Making Money From Inflation

Making Money from Inflation

Inflation is the all-encompassing and continued rise taken together level of prices measured by an index of the cost of various goods and services. Recurring price increases erode the purchasing power of money and other financial assets with fixed values, creating grave economic distortions and uncertainty. Inflation results when actual economic pressures and anticipation of future developments cause the demand for goods and services to exceed the supply available at existing prices or when available output is restricted by faltering productivity and marketplace constraints. Sustained price increases were historically directly linked to wars, poor harvests, political upheavals, or other unique events.

When the upward trend of prices is gradual and irregular, averaging only a few percentage points each year, such creeping inflation is not considered a serious threat to economic and social progress. It may even stimulate economic activity: The illusion of personal income growth beyond actual productivity may encourage consumption; housing investment may increase in anticipation of future price appreciation; business investment in plants and equipment may accelerate as prices rise more rapidly than costs; and personal, business, and government borrowers realize that loans will be repaid with money that has potentially less purchasing power.1

A greater apprehension is the rising prototype of constant price rises characterized by much higher price increases, at annual rates of 10 to 30 percent in some industrial nations and even 100 percent or more in a few developing countries. Chronic inflation tends to become permanent and ratchets upward to even higher levels as economic distortions and negative expectations accumulate. To accommodate chronic inflation, normal economic activities are disrupted: Consumers buy goods and services to avoid even higher prices; real estate speculation increases; businesses concentrate on short-term investments; incentives to acquire savings, insurance policies, pensions, and long-term bonds are reduced because inflation erodes their future purchasing power; governments rapidly expand spending in anticipation of inflated revenues; and exporting nations suffer competitive trade disadvantages forcing them to turn to protectionism and arbitrary currency controls.

One smart thing an investor should do during the time of inflation is purchase equity in the form of a home. One reason to start here is because you are borrowing money. As long as the rate of borrowing money is less than the inflation rate, which it usually is because interest rates move slower than the inflation, there will be profits in the long run. A mortgage is very safe because the rate remains constant throughout its life, even thought the inflation rates will climb. Let's take a look at an example. Prices are skewed because it was done in 1980. "Taking a life savings of $8,000 and bought a home for $46,500, paying for it with a 20 year government-guaranteed 6 Ñ*% mortgage. Twelve years later, you still owe $30,000 on the mortgage, but because of inflation that $46,500 house is now worth about $250,000. The equity is now about $220,000. So an $8,000 investment has grown to $220,000 with no taxes on the increased value."2 In a couple of years that house could increase to even more, and when sold bring in a huge profit.

Some analysts have recommended the use of various income policies to fight inflation. Such policies range from mandatory government guidelines for wages, prices, rents, and interest rates, through tax incentives and disincentives, to simple voluntary standards suggested by the government. Advocates claim that government intervention would supplement basic monetary and fiscal actions, but critics point to the ineffectiveness of past control programs in the United States and other industrial nations and also question the desirability of increasing government control over private economic decisions. Future stabilization policy initiatives will likely concentrate on coordinating monetary and fiscal policies and increasing supply-side efforts to restore productivity and develop new technology.

The relationships between money and output and between money and inflation in economies that have adopted a commodity standard and those that have adopted a fiat one were examined to determine how a shift in monetary standards affects inflation, employment and production. Results revealed that the growth rates of various monetary aggregates are more highly correlated with inflation and with one another under fiat standards than they are under commodity standards. However, neither standard showed higher correlation between money growth and output growth. It might have been expected from the poor fit of regulated-price inflation and money that the fit between freely determined prices and money would have been better than that of overall inflation and money. However, we have shown that the fit between money and overall inflation is superior to that for freely determined prices, or indeed for any component. Assessing the relationships between money, inflation, and output under different monetary standards requires empirical counterparts to the concept of money. We use an eclectic approach. Following conventional studies of money and inflation, we use a broad measure