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?

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