Inflation – Making Pennies Worthless, 3.257% a Year
Don’t expect to see that on a t-shirt or anything (let me know if you do!) but inflation is hurting our poor defenseless pennies. We all know what inflation is, but most of us don’t really think about it on a daily basis; even when we’re making our most important financial decisions.
It’s those stories you hear about a pack of gum cost 5 cents back in the day and now they cost fifty cents or more; that’s inflation, or the erosion of our currency’s purchasing power.
Let’s ignore the bigger macroeconomic issues as to why inflation exists and whether it’s good or bad, because honestly I don’t think most people care. We can let economics and policy makers analyze those aspects because it matters to them (it better!)
For us little people, let’s talk about how they measure inflation. There are two indexes (indices if you prefer) most people talk about: the Consumer Price Index (CPI) and the Producer Price Index (PPI). They are the big indicators and the US Bureau of Labor and Statistics tracks them both. In summary, the CPI tracks price changes with respect to the consumer and the PPI tracks them with respect to the producer.
They say in the long run the two trend similarly but in the short term the PPI will lead the CPI (which follows intuition, producers raise prices before consumers feel them). Well, when the Federal Reserve meets (8 times a year) to decide whether or not to adjust the short term interest rates, the CPI/PPI is a factor they take into consideration.
Well, how does this affect me/you? Basically, your investment’s true return is really its stated return minus inflation and taxes. Nearly everyone accounts for taxes because you take money out of your pocket. Inflation is an invisible tax because you’ll just lose purchasing power, not actual dollars.
But I don’t invest a lot of money; where else will this affect me? Your salary! Are you happy with that 2% raise? You would be if everyone around you also received a 2% raise (or less), but what if I told you the historic rate of inflation was 3.257% since 1913 (according to the inflation calculator on the USBLS website)? That meant if our rate of inflation this year were 3.257%, you actually took a purchasing power pay cut of 1.257%!
How do the interest rates of ING Directrel and Emigrant Direct sound now?
How about that bond
When you have to beat 3.257% CPI-based historic inflation rate, it doesn’t look as appealing huh?
Look at some of the actual historic rates and you can see that in some years the rates were much higher (though you would expect rates of return for CDs, bonds, and the like to be much higher as well). So think about the rate of inflation next time you make any sort of financial decision, it’ll open your eyes.