographic shift could counteract inflationary drivers as global consumption patterns stabilize. Japan already exemplifies this, with its aging population leading to economic stagnation coupled with low inflation over recent decades.

Examples

• Deutsche Bank predicts population peaks in 2050, followed by declines.
• Aging Japanese demographics have led to stagnant GDP and nearly flat inflation.
• The average global consumption rate peaks at age 46 and then declines steadily.

6. Blockchain as a Solution

New technology, like blockchain, may reduce inflation's effects. Blockchain technology, underlying cryptocurrencies like Bitcoin, provides a public, immutable record of transactions, limiting governments' ability to inflate money supplies arbitrarily.

Unlike national currencies managed by central banks, blockchain-based currencies follow transparent, predictable rules. If adopted widely, blockchain could support a stable global monetary system immune to politically motivated money creation.

Examples

• Bitcoin’s limited supply cap prevents excessive money printing.
• Blockchain's decentralized ledger ensures transparency unavailable in today's monetary systems.
• Experts propose blockchain-based global finance solutions to curb abuse.

7. The Long-Term Impact on Savings and Debt

Inflation erodes savings stored in cash or low-interest accounts over time. In contrast, debtors benefit as the real value of what they owe diminishes. This system incentivizes borrowing rather than saving, fueling economic activity but creating long-term inequity.

When inflation slows or reverses, this situation could invert. Borrowing might become less attractive, and investors would need profitable ventures rather than relying on inflation-driven gains.

Examples

• Cash loses value equivalent to the national inflation rate annually.
• Mortgage holders benefit in inflation as debts shrink in real terms.
• Reduced borrowing could improve equity, forcing capital to back productive businesses.

8. Preparing for Lowflation

Even after inflation peaks, the likely scenario is lowflation—a slowdown rather than outright devaluation. Low interest rates will drive asset prices higher, especially property and stocks, while cash savings remain vulnerable.

Adjusting financial strategies by diversifying holdings into inflation-resilient assets, like commodities or digital currencies, can hedge against continuing monetary shifts in an evolving global economy.

Examples

• Lowflation periods follow inflation waves’ peak rather than deflation.
• Stock values rise under central bank-led stimulus measures.
• Precious metals often protect against turbulent economic phases.

9. Predicting the Transition to Stability

Economic predictions are erratic, but awareness helps mitigate risks. After inflationary turbulence, economies stabilize, supported by lower consumption. Borrowers lose their inflationary advantage, and steady stock recoveries unfold.

A more equal financial system could emerge at this cycle's end, but the transition may be rough. Using digital currencies or secure wealth storage methods could safeguard family wealth during the upheaval.

Examples

• Stock markets eventually rebound after debt-system resets.
• Post-inflation, borrowers lose the debt-forgiving advantages they previously gained.
• Adoption of cryptocurrencies could reduce transitional financial disruptions.

Takeaways

1. Monitor global inflation cycles to time asset allocation and adjust holdings accordingly.
2. Consider diversifying into inflation-resistant assets like commodities or digital currencies for protection against monetary devaluation.
3. Stay informed about demographic and economic shifts, like population changes or blockchain integration, that could influence future inflation.