One of the concerns I hear expressed more often today, is the fear that inflation is forthcoming. In my adult life I have experienced high inflation only once, but it is one of those experiences that are not forgotten. A question that can be raised though, is inflation bad or good?
Inflation is one of those events that in moderation it is good, but too much and it can be very bad. Can you imagine living in the U.S. without any inflation? Before you jump for joy, think what that really means. My parent’s $25,000 house purchased in 1963 would still be worth $25,000. While housing prices have fallen recently, the long term trend is still up, due to inflation. Why would you want to own a house if in the future it would still be worth its original purchase price? There would be no reason to pay all of that interest; it would be better just to rent. Part of any investment’s gain is appreciation from inflation. Granted, investments like stocks can become worth more if the company is more profitable. But many investments go up in value partly from inflation.
A price increase is always blamed on inflation. But that is not always the case. Oil, since it is traded in dollars around the world, can cost more to U.S. buyers when our currency is worth less against the value of other currencies such as the producing nations. Therefore, when our currency is deflated it takes more dollars to purchase the same commodity. While this is clearly inflationary, it is not something our government can always do something about.
One of the primary components to inflation is wages. Wages account for over 60 percent of our economy, thus when wages increase its impact is far reaching. The cost of most items produced is impacted due to higher wages and without raising the product’s price or producing the product more efficiently, profits will be less. Thus, where does it stop? The goal of most workers is to improve their standard of living and this can be accomplished by receiving a raise. However, by the time the wage increases of all employers works its way into costs, the cost of all we purchase has gone up and eroded the benefit of the raise. Fortunately in the U.S. many of the employers have been able to provide wage increases but also experience gains in productivity or efficiency, thus permitting wages to increase at a faster rate than price inflation.
By understanding how wages impact inflation, for the next several years the threat of inflation as caused by wage increases will be reduced. Since unemployment has risen, there is more competition for the jobs than are available. This will permit many employers to maintain and perhaps lower their wage costs for a few years. This alone will assist in moderating the impact of inflation. This is not to say we will not see higher energy costs. Many of these costs may be caused more by a weak dollar than demand driven inflation.
While the government has turned the money printing presses on high, the banks are clearly assisting in the control of spending. By tightening their lending rules, the increase supply of money is not finding its way into our economy too rapidly. Spending is the solution to getting out of the recession, but when too much money is chasing too few products, the end result is higher prices and the cause of inflation. Without the banks lending and businesses idling capacity, our economy will be able to avoid inflation for the near term.
But, inflation is still a concern. Steps to hedge against inflation could be taken by owning commodities such as oil, gold, or real estate. Since higher prices may be created by a weaker dollar due to the high budget deficits, then owning investments traded in dollars around world will provide some protection. Also investing outside the U.S. can also provide a hedge.
For the near-term, inflation should not be a significant factor since the banks are acting as a throttle on how fast the money flows back into the economy. Additionally, wages will not be rising too quickly due to the competition for jobs for the next 12 to 18 months. But with each passing month, the picture of when and how inflation will impact our economy will become clearer.
For help with managing investments contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our website, www.goqfc.com. There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other tools all available for free.