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Inflation: Why You Should Care About It

Jun 26, 2014 | Market & The Economy | 0 comments

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A few quick facts about Inflation:

  • It’s your biggest enemy the day you retire
  • It’s your biggest friend when you buy a house
  • It’s your biggest argument in a wage negotiation
  • For some reason, we only recognise inflation, never deflation
  • We all have our own ‘personal’ inflation rates, as our ‘basket of goods’ varies from one person to the next

What do most people think about inflation, other than when it goes up, it’s time to panic and think the worst? And is this really correct? Furthermore, is inflation really all that bad?

My wife was a caterer by profession. For her, the cost of food was everything. Today, she often emerges from the shops exasperated by the rising cost of food. She still thinks like a caterer: rising prices were her margin disappearing in front of her eyes. I have never had enough courage to point out that she does not give half as much emotion or thought to when she sees a bargain or reduction in price.

According to David Mohr of Old Mutual, this is a very common reaction. Mohr also says that for the last 40 years, people have been criticising Stats SA for low-balling the inflation figure, but when an analysis is done on the historic data, it shows that their estimation is not far off the mark.

Knowing what inflation is and how it works for and against you is as important as knowing what you spend on a monthly basis.

Inflation and other economic concepts easily explained

Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. This is how it’s measured:

A selected basket of goods reflective of the average consumer is priced annually. The following year, the increase in the price of the same basket of goods is measured and shown as a percentage. Currently this percentage is just above 6% in South Africa and is known commonly as CPI (Consumer Price Index).

If prices decline, this is referred to as Deflation. We do not experience much of this in South Africa but it certainly sounds good when thinking about your grocery shopping.  However, the consequences of deflation are dire.  In Ireland, house prices fell between 40-60% between 2007 and 2013.  The results were that salaries were either frozen or driven down and people stopped buying goods. The negative knock-on effect of deflation to the wider economy is enormous.

Disinflation is when there is a decrease in the rate of inflation – a slowdown in the rate of increase of the general price level of goods and services.  We have seen this in recent years in SA and this is good for share and bond market investors.

Hyperinflation is what we saw in Zimbabwe a few years back, when prices move up very quickly. For example, you book into a hotel room, and if you booked in the next night you’d pay a significantly increased price. This is not good for most investors as your investment becomes significantly eroded.

Stagflation is a situation where the inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high. It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate unemployment. This again makes economies very nervous.  People feel insecure in their jobs, spend less, and again, this knocks on to the economy.

In order for our investments to grow, inflation has to increase … but it’s the rate that it increases that determines whether there is a positive or negative return on our investments. Therefore some inflation is a good thing, but hyperinflation is going to significantly erode our investments. This is why it’s so important to have a financial planner on board. Your circumstances will dictate your tolerance of Inflation, and your financial planner can guide you towards a diversified portfolio of investments that give you a return above inflation.



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