The Inflation equation
Updated: Mar 18
Inflation destroys the middle class. The rich stay rich and the poor stay poor, it is the Middle-Class who feel the brunt of the pain. But it doesn’t have to be this way, we always have options. After-all, the rich manage to stay rich, so why can’t you keep hold of your money?
Firstly, let’s take a high-level look at inflation.
As the money supply increases, the price of goods start to rise. Wages typically don’t rise at the same rate and so we begin to feel the squeeze.
Savings in the bank start to lose purchasing power as prices rise. This happens slowly at first, but inflation is a process rather than an event, it builds momentum until prices are doubling on a regular basis.
As hyper-inflation sets in, prices sky-rocket, your savings have become worthless and all you have to rely on is your income and you are living hand-to-mouth, day by day. You have no savings, no wealth, a job that provides your only lifeline. This is what it feels like to be poor and this is what hyper-inflations do best, drive people into poverty.
Why do they keep pursuing inflationary policy?
Now I think I can speak for us all in saying that this sounds like something to avoid at all costs. So then, why do Central Banks pursue it so persistently?
Central Banks try to create and control inflation. They want it, but they don’t want too much. A dangerous path to walk.
When we talk about the dangers of inflation and its destructive powers it is usually from the perspective of savers. What is overlooked is that not everyone suffers the same fate, hence why Central Banks try to create it in the first place.
Value is like energy, never destroyed, only transferred from one form to another. As you watch the purchasing power of your savings fall, those in debt see the reverse happen, the value of what they must repay is not increasing but falling, courtesy of the savers.
Inflation is a boon to those in debt and no one more so than governments, the world’s biggest debtors.
It allows them to take on more debt and overtime it simply disappears, settled and paid for by the value taken from the savers in the economy. Inflation really is a matter of perspective, great for some and destructive for others.
Savers are losers
When I first heard the phrase ‘savers are losers’ it didn’t make a lot of sense and just seemed to contradict everything I understood about finance. However, in understanding the two sides of inflation this phrase starts to make sense.
Savers save and inflation erodes their savings over time. Debtors take on debt and inflation reduces their debt burden over time. In an inflationary world, value flows from savers to debtors, the savers lose and the debtors win.
What is important is to be on the right side of the equation, the side where your wealth grows and your debt burden falls. Sound too good to be true? Read on.
Am I suggesting you go out and blow your savings and get into debt? Well, let’s explore the idea a little further before answering that.
Its all about the assets
It is important to understand the difference between assets and real assets. Assets come in many forms, from financial contracts such as bank deposits or bonds, ownership rights such as equities and real assets such as land. Whilst the first two groups are man-made the third are ‘real assets’ because they are of this world.They existed before the days of Adam & Eve and will be here long after we have left this planet.
Land, precious metals and oil are all real assets. The reason they are so important is because they have no counter-party; they are valuable in and of themselves. Even in a world of Financial Armageddon, with insolvent-banks and bank-runs, it may seem like the entire world is falling apart around us, yet real assets would remain untainted. All the real wealth in the world would still exist, the gold would still shine, the farms would still produce and the land would remain in situ. After all, they aren’t a man-made construct like most of the things we consider to be assets - these are ‘real’ and given that name for a reason, they cannot just disappear because they are of this planet.
Given that 2008 provided a recent reminder that financial Armageddon is always but a few steps behind us it suddenly makes a lot of sense that governments, Central Banks and the wealthy are pouring money into precious metals.
The other beauty of real assets is that they stay afloat during hyper-inflations. Consumables increase in price but as they are consumed the gain in value is lost. Real-Assets however, are never consumed, only exchanged. They maintain their value from start to finish and remain completely unaffected in what they are. They store your value into the future, hyper-inflation or not. Even in a world of modest inflation, they absorb the price increases that result from the gradual loss of purchasing power of your money in the bank.
Getting on the right side of this equation involves converting bank savings into real assets. It is that simple. It is how the rich stay rich and why the Middle Class get wiped out. Why lose your hard-earned purchasing power to inflation when you can actually gain from it?
This is where we can begin to see the synergies between debt and real assets in the context of inflation. The use of debt to purchase real assets in an inflationary environment is an extremely sophisticated method to get rich. On the one side your debt is reducing in value (like that of governments) and on the other your assets are increasing in value. That’s a double whammy! It is however, an advanced technique and it wouldn’t be wise to adopt without considerable experience in the game. One step at a time.
Silver to start?
At US$16 however, an ounce of silver is perhaps the most accessible real asset I can think of. We are not all in a position to go out and buy acreage of farmland and so I believe silver and gold are the best entry points into this world of the rich.
As your coins begin to stack up, consider yourself not just protected against inflation, but benefiting from it. Moving your savings out of cash and into a real-asset places you on the right side of the inflationary equation and helps you build wealth into the future, not lose it.
From there who knows where the journey will take you.