I am not an economist, but I can do basic math and my guess is you can too. The reality we all face right now is inflation is eating more of your money on a daily basis. That is why it is more important than ever before to invest money in assets that benefit from inflation instead of being harmed by it.
Jerome Powell is the current Chairman of the Federal reserve. If you aren’t familiar with the federal reserve it is the central bank of the United States of America, and its goal is to provide our country with a safe, flexible, and stable monetary and financial system.
The federal reserve does a few different things to supposedly make the American economy stable. And I say supposedly, because it is a total mess right now, because of the things the federal reserve didn’t do. But they mainly set interest rates, influencing the supply of money in the economy, and, in recent years, making trillions of dollars in asset purchases to boost financial markets.
Jerome Powell and what he does or don’t do makes him the most important person in our federal government. The president, the congress, and the senate can create a better environment or a worse environment for the Fed Chair to operate in, but at the end of the day, the Fed Chair person, (Powell currently), is the most consequential person in our government.
One of the mandates for the federal reserve is to keep inflation around 2 percent. Why do they shoot for the 2 percent number isn’t all that important, but that is the goal. Some people think 2% is too low of a number to begin with.
But here is a quick summary of why the government believes 2% is a good number to shoot for.
From the website Five Thirty Eight.
“The Fed thinks that 0 percent inflation is bad. At that rate, we risk the opposite phenomenon: deflation, where prices drop. Now, lower prices might sound like a good thing. But periods of deflation can actually lead to economic downturns, as research has found it’s bad for wages and overall growth. We’ve seen this multiple times in U.S. history, like during the Great Depression and the Great Recession. One reason is that people tend to delay big purchases when they see prices dropping, because they figure they might get a better deal in a few months. The result is that companies struggle, they lay off employees and wages fall.
Meanwhile, inflation can be beneficial. Let’s say you’ve recently bought a car, and you got a $10,000 bank loan to pay for it. A year from now, with, say, 2 percent inflation that $10,000 won’t be worth as much. At the same time, you’ve maybe gotten a cost-of-living raise to keep up with the value of the dollar. And now you can take some of that extra money you have and put it toward something else you want — which has the added benefit of spurring on the economy.
So, economists generally agree that some amount of inflation is important. And central banks around the world have settled on 2 percent — including in the U.S., where it was officially made the standard in 2012.“
How does this impact you on a daily basis.
Example using a 2% inflation rate:
Today your dollar is worth $1. With 2% inflation. At the end of the year same dollar is now worth .98 cents. On the flip side of that. Take a product you buy on a regular basis, and it costs a $1. And the end of the year that same product costs you $1.02. So if your dollar is now worth .98 cents and the product you are buying is now $1.02 you are actually 4 cents behind.
The Fed believes that this amount of inflation is the right amount.
And you can see below with the charts that historically they have done a decent job at maintaining the 2% number with the exception over the last year. As you can see below.
1 year inflation rate
5 year inflation rate
25 year inflation rate
So we are in the midst of the highest inflation of most of our lifetimes.
When you look at the last year versus the 25 year. It is really scary. And it hasn’t moved in months.
So now do the calculation on that dollar.
If we look at the current inflation rate from January in the above chart. 6.4%. Let’s look at that same dollar.
Today your dollar is worth $1. With 6.4% inflation. At the end of the year same dollar is now worth 93.6 cents . On the flip side of that. Take a product you buy on a regular basis, and it costs a $1. And the end of the year that same product costs you $1.06.4 So if your dollar is now worth 93.6 cents and the product you are buying is now $1.06.4 you are actually 12.8 cents behind.
Kind of scary when you start doing the math isn’t it?
And you now know why you can’t afford what you used to buy.
As I mentioned earlier. Now more than ever it is important for you to put your money into assets that benefit from inflation versus being hurt by it.
Real Estate is one of the biggest winners when it comes to inflation.
A house worth $100,000 last year is now worth $106,400. On the surface that doesn’t seem like much difference, but you compound that over the next five years and that becomes:
Year 1 price: $100,000
Year 2 price: $106,400
Year 3 price: $113,209.6
Year 4 price: $120,455.01
Year 5 price: $128,164.13
Meanwhile the chances your wages increase that same amount is very low.
So let’s say the Federal reserve gets inflation back to 2% sometime soon. Let’s look at the same $100,000 house.
Year 1 price: $100,000
Year 2 price: $102,000
Year 3 price: $104,040
Year 4 price: $106,120.8
Year 5 price: $108,243.21
You can still see how real estate benefits from inflation versus being hurt by it.
There isn’t much any of us can do to impact inflation. It is happening and it is always going to happen. But you can start to invest your money in to things that benefit from inflation versus losing money because of it.
To your success and your future.
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