Make no mistake - Inflation exists by design, and you can choose to either lose or profit from it.

If you studied economics in high school, you would understand the concept of how supply and demand interact in the economy. For example, if there is an abundance of (say) lettuce in the market (over supply relative to demand), then the price of a lettuce will be cheap - it becomes worthless and not overly valued at (say) $1 per lettuce. However, if there is an event, such as weather, that wipes out lettuce crops which in turn cuts the supply of lettuces relative to demand, then the price of a lettuce goes up to (say) $15 per lettuce - as it is currently in Australia.

The higher the supply of something, the less value it has. The lower the supply, the more value it has - simple right? That's why the oil producing countries (OPEC) control the production (supply) of oil in order to maintain their profit margins. If there is too much supply relative to demand, then oil becomes cheap and profits dwindle. If supply is short relative to demand, prices will skyrocket and people will be unable to afford the fuel - again profiits will suffer due to lower volume sales. Therefore a balance must be met between supply and demand, in order to maximise profits for the OPEC members!

In a previous post titled "Is it inflation of goods and services, or is it devaluation of the currency that is happening?" (see link at bottom of page), I addressed the fact that money loses value each and every year, and stated that maybe the topic of inflation needs to be looked at differently, more as the devaluation of the dollar, rather than the inflating or increasing of the cost of goods and services. If you haven't read that post yet, I suggest you do so before continuing here.

If you have looked at economic history, you will know that once-upon-a-time the dollar was backed by, and hence, pegged to gold. This meant that technically, you could exchange your dollars directly for gold.

As a result, if the government wanted to print more cash to inject into the economy, they had to have the gold reserves to back the newly printed cash.

Back in 1971, all that changed when US President Nixon decided to take the dollar off the gold standard and make it independant. All other countries followed because it was a great way for governments to print all the cash they wanted in order to pay for things thay needed to fund, as well as pay down their debt.

Of course, every action has consequences, and these consequences were huge.

If you look at the historic prices of gold, housing, commodities and other true assets, the prices of these items were quite stable for decades. However, once the dollar was no longer backed by gold, and governments could print as much cash as they liked, the dollar became "worhless" and began to lose value against all true assets at a huge rate.

Consider this....

Back in 1980 a $10 note could buy me 50 litres of fuel.

Today, in 2022, the same $10 note will buy me about 4 litres of fuel.

It is the same $10 note, however, it's value has diminished. It is not valued as much as it was 42 years ago.... even though it is exactly the same $10 note!!! The reason the dollar has so much less value, is because so much has been printed by governments that the oversupply of the dollar has made it less valuable - just like what happened in the examples above.

Of course, no governemt wants to state that their currency is losing value over time - as it would appear as though they are mismanaging the economy.

So, instead of saying that the dollar is losing value, they claim that the prices of goods and services are increasing - and they refer to that as "inflation"..... however, we know that it is the dollar that is becoming less and less valued over time, and NOT inflation of prices.

Still skeptical??? Then consider this......

1980: The cost of 50 litres of fuel was the same as the cost of 40 loaves of bread. The same 40 loaves of bread would cover the cost of train fare from my home into the city for a month. The 50 litres of fuel, 40 loaves of bread and the month of train fares each could be bought for about $10.

2022: The cost of 50 litres of fuel is about the same as the cost of 40 loaves of bread. The same 40 loaves of bread will cover the cost of train fare into the city for a month.

The 50 litres of fuel, 40 loaves of bread, month of train fares still are the same value relative to each other 42 years later, HOWEVER, none of these can be purchased for $10 any longer. Each of these items will now cost you over $100 to purchase!

It is the same bread, same fuel and same fare. We still value each of these items the same as we did 42 years ago relative to the other. So, you can still swap 50 litres of fuel for 40 loaves of bread, and one month of train fares into the city.

This is an important point.... "We still value each of these items the same as we did 42 years ago relative to the other. So, you can still swap 50 litres of fuel for 40 loaves of bread, and one month of train fares into the city", but what has changed is that we value the dollar much less than we did 42 years ago - in fact, the dollar has lost 90% of it's value in the last 42 years.

Now that we understand that "inflation" is the actual value of the dollar diminishing against the value of all goods and services, rather than the price of goods and services increasing, we can begin to understand why the government wants inflation to exist and why they created it, and finally how you can choose to either benefit from it or suffer because of it.

Now, let's look at the following example. In 1987, I purchased my first property with my wife here in Sydney for $96,000. We borrowed a total of $60,000 from the bank (our combined total annual salary was $50,000). This $60,000 mortgage was a fortune for us back then and a huge debt burden. However, today in 2022, the same house is valued at $1,350,000, and if we still had the full $60,000 mortgage in place (we don't) that debt (liability) would be relatively miniscule compared to our house (asset) and very manageable. In fact, today there are people with bigger credit card debt that what our first mortgage was back then.

What has happened is that assets have increased exponentially in value relative to the dollar.

Applying what we have just covered to the economy, we know that governments can, and do, actually print money at will, for whatever reason they deem fit. It could be to stimulate the economy, create liquidity in the markets, pay bills etc.

Increasing the supply of anything, will decrease it's value over time - we see this with lettuce, oil and now we understand that the same happens when applied to money. The more dollars the government prints, the less value dollars will have against everything else (the old supply and demand story).

Now we know that around 2010 after the GFC, governments around the world printed money at super crazy speed and injected that money into the economy as well as lowered the interest rates. The reason for that was to stimulate the economy. However, though stimulation of the economy was the objective (and yes, it worked) the "hidden" legacy and result of that was that the oversupply of cheap money began to increase asset prices - which we now call "inflation" (of course, we now are smart enough to know that the oversupply of the cheap money actually devalued the dollar against all assets).

Since 2010 until now, we have seen trillions of dollars created and injected into economies throughout the world - known as "quantitative easing". In 2020, immediately after and directly due to the COVID-19 pandemic, governments world wide did the same quantitative easing (creation and injection of cash into the ecomomy) and again lowered interest rates to stimulate the economy. These actions worked to get the economy out of trouble, BUT the legacy effect of creating all this excess easy and cheap money is that money has now lost value due to "inflation". We can now see this in the increased cost of assets, goods, and services world-wide.

We know that governments raise money by taxing their citizens and businesses. We also know that governments spend more than they can afford in order to meet silly election promises. Another way governments raise money to pay for things is by borrowing. One of the ways they can do this (for example) is by selling Government Bonds. Basically, they create an IOU (Bond) and sell it in the market place. You, or an institution, will buy that Bond from the government and in doing so, you receive an annual interest rate (return on your investment) and at the time of maturity of the Bond (various timeframes are available depending on the Bond of up to 10+ years), you can hand it back and collect your principal. Easy right?!

Now, let's look at this a little differently..... If I had purchased my first house in 1987 by borrowing money the same way as the government, I could create a Bond for $60,000 with a 20 year maturity, sell that Bond to you and pay you a nominal amount of interest. After 20 years, you would come to me and request your principal of $60,000 back. I oblige and give you your $60,000 back to you and take back my Bond.

The thing is that the $60,000 I give back to you in 2007 has lost value over the last 20 years due to inflation.

My house is now worth $900,000 (up nine-fold), our combined salary has also increased substantially (about four-fold). If I was to buy my house in 2007, I would be borrowing over ten times the amount I did back in 1987.

However, it is now 2007 and I am paying you back only $60,000 - which is negligible compared to my 2007 salary, and the value of my 2007 asset (house). Inflation has allowed me to borrow what was a substantial amount of money back in 1987, and pay it back to you in 2007 after the value of the money has diminished by 90%. In other words, $60,000 in 1987 is MUCH more valuable than $60,000 in 2007.

That same $60,000 back in 1987 is worth even less today than it did in 2007.

In fact, to put things into perspective, that $60,000 borrowed

• In 1987 that $60,000 was appoximately 62% of the value of the house.

• In 2007 that $60,000 was approximately 6.7% of the value of the house.

• In 2022That $60,000 was approximately 4.2% of the value of the house.

So as you can see, when the government borrows money today, and then pays it back in tomorrow's dollars, the debt is worth much less due to the effects of inflation. When you understand this, then you will then understand why the government NEEDS inflation in order to reduce their debt over time. Of course, the challenge faced by all governments is that they need inflation at a "reasonable" level that will reduce government debt over time, without crippling the economy and sending asset prices (relative to the dollar) skyward and creating hyperinflation!

Inflation, is why the idea of holding too much cash, is a receipe for losers.

Since cash loses value over time, and the amount of interest paid on the money does NOT keep up with inflation, it becomes a losers folley.

The vast majority of people do not understand the above simple facts regarding "inflation".

This also means that the vast majority of people also fail to understand that, what works for the government, can also work for individuals. In fact, individuals can, if they are smart about it, make an absolute fortune over time using this knowledge.

One final real-life example for you to consider:

It is 2012. You have $250,000 available in cash we can consider 3 different scenarios and see how the outcomes play out over a 10 year period..

Scenario 1: Joe takes the $250,000 and buys two cars, one for his wife and one for himself, takes the family on an overseas vacation and puts the balance of $100,000 into a bank account earning an average of 2% pa interest for 10 years.

Projected outcome: The cars are worth maybe a total of $15,000 after 10 years. The holiday money is gone. The saved money has increased due to compounding to $122,000, but there is a capital gain tax component of $7,000 (roughly) that needs to be paid.

Total value after 10 years of $130,000

Scenario 2: John takes the $250,000 and invests it in a term deposit. He never spends any of the capital, but does spend the $7,500 interest that the money generates each year on "stuff" (after tax has been paid of course!).

Total value after 10 years of $250,000

Scenario 3: Jack takes the $250,000 and purchases two small factory units that are each worth $250,000. He puts $125,000 deposit on each, borrows another $125,000 for each one so there is a 50% loan to valuation ratio (total of $250,000 borrowed as an interest only loan at 5.5% average rate over the 10 years). He rents each factory out at an average rental of $22,000 each over the 10 year period. The properties are cashflow positive and hence cost nothing out of Jack's pocket. The total monthly rental return from both properties is approx $3,200 per month after all costs. The loan repayment is approx $2,000 per month, leaving a positive annual cash flow of $10,000 after tax paid. The $10,000 per year is invested each year into shares that give an average dividend of 7% pa paid monthly (yes, that dividend really exists!)

After 10 years: Properties are now worth $650,000 each - Total $1,300,000*.

Invested Cash is worth a total of $147,000. Outstanding Debt is $250,000 (no principal repaid as loan was interest-only).

Total value after 10 years: $1,300,000 + $147,000 - $250,000 = $1,197,000

* Actual real numbers from an actual personal experience during the same time period

You can see, from the above 3 scenarios, that depending how the money is used/invested, vastly different outcomes are possible.

Scenario 3 shows how Jack uses time, inflation, dividend re-investing, compounding, and how he managed to use yesterday's money to purchase income producing assets that appreciated in value (relative to the dollar) grew quickly and can in turn can be paid for in tomorrow's cheaper dollars.

Scenarios 1 and 2 show how Joe and John have fallen behind. In fact here are the real outcomes for Joe, John and Jack in 2022 dollars assuming an average inflation rate of 4%**(remeber they started with $250,000 cash in 2007):

** The 4% inflation rate is based on the Government calculation, however, real asset inflation was much higher than this, and that is why property prices have increased so much.

1. Joe invested his $100,000 after spending $150,000 on "stuff" and after 10 years had a total of $130,000. However, due to inflation erroding the value of his cash over the last 10 years, he now has the buying power of $86,500

2. John may have $250,000 left in cash, but due to inflation effects over the last 10 years, he now has buying power of only $166,000 in 2022.

3. Jack has stayed away from cash and instead invested in property assets and stock assets. As a result, Joe has multiplied his initial $250,000 by almost 5 times and turned it into $1,197,000 ($1.2M) in 2022 !

Lesson:

Using today's money to purchase income producing assets, means you will be paying them off in tomorrow's less valuable currency while your asset grows in value over time, and continues to produce an income during that period also!

This is how the rich get richer.

Lesson:

Sadly, the vast majority of people will borrow money to buy liabilities such as cars, holidays, holiday homes, furniture, boats, jewellery etc that either lose value over time and/or cost money to keep. Do NOT be one of these people.

This is how the poor get poorer.

Lesson:

Cash is a poor investment and loses value over time. Don't be like Joe and John.

Lesson:

Inflation was designed by the government to reduce their debts. This is why they removed the requirement for the dollar to be backed by gold (or any other asset). However, what works for the government to create wealth also works for individuals but ONLY IF money is used to buy assets and NOT liabilities.