What is Inflation and Can You Avoid It?

What is Inflation - Can Bonds Help

Are you considering inflation-adjusting bonds to avoid future inflation?

I had dream once that I went to the grocery store and everything was priced ten times what it normally was. Milk cost $30!

So I went to another store. Same results. Prices were marked up ten times what they normally were. A bottle of coke was $10!

In a panic, I ran to the nearest store clerk and asked him why prices were so high. I said, “It’s 2010 man. We’re in a recession. Why are these prices so high?” He looked at me like I was crazy and said, “sir, it’s the year 2050!”.

The shock woke me from my dream and I checked my my phone to make sure it was still 2010. Whew!

Okay, that was a lame story, but that’s what inflation is all about.

What is Inflation?

A common question is “what is inflation?” Inflation is simply the general rise in the price of goods and services over time.

Basically, when the price of the sandwich you buy for lunch rises, the dollar that you use to buy it is worth less.

So, over time, the nature of inflation is to reduce the value of the exchange currency. This explains why you could by a can of coke for $.25 when I was a kid. But now they cost $.75.

Inflation is measured by watching the change in an index, like the Consumer Price Index (CPI).

Effects of Inflation

Historically, the inflation rate has been around 3%. We had a high period of inflation in the 1970s here in the US, with annual inflation rates for some years more than 10%.

High inflation is obviously not preferred because salaries can’t keep up, at least in the short-term. And, people who have money saved get hurt because their savings can now buy less. On the flip side, inflation can be good if you’re holding debt.

Most economists would prefer a low level of inflation vs no inflation though. From what I understand they like this slow increase in prices to keep recession at bay, and to have enough speed going to be able to press the brakes if needed without sending things in reverse.

Is High Inflation Coming?

We are currently experiencing very low levels of price inflation. The CPI hasn’t been increasing by much at all. In fact, some economists are starting to predict deflation.

This seems confusing to me though since we’ve done a lot of money printing in the last 2 years. Thus, high inflation, or even hyperinflation is a concern for many in the long-term. Confusing.

TIPS: Hedge Against Inflation

There are several ways to attempt to protect yourself against high-inflation. Dave Ramsey recommends real estate bought for cash. Some recommend commodities like Gold. And there is another way that’s I’ve never discussed here.

One of these ways is to invest in Treasury Inflation-Protected Securities (TIPS). TIPS are backed by the government, which have a fixed return, and are adjusted for inflation using the Consumer Price Index.

If you are concerned about future inflation it might be wise to consider them for your retirement portfolio.

What are you doing about inflation?

Last Edited: March 16, 2013 @ 4:49 pmThe content of ptmoney.com is for general information purposes only and does not constitute professional advice. Visitors to ptmoney.com should not act upon the content or information without first seeking appropriate professional advice. In accordance with the latest FTC guidelines, we declare that we have a financial relationship with every company mentioned on this site.
About Philip Taylor

Philip Taylor, aka "PT", is a CPA, financial writer, FinCon CEO, and husband and father of three. He created PT Money back in 2007 to share his thoughts on money and to meet others passionate about managing their finances. All the content on this blog is original, and created or edited by PT. Read more about Philip Taylor, and be sure to connect with him on Twitter, Facebook, or view the Philip Taylor+ Google profile.

Comments

  1. Thanks for sharing this information. Good little reminder and easy to read.

  2. helicopter ben says:

    Inflation is and always will be an increase in the money supply, and being the head of the federal reserve; allows me to create money out of nothing or thin air. It may appear there is no inflation right now, but just go by a crappy package of Kraft cheese for $4.25 at the grocery store. Through our smoke and mirrors program, and two sets of books we can manipulate inflation but not forever. The law of economics will take over. We are in an interest rate trap, that’s why we keep them at zero as long as possible. So long as my wall street cronies get bailed out, we will keep the serfs (you) in a false reality building up our next bubble. It will be the dollar next time.

  3. @ben – that’s monetary inflation. there is also a real price inflation which we aren’t seeing yet. i can’t argue that we won’t see it in the future though.