What Does Inflation Mean to You?
By Derek Beese
Take a balloon and blow air into it so it expands and there you have inflation!
Quite so, but there is also a much more sinister meaning which eats away at our monetary worth by stealthily dipping its hand into our pocket. Usually we do not feel it but we do see its effect in the way prices keep rising.
If prices rise we need more money to buy the goods and if we cannot get more money then we can only buy less. What causes this to happen? This is a very complex question and because it is so complex, people outside the world of finance block it out as something they cannot understand. BUT it affects all of us every day of our lives so we should at least try. If we understand the cause then we can do something to correct it.
I have talked on this blog in the past about money and value; inflation is all about the value of money. Search out those previous articles and it will help you to follow this one.
The value of money is simple, isn’t it? A Dollar is a dollar, a Euro is a euro, a Pound is a pound, and a Yen is a yen. If each of these countries were totally isolated, with a great wall around them, so that they could not communicate with each other then everything used in each country would have to be produced within its own walls and would be paid for in its own money (currency). This money is issued and guaranteed by the government of the country and the total amount at any one time is controlled by that government and passes around from person to person and business to business to settle debts. This is called “money in circulation”.
Now this isolated country that we have invented has to produce all of its own food and drink for its people to live and also everything that the people use in their daily lives. This is the “product”, and if the number of people and the product remains constant and the money in circulation remains constant then the cost of everything used will remain constant because the cost is “the money divided by the product”. For example, if the total money in this wonderland is 100,000 and we have a total produce of 1,000 identical items then the cost of each one is 100 (100,000 divided by 1,000).
So far so good, but if the balance is disturbed, say by transferring some of the people making this product onto other jobs which do not make any product, then the amount of product will drop, let’s say to 500 and the cost of each will then be 200 (100.000 divided by 500).
In simple terms the product has become scarcer and its value has increased to reflect this based upon the “human perception” principle mentioned in one of the previous posts. Similarly if the product remains the same but the powers that be, increase the money supply, then the cost of each item will increase. (200,000 to produce 1,000 = 200 each).
An example of this occurred in Germany after the First World War. The armistice agreement imposed on the German people a liability to repay France for all the damage done. This was payable in German currency which the French would convert to their own currency to make good the damage by using their own people. Germany however was a bankrupt nation after the cost of the war, like most of the others, and could not earn enough by selling its produce to pay the debt, so the easy way out was for the Government to print additional quantities of its currency every time a payment became due. Thus they increased the supply of money without an equal increase in product and the result was that the money bought less and less. The debt to France was paid as required by the agreement (in German currency), but the value of the payment when converted to French Francs became more and more worthless so they had no real benefit. Eventually there was so much German money around for no compensating increase in product (that is, the money became so valueless) that no-one including all of the German people wanted it, and in Germany a single loaf of bread cost a wheelbarrow full of money to pay for it. This imposed enormous hardship on the German people who found themselves unable to buy the necessities for them to live. Prices were doubling by the day and money became completely useless so the only solution was to go back to barter. In these conditions a week’s load of food was worth more than the most valuable diamond in the world and would be exchanged for it provided the food owner was willing.
A similar situation is taking place today in Zimbabwe. The produce (output) of the country has been shrinking for many years and the money supply has been progressively increased by the national bank to pay for the government’s liabilities with the result that the currency is totally worthless. A recent report said that a new Z$10,000,000 (that’s right, ten million)note has been issued but all that it will buy is a loaf of bread. This is inflation on a massive scale and is devastating for the people who live there.
So inflation is not a good thing but governments and borrowers flirt with it because it makes it easier to pay off debt. At one or two percent per annum it does some harm but not enough to cause any serious hardship. As it gets above this level however we all begin to feel the pinch because our money will, quite visibly, not buy what it would before. The end result is to penalise the careful, thrifty people and to make life easier for those who run up big debts. That is not a result that is that is either wanted or just but is convenient for those who have borrowed and have to make repayment.
So keep an eye on those figures announced every month in your country. It is the policies exercised by the government that affect them and if the trend is upwards that is not a good sign. Trends are important because these actions take a long time to become apparent and by that I mean years not months, but if the wrong policies are followed for too long then inflation will happen just as surely as night will follow day.
Of course there are a vast number of complexities mixed into the pot to make the issue difficult to understand clearly, even for financiers, but the basic principle remains the same whatever the “confusers” tell you.
Like the balloon at the beginning, inflation causes monetary things to get bigger and bigger until eventually BANG!!!
