We Need to Talk About Inflation

And you should be worried

Inflation is one of those concepts that everyone knows about but very few understand (unless you have the misfortune of living in a high inflation environment). In the western world we have been fortunate that we have not had to deal with runaway inflation in decades. So, what is the big deal?


What is inflation?

Inflation is the erosion of your money’s purchasing power over time. You don’t actually see your money going down in value, what you do see is the cost of items increasing.

The mars bar and pint of milk are considered to be household staples and are the classic examples used to show inflation at work

Do you remember going into the shops as a kid to buy your favourite chocolate bar? (of course you do). Isn’t it crazy how everything was so much cheaper back then… That’s inflation. Inflation is the erosion of your money’s wealth over time.


What Causes Inflation

This subject can get very deep fast and we don’t want to bore you to the point of non interest in the subject. The basic causes are detailed below and can be investigated in more depth if you wish here.


Summary of Main Causes of Inflation

  1. Demand-Pull Inflation: Demand for a product grows too fast for the supply, thus pushing prices up. We covered an example of this using shipping containers here.

  2. Cost-Push Inflation: For example, higher oil prices = higher petrol costs = higher taxi fares

  3. Devaluation: A decline in the value of a currency which makes it more expensive to buy products from abroad but also makes local products cheaper to export

  4. Rising Wages: Higher wages increase a firms costs so they increase the costs of their services which are passed on to the consumer who has to spend more of their wages for the same product. These consumers will then demand higher wages from their employers who then need to increase their costs… you get the idea.

  5. Expectation of Inflation: Workers expect prices to increase and demand higher wages from their firms who in turn have to increase their costs aaaand we are back on the Merry-Go-Round.


Shrinkflation

Another reason as to why you may not be directly noticing inflation is that product producers have a very effective trick they can play on consumers over time. The trick is Shrinkflation which essentially means that you reduce the quantity / volume of a product while tending to keep the headline pricing equal.

It is also hard to pick up on shrinkflation day to day for the general consumer without multi-year tracking. This is another hidden inflation tax that hits you directly in your pocket. Once you start noticing this you can’t unsee it, like the Red Pill from the Matrix.

In 2018 Toblerone tried to keep the price of its iconic chocolate product around a £1 by reducing the amount of chocolate. After a public outcry they reverted to the old shape and went with a price hike instead.

Inflation is on the rise and we can trace a lot of its links back to the constant expansion of currency. Printing money increases the monetary supply in circulation which in turn can have extensive knock on affects that can cause inflation. Inflation is a spaghetti monster of interconnected causes and studying it is an industry in itself.


The Wealth Gap View: Inflation can be a dull & boring topic for the casual reader. We don’t want to make this topic a minefield of information.

That being said, in the current environment your CASH (the money you earn) has notably less Buying Power than it did one year ago, especially if you were saving for a house (house prices have soared). The amount at which this has happened is a hot debated topic by economists around the globe. What we can all agree on is that cash is losing value over time.

The loss of purchasing power in Cash is extremely problematic, especially if all of your savings are in it. Cash is still a liquid asset and essential for day-to-day expenditure so it still has its uses as a short term holding. If you are holding cash over the medium to long term (5+ years) then you risk your cash losing significant value over that period as your cost of living rises while your cash does not.


We cover what you can do to protect yourself from your cash savings melting here!


Until next time

The Wealth Gap