Inflation-The Silent Thief

Warning, Inflation Bumps Ahead!

The inflation rate in the United States has been so low for so long, you might be tempted to think that it will remain low into the near future. The current inflation rate is at just 1.2%. During the era of “multi-bubble” economies, we haven’t had to worry about inflation much. Keep in mind however, that during the 1980″ inflation climbed above 15%.

What is inflation? Inflation means that the dollar is worth less than before and therefore all of your dollar-denominate assets (stocks, bonds, real estate, etc.) are also worth less, compared to the equivalent assets in other countries. In a high-inflation environment, assets lose significant value. The only way these assets regain their value is by earning an annual return at a rate that exceeds the prevailing rate of inflation. It’s as if you are on a boat trying to go upstream: the only way to make any headway is to travel faster than the current is pushing you backwards.

The same is true for your income. You have to get a pay raise every year that is equal to the annual inflation rate, just to stay even. Otherwise, you are actually earning less money.

Will we see a return to the levels of inflation that were experienced the mid 1970’s and 1980’s? There is very compelling evidence that inflation is likely grow to 10% and perhaps even more in the next few years. At 10% inflation, your stocks, bonds, real estate, etc. would have to grow at least 11% in value every year just to be worth a mere 1% more than the year before. More likely, real asset values will increase much less than 11% (if they grow at all) and real asset values will drop.

Do you find this hard to believe? We are going to present a series of articles (starting with this one) that we think outlines how inflation will grow from its current rate of less than 2% all the way to 10%.

Inflation – The Beginnings

So, where does inflation come from? Many people believe that price increases cause inflation but, higher prices for goods and services are actually the result of inflation, not the cause. What actually causes inflation is the amount of currency in circulation relative to the size and growth of the economy. A rapidly growing economy needs increasing amounts of currency to keep up with the demand. But if we rapidly increase the supply of money in an economy that is not growing rapidly, the value of that money eventually declines (based on supply and demand) and inflation rises. When money is worth less, things cost more. For example, if the inflation rate is 2% annually, a $1 candy bar will cost you $1.02 in a year. As someone once said, “In inflation, everything gets more valuable – “except money.”

Part of the reason that I believe we are on the road to 10% inflation is the size of the recent increase in the US money supply. If the Fed had increased the money supply by 20% or 30%, there would be little reason for concern. But, according to the St. Louis Federal Reserve Bank, the United States’ money supply has increased by almost 300% since late 2008!

This is a huge increase and the consequences of this are going to eventually be enormous. If you believe that jumping our money supply from $800 billion just two years ago to nearly $2.4 billion in 2010 is huge, there is some talk that the Fed is actually contemplating increasing the money supply even further – perhaps to as much as $5 trillion!
Nothing like this has ever occurred before in the United States. Many people understand that we are printing more money, but few are aware of the huge portent of the increase. As with most things, size matters. A small increase in the money supply that roughly tracks the increase in the GDP won’t increase inflation, but large increases in the money supply that dramatically outstrip the increase in GDP will most certainly trigger a dramatic jump in inflation.

Keep watching our web site for the next installment in this series about inflation. In our next installment, I will explain the “lag factor” that has so far kept us from experiencing the inflation one would expect to see from the dramatic increase in our money supply. We’ll also examine the devastating effects of hyper inflation in some other countries.