One term that is very relevant to today’s world is inflation, which will be the topic of this newsletter.
Over time the buying power of currency goes down. 100 years ago, 1 dollar was far more valuable than 1 dollar today. There are multiple possible explanations for why currency devalues over time. We will discuss some of the possible explanations below. The explanations are not mutually exclusive, and reality can be a mixture of multiple explanations.
The first possible explanation is that inflation is caused by an increase in aggregate demand. As mentioned in earlier newsletters, there is a connection between demand and price. Essentially as more people want to buy an object, unless supply increases to compensate, the result will be more people competing to purchase a limited supply. Think of an auction and how people are bidding for a single item. One quote by researchers Barth and Bennett that summarizes this explanation is “too much money chasing too few goods”. Some ways that aggregate demand is increased are government spending, lower unemployment, and population growth.
Another possible explanation is that inflation is caused by a decrease in aggregate supply. There is a connection between supply and price. If the supply of an item goes down, the people who wish to buy the item will have to compete harder with each other to get it. For example, let’s say 100 people wish to buy chairs. If there are 100 chairs available, everyone is happy and there is no competition. If there is only 1 chair available, then the people will compete fiercely with each other. Competition is done on the basis of price. Basically, people are saying I will pay more to get the item I want. Some ways that aggregate supply is decreased are natural disasters and war.
Another possible explanation is that the supply of currency (as created by the government) is increasing faster than how quickly goods are being created in the economy. Again, inflation would be caused by “too much money chasing too few goods”.
The next question that must be answered is that with inflation draining the value of your currency, what should you do with your currency. If you keep your currency in a vault under your house, eventually that currency will become completely worthless. Often, banks don’t pay a high enough interest rate to keep up with inflation. We assert a great way to deal with inflation is investing in assets such as stock and real estate. Historically, as inflation increases, those assets increase as well. They often increased either the same as or more than the inflation did.
If you have any questions about your investments, please call at any time. We sincerely hope you got value from this newsletter.
We appreciate your business and trust.
Thank-You
Dan and Eli
As we’re writing these to help our readers, we would be very appreciative of any input in regards to what we should write next. If you want us to write about a particular topic, please contact me. Please contact me if you would like to submit a post to our blog.
If anything that we mentioned above interests you, please consider downloading our free e-book. The book contains our thoughts on investment management and some information that we think everyone should know. You can also download it below.
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