What is inflation and can you protect yourself from it?
"In my day, you could buy a cup of coffee for a nickel and see a movie for a dime," but today you can't do either thanks to inflation.
Maybe it was a cup of coffee, a movie, or your grandfather purchasing his first new car for less than $1,000 however your version of the story goes, you have likely heard these price-related anecdotes from older generations. Today, if you can purchase a cup of coffee for less than four dollars, you have found a good deal. You can scarcely see a movie and spend under $20, and most new vehicles cost more than your annual salary.
The culprit behind these phenomena? Inflation.
What is Inflation?
To put it simply, inflation is the average rising price of goods and services. Expressed as a percentage rate, the rate of inflation describes how quickly these prices increase from year to year. For example, the U.S. Bureau of Labor Statistics reported the rate of inflation for the first half of 2017 at 2.0%. This means that over the period from January through June, the average price of goods and services increased by 2.0% compared to prices in December of 2016.
The rising prices associated with inflation directly reduce the buying power of each dollar. Imagine being able to buy 20 cups of coffee with a single dollar bill. Now, think about what you can purchase today with one dollar. By increasing the cost of everyday goods and services, inflation reduces the value of currency.
Does Printing Currency Cause Inflation?
The economy is a mystifyingly complex system, and all of the exact elements, situations, and relationships which cause inflation are not clearly understood. Many mistakenly assume that an increase in the amount of available currency directly causes inflation. When the supply of money increases, inflation occurs. Similar to inflation, however, the increase of currency is itself an effect, and not a cause. This means increased currency coincides with inflation, but does not cause it.
A real-world example of a known cause of inflation is the rising cost of oil prices due to OPEC's market power in the 1970s and '80s. Though not many families purchase barrels of oil, the cost of oil affects all of the industries which rely on it. This includes any industry which requires shipping or delivery as a part of its operations and any industry dealing with petroleum-based products. As a result of sharply rising oil prices, the price of almost all goods and services increased, causing major inflation.
Generations of post-Great Depression economists have made careers out of positing theories related to the causes and effects of inflation. To determine the cause of inflation, an economist must determine what factors lead to rising average prices and/or the rising demand for currency. Some of these factors include supply shortage, increased demand, and market power (think monopolies or situations where only a few entities comprise an entire market).
Can You Protect Yourself from Inflation?
Since the 1930s, inflation has been an ever-present force; currency's buying power continually declines. To protect your assets in the face of rising inflation rates, diversify investments. Consider moving some assets into investment categories which do well during high inflation or are protected against inflation. Some options include precious metals, mining companies, and government bonds linked to inflation, such as Treasury Inflation-Protected Securities. No matter how you protect your assets, the price of coffee stands to increase. At least one day, you can tell your grandchildren stories about spending under five dollars on a cup.