Why Inflation is Inevitable

If you have been following the news lately you have been hearing more reports predicting that inflation is headed our way. But have you ever wondered where inflation comes from and why the government likes it?

To begin with inflation is essentially a result of the relationship between the amount of goods and services our country makes, compared to the amount of money the US Treasury releases into circulation. Here is an overly-simplified version of how it works.

Suppose you have access to some fine quality wood, some tools, and a seven-year old kid who knows about computers. You figure out a technique to mass-produce yoyos and your young protege devises a way to insert a small receiver in them that picks up signals from a cell phone; so whenever people spin those yoyos, they makes all sorts of creative sounds. Before long, you are making a million yoyos a year.

If it cost you a dollar each to make those yoyos and you sell them for three-dollars each, then your little empire is adding two-million dollars per year (one million yoyos times two dollars each) to the Gross Domestic Product (GDP).

In the meantime, and on regular occasions, the FEDs get together to discuss the state of the economy. Since people like you have “created” wealth out of thin air (you gotta love Capitalism) the Government needs to release some new money into society, otherwise we would have more goods, but no new dollars, and that would cause prices to drop. The Cato Institute has a good definition of deflation.

Note: If you are not sure how that works, imagine a group of ten children who each has $1. and they each want to buy one of your yoyos. If they only have one dollar, then that is the most you can get, but if they earned another dollar, then you could sell your yoyos for more. Another way to look at it is, assume there is only one dollar in all of out society and you have it. That would be a very valuable dollar and everybody would be lowering the prices of their products to attract some of that precious money. On the other hand, if we all had a million dollars, we could pay a lot for the things we want, but no single dollar would be worth very much. So inflation is a relationship between the amount of goods available and the amount of money available. Edna Carew has another good explanation.

If there are too few new dollars relative to the goods and services created there can be deflation. The Cato Institute explains it well.

So, one of the FED’s purposes is to determine how many services and goods (like your yoyos) have been manufactured and to release the correct amount of money into society to keep prices in balance.

However, the point of this article is to establish that the FEDs have a more sinister motive than simply keeping prices “in balance”. In fact they actually like inflation. I will tell you “why” they prefer the cost of every thing to go up the next time, but for now I hope you realized “how” they do that (by releasing more money into society than the new goods and services justify) Here is a good article about money supply.

One additional point before we move on. Rising prices is not always in our best interest. While there is no doubt we all like to get pay-raises at work, that new infusion of income can easily be off-set if we have to pay more for everything else. Furthermore, there are certain people who are severely damaged by higher prices. Seniors, and anybody else who has fixed income, suffers if prices go up. As a result, inflation eats away at their standard of living. When inflation is rising quickly, you will here these people talking about “COLA” but they do not mean soda pop. They are talking about Cost Of Living Adjustments in their Social Security checks. USA today has article about the pain these seniors experience.

All of this sets up an interesting political dynamic because the congress is generally trying to inch prices up, but the most active voting block is the very group who dislikes inflation the most. So politicians are constantly balancing the benefits of inflation against the anger of the seniors.

In my next post I will tell you “why” the government flies in the face of the seniors and pursues inflation anyway. After that, we will talk about how you can use all of this to your advantage.

Several other stories about inflation

An article on my website about inflation

Until then, I welcome your comments.

And, don’t forget to visit my other blog.

Compound Interest

Tenants who get evicted served as the inspiration for my next book. In most cases, they could have avoided the problem if they just had some rudimentary understanding of finances. One of the most compelling lessons has to do with the power of compound interest. In fact compound interest is so dynamic Albert Einstein is frequently "credited" with declaring it the Eight Wonder of the World (although there is no real evidence that he really said it.)

Regardless of Einsteins role, I love stories about compound interest. Here are some good ones that I share in my book, Stop Flushing Your Money Down The Drain.

1. If you put $100 per month into a savings account or investment for ten years, and if that investment always pays 7% interest, you can pull out $100 per month for all eternity. WOW and double WOW! If my parents had done that when I was a baby, we all would have had more money when we needed it.

2. If you can save $4 per day from places you are wasting money now, for 40 years (an adult’s working life) and if you earn 7% interest on that money, you will have $465,000 to begin your retirement. Some possible places to get that money? Change insurance, save interest by paying off credit cards, buy used cars, get a smaller home, downgrade TV package, stop buying fancy coffee, cheaper vacations. etc.

3. If Christopher Columbus was your great, great, great, great granddaddy and he placed one single penny in an account bearing 6% interest and you stumbled upon that account now, it would be worth an astounding 100 Billion dollars, or over sixteen-million dollars PER DAY. That would make you nearly as rich as Bill Gates and Warren Buffet, combined.

4. In the early 1600s, the American Indians sold Manhattan Island, in New York, for beads and trinkets worth about $24. Now, that real estate is among the most expensive anywhere in the world. That would suggest the American Indians got the worst end of the deal. However, if they had invested their $24 and received 8% compound interest, they would now have way over a QUADRILLION dollars. That is enough money to buy back the island and get all of the buildings free and clear, and still have billions of dollars left over. OMG!

Understanding and employing compound interest can make YOU rich. Some basic things you need to know are:

You have to start saving money and do it consistently. Don’t tell me that you need all the money you make now just to get by because that is a false argument. If your budget is stretched, it is not because you earn too little, but rather, it is because you spend too much. There are people getting by on 90% of what you make. All you have to do is live like they do and save the remaining 10%. According to David Bach, “the biggest mistake people make is never starting.”

The sooner the better - It is far better to begin saving now and do so for ten years than it is to wait for ten years and then save for 45 years after that. For a powerful illustration as to why you need to get going now, check out the chart from my friends at Safer Child. Even delaying one year can be costly. Check out the middle of the story at Grow Rich Slowly.

Compound interest also works against you and your debt. This can be crippling. In my book, and one of my earlier posts, I show readers why any money you waste has a FOREVER interest charge attached to it. That is because you could have paid off debt, but since you did not, interest expenses go on and on. Sorted.org has some good stories about compounding and the one called “Get Out of Debt Fast” is how compounding can work against you.

So the bottom line is Compound Interest is dynamic, whether it works for you or against you. It is most unfortunate that the tenants who get evicted never learned that lesson. Did you?

To visit my other blog about human interest stories

The Real Cost of Conveniences

I am a little over half way through my next book, Stop Flushing Your Money Down the Drain. A substantial portion of it is devoted to the most common ways we waste our money. In my other blog I discussed one of the categories, before I decided to begin this blog, but it fits here so well I am going to simply reprint it.

I will be posting much of the other topics from the book in the weeks and months to come. Until then, here is “The Real Cost of Conveniences”.

What is the most you would pay for a cup of coffee?

By 7:00 a.m. this morning, I was at the local Albertsons. There is a Starbucks inside and several people were already in line. I have been to that store many times and they have quite a few regulars.

I bought the biggest and best and most expensive cup of coffee they had. It was a Large Pumpkin Spice Frappuccino with four shots of espresso. Get your own recipe here. It had a healthy dose of whipped cream and some cinnamon sprinkled on top. It was chilled, like a fantastic malt. For the next forty-five minutes, I savored every sip!!!

The YUMMY purchase was research for a new book which I am writing: Stop Flushing Your Money Down the Drain. It is a financial planning book, mostly designed for people who never really learned the ins and outs of financial decisions. In it, there are good discussions of insurance, lenders, auto purchases, the cost of raising children and pets, how to get better jobs, why formal education is overrated, and much, much more.

There is also a substantial section covering "The Worst Things we Spend Our Money On" (excuse the poor grammar). One of the first parts of that section is "Conveniences." In that section I point out that many people pay through their noses for convenience. The examples are everywhere: Carwashes, drive through foods, convenience stores (imagine that), going out to dinner, packaged items...and gourmet coffee.

I go on to illustrate that if a person wastes $4 per day on conveniences (or anything else), he losses an incredible amount of money, over time. I show my readers that if they would have used that money to pay off other debt or to invest it, after 40 years (a typical adult-life, before retiring) the consumer would have accumulated a whopping $465,000, counting interest. I think that is dumbfounding!!!

So, what does all of this have to do with that particular awesome cup of coffee? Since I have only bought one other cup of gourmet coffee in my lifetime, this cup was very special. In this case, I wanted to find out exactly what is the very best experience somebody could have with such a purchase. For $7.75 I spent 45 minutes in coffee heaven. But, now the coffee is gone and so is the $7.75. And I can say without any doubt, it was NOT worth it. To compound my misfortune, I will be paying interest on that money forever. I will explain why in a moment.

It is easy to justify such convenient purchases with self assuring comments like "I deserve this" or "It is only a few dollars" or "I can always cut back tomorrow." These are the kind of justifications that lead otherwise smart people to financial ruin.

I am not suggesting that there is anything wrong with an occasional treat, such as the Frappaccino which I cherished, but rather I am talking about the habit of making allowances for routine extravagant purchases.

Worse yet, are the poor souls who compound their monetary woes by using their credit cards for such purchases. This can be another sin of convenience. Nearly everybody knows that plastic cards are not free money, but when those impulsive opportunities present themselves sometimes the plastic money is just too easy to get; consequences be damned.

I suppose a great debater might be able to persuade me that using a credit card is okay if the consumer budgeted for the purchase in the first place; and if he pays off the card each month without any interest charges being added to the loss - but I doubt if more than 10% of those using credit cards in this way fall into both categories.

The reason that impulsive purchases and conveniences are so damaging is that EVERY SINGLE PURCHASE WE MAKE BRINGS WITH IT A LIFE-TIME OF INTEREST EXPENSES, EVEN IF THE PURCHASER PAYS CASH FOR THE ITEMS. Let me use food to illustrate my point.

When you pay somebody else to prepare your meal for you, either at McDonald’s or some fancy restaurant, some of your cost is a convenience fee. For example, if you could grill a burger at home for $1 but you pay Burger King $3 instead, you are paying them $2 to do the work for you. From that moment on you will have an interest cost on your wasted $2... FOREVER!!!!! That is right: Forever!

That is because you could have used that $2 to pay off some other debt you have. If you have an unpaid credit card, you could have paid some of your debt down and saved the interest charge on that debt, perhaps 12% or higher. If you had a car loan but did not pay it down with your $2, interest continues on $2 at the rate of that loan. What is the interest on your mortgage loan? You could have saved that interest rate on $2 by paying down your loan by that amount.

Any loan that remains outstanding has an interest expense that you could have avoided. Even if you are completely debt free, you could have invested the $2 and received interest income forever, but by forgoing that opportunity there is an eternal interest loss and therefore a FOREVER expense.

Now add to this that people who buy impulsive and convenient hamburgers or coffee, don’t do it just once. They do it day after day. If they are not wasting their money on coffee or hamburgers, it is excessive insurance premiums, cigarettes, ATM fees, extravagant TV packages, lottery tickets or any number of other unwise choices.

As stated earlier, if a person only flushes $4 per day or $120 per month in any combination of these things, he or she is losing $465,000 over forty years (assuming 7% interest).

I am not trying to take away your pleasures. After all, what good is it to arrive at old age with a drawer full of money, if you have no life experiences to compliment your years? I am simply attempting to point out the real cost of our choices, so that we can make more wise ones.

In my new book, I lay out a list of categories in which most people are already wasting more than $4 per day and the simple things they can do to end up with a lot of "extra money" just by paying attention to their choices and redirecting some of the money they already make.

So I suggest you budget for your gourmet coffee or other convenience purchases. It is okay to order a pizza to be delivered if it fits within a budget, but do not succumb to the habit of paying for convenience over and over and over. Kathy agrees with me. And worse yet, do not put those purchases on credit cards unless you can pay off the card when the statement arrives.

Now that you understand the real cost of convenient coffee (and other purchases) I hope you will be able to make smarter choices. If you only buy one Frappaccino per lifetime, I can assure you that it really is special but if you get one every day because "I deserve this" then you are flushing $465,000 down the drain. Even a complete idiot would know that no cup of coffee is worth that.

Perhaps something in between will make sense for you.

What Say You?

Drop by my other blog if you get a chance

How Debt Sneaks Up On Us

I am constantly harping on the damning effect of debt but it is time to identify the primary reasons people get into such financial predicaments. Following are the top 10 causes as I see it.

1) No Mentors - Unfortunately very few of us have good financial mentors. Nobody tells us about the pitfalls of credit. Too often, the very people who should be able to guide us in our financial decisions, such as teachers and parents, don’t really do all that well with their own money. Therefore, we are left to learn our lessons the hard way: By trial and Error. Sadly, most people whom I know that are financially responsible had to make mistakes and learn from their pain; then there are the ones who don’t even learn from their own mistakes.

2) Easy access to credit – It is no wonder we get into credit trouble. The credit card companies converge on new college students before they even unpack their bags. Stores are constantly trying to get us to apply for their cards. Banks advertise on TV and radio why we should get their cards. Auto dealers will hand a set of keys to almost anybody who has a job or a down payment if they will simply sign on the bottom line. We have even heard of dogs and dead people getting credit cards. With cavalier policies like that, ill informed consumers are doomed.

3) Failure to keep score – Budgeting is at the root of financial responsibility. It you don’t know where you are at or where you are going or how you are going to get there you might as well face a certain grim reality: You are lost. How can you possibility expect to “get there” if you have no idea where you are going? Get a realistic budget and stick by it. You will be surprised where your money goes.

4) Instant gratification - In our TV driven world we see crimes solved, remarkable reality TV accomplishments and sporting victories all portrayed as if there is no work involved. We are a lazy society, susceptible to sales pitches about quick fixes, instant food, over-night romance and lottery winnings. Ryan Healy calls it Premature Lifestyle Enhancement. But, very few people have an incentive to tell us about the importance of discipline, hard work, practice and perseverance. If we only hear about the glamorous life, how can we be expected to restrain ourselves?

5) Unwise spending choices - We pay too much for everything from mustard to vacations. When you buy the smallest jar of mustard, you are paying the most per ounce for it. The same about anything else you could buy in bulk and save money. By overpaying for so many things your money does not stretch as far as it could, and this leaves you with unnecessary debt. You should start thinking about using coupons, buying out of season, and getting larger quantities of non-perishables.

6) Excitement – There is a certain flush of power or adrenalin when we buy things. It makes us feel important. We see so many other people throwing money around we want to project a certain degree of prosperity ourselves. So we pull out our credit cards and buy all sorts of things we don’t really need. Before long, our credit cards are at the max. Like all other bad habits, unnecessary spending can become an addiction. We tend to justify such purchase with thoughts like “I deserve this.” But that is actually a counter-productive instinct. Gomestic says that in large part, people make purchase this way to counteract the feeling that nobody cares about them. The truth is that such impulsive purchases deny you the more important items that you really do deserve.

7) Bummers - If you are like me, you are constantly surprised by the unexpected monetary demands that come knocking at the door. When we don’t save for the proverbial “rainy day”, we are not prepared for life’s setbacks. That can easily mean that other debts do not get paid off or we use our credit cards to get by. Here is a good article about "Avoidable vs. Unavoidable" debt.

8) Minimum payments - If you think in terms of “what is the least I can pay” rather than “What is the full amount of the debt” you are asking for trouble. If you don’t pay off your cards every month, the lenders attach interest charges that prohibit using that money for other items. When you get paid you find yourself thinking “who do I owe this to” rather than “How do I want to use this money” Pay off your statement in full every month and you will be much more careful about what you buy.

9) Excessive refinancing – In years gone by, people tried to pay their homes off. But more recently, the masses have looked upon their homes as an additional source of income. Every time the home value goes up, they run out and refinance to get some of the equity out. That is troublesome on several levels. First and most obvious, they owe more for their homes and their payments go up. Second, it sets a false sense of financial health. As long as the consumer can refinance her way out of debt, she sees no reason to exercise restraint in her spending. I have known quite a few people who have run their credit cards up then refinanced their homes multiple times to pay off the debt. Each time they convince themselves they will not do that again. However a year or so later the credit cards are at their limits again and they repeat the process. Sadly, we all know what happened to the housing market a couple of years ago and the gravy train stopped but the debt remained. Many of those people went broke.

10) Imitating Ostriches – I weigh too much and I rarely step on a scale; partly because I don’t really want to know just how bad my problem is. The same thing happens to people who are wrestling with their finances. They know they are struggling, but they just don’t want to know how bad things really are. We can both solve our problems if we would just pull our heads out of the sand, examine the truth and act accordingly.

There are many other reasons why we get into too much debt. Which ones do you think are worth mentioning?

Don't forget to visit my other blog

Just when you thought the real estate market was going to settle down, a new and bigger wave of foreclosures is headed our way! The first wave came from the sub-prime loans; the second wave is from Alt-A loans. A fairly ominous report from the New York Times Is here.

In case you don’t know how all of this began, let me give you a brief overview. Subprime loans have been around since the early 90’s. Sometimes the loans were made to credit card holders but most of the money was lent to home buyers. Sub-prime loans are made to borrowers who are not considered “prime” because they lack one or more of the usual qualifications which lenders require. So, if a borrower has insufficient employment history, poor credit, or too little money they become candidates for those riskier sub-prime loans. To compound matters, many of these borrowers take out Adjustable Rate Mortgages (ARM’s) to keep their payments lower; at least in the beginning.

Prior to 2004, lenders had fairly strict lending practices; but then, in an attempt to help more people become homeowners, they were urged to loosen up their requirements for subprime borrowers. Most lenders are happy to make such loans provided they can transfer the risk in the event that the borrower defaults; but they need a secondary market to sell their loans to. Enter Freddie Mac (They buy the loans from the lenders) Fannie Mae (They get the money) and AIG (They insure the loans).

Around 2007, the interest rates on those sub-prime ARM loans began to adjust higher. Since so many of the borrowers were marginal in the first place, they could not support the higher payments and an avalanche of foreclosures ensued. After two years, we are just starting to see some of the numbers improving, suggesting the worst is behind us. But wait! Another wave is on the way.

In addition to making all of those sub-prime loans, the lenders were also making loans in another somewhat risky category called “Alt-A” loans. These borrowers had better credit scores and other qualifications than the sub-prime borrowers did, but they were not “A” borrowers either; hence they were called “Alternative A” borrowers, shortened to Alt- A. The most common allowance which was granted this group was they were not required to verify their income. So, many people referred to them as “Stated Income” loans.

The underlying problem with so many of these loans was that the borrowers were allowed to make payments that did not even cover all of the interest that was due. The shortfall was simply added to the unpaid balance of the loan. That creative twist seemed appealing to lots of borrowers because home prices were on the rise throughout that time and most of them just assumed that the home value would continue to rise and eventually they would have new equity which they could get to, one way or the other.

But a villain was hiding in the shadows; namely there was a 3-year window on the payment arrangements. Now, the windows are beginning to close on all of those loans. The borrowers can no longer make payments that are less than the interest which is due. Furthermore, they have to also start making principal payments. In the mean time, the market prices did not continue to climb as they expected. On the contrary, most homes have fallen in value. In many cases, that means these borrowers owe more for their homes than they are worth; and that means they cannot refinance them with some less-painful loans.

As a result, a lot of additional homeowners are going to lose their properties; some because they must sell (divorce, corporate transfers, estate sales, etc.) and others because they cannot handle the higher payments. To add more fuel to the fire, there are a lot more Alt-A loans than sub-prime loans. Here is a recent article by our friends at the Money Game. Four states are especially vulnerable: California, Florida, Nevada and Arizona.

There are also lots and lots of commercial loans in the same predicament.

The only silver lining in this gray cloud is that interest rates are very low again so some of those people may be able to get good replacement loans, if they can act soon enough.

If I had to guess, I would say we are in for another two years of foreclosures on every block, but all is not lost. There are three categories of people who can benefit from a climate like this: Real estate investors, Brokers who specialize in working the foreclosure market and First Time home-buyers. Most of us can get in on the bandwagon somewhere, if we just know what to do.

Ain't that a bummer?

Drop by my other blog

The “Fortunate” Ones

Most people don’t know that in spite of recent economic times there are over seven-million millionaires in our country? That is probably because the media has more to gain by broadcasting the plight of the homeless and down trodden than they do by trumpeting the success stories. For some reason people want to hear about crime, struggles, and hardship so that is what garners ratings and sells newspapers. Most good stories are usually hiding somewhere between the later pages.

The politicians like to portray the financially successful people as “winners of life’s lotteries” as if they were merely lucky. This mischaracterization of the accomplishments of these people serves to set up an unnecessary bitterness between the classes. A much better alternative is to show the “less fortunate” group what they can do to raise their standard of living via their own endeavors.

In a previous story (see archives section) I illustrated, through the use of a strawberry farm, one of the main flaws in the mind of many: That is they live in a world of scarcity. They think there is only so much money (or strawberries or practically anything else) so those who have these things must either be lucky or they must have cheated in some way. That cynicism prevents them from achieving their own potential. Instead of looking inward for their successes, they hope the boss, the union or the government will watch out for them.

Sometimes they will try to increase their value by working harder, or taking training or getting more schooling. Those are worthwhile ideas but in most cases their new value, if any, is still determined by their employer or provider. It does not ordinarily lead to financial security, just a slightly plusher rut.

The difference between the “fortunate” ones and their counterparts has to do with how they look upon money. The less fortunate group perceives money as scarce, so they struggle to accumulate it. But the “fortunate” group knows there is lots of money to be had and they learn how to make the money come to them.

The “fortunate” ones understand the difference between good debt and bad debt and are therefore more likely to be debt free in the typical way we think of debt. They usually have some sort of budget and they abide by it fairly well. Because of that budget, they are more likely to save money than spend it on wild indulgences. By avoiding impulsive purchases they can use the savings they enjoy to make investments that generate passive income. Once they get to the point that they can live on the passive income, the rest of the money they earn is available for additional investments or enhancing their lifestyle. Once they get to that point, their net-worth grows exponentially.

It is not overly difficult for the common person to join the ranks of the “fortunate” ones. The first thing to do is rethink the role of debt. Basically, bad debt is a result of impulsive purchases or debt which cannot be paid off each month. It carries interest charges that eat into the buying power of the consumer. Essentially, any money spent this way is wasted and could have been saved and invested. For another list of millionaire practices as told by U.S. News and World report go HERE.

The next thing to do is look for ways to get your money to generate additional income. This can be as simple as buying CD’s or annuities. You might buy stocks or real estate. There are several other asset classes worth considering and each one offers its own risks and benefits. Here is a blog that explores how to earn passive income on line. Overall I like real estate the most because there are 4 ways to make a profit and you can get somebody else (tenants) to pay all of the bills.

Semi-passive investments are also appealing. For example, if you could buy or build one of those drive-thru car washes. Customers will put money in your pocket while you are not even there. A friend of mine has five-dozen laundry machines placed in several apartment buildings around town. They are fairly easy to maintain, they pay for themselves and they generate $30,000 a year in extra money. It only took him about four years of a casual but on-going effort to build his business from scratch. At the rate he is going it will only take a few more years to live off of that money. He can even hire somebody else to do all of the work if he wants to and retire while still in his thirties. His primary job, while respectable, can never offer him flexibility like that.

Even if you can’t think of a way to make money “on the side”, you can still earn a nice return just by paying off other debt, such as a mortgage. If you save 5-7% interest on that money you are using your money much better than running up credit card debt.

As difficult as it may be to believe, it is not impossible to become a millionaire in the US. There are over seven-million people who figured out how to do it. The easiest way to join them is to rethink how you look upon money. The first thing to do is stop wasting it. The next primary object is to accumulate passive income.

What say you?

Drop by my other blog