Inflation: A Penny Not Saved is a Penny Stolen

Like any five-year-old, I loved toys. And I wanted new toys, probably because all my toys were from the hand-me-down box. I would pester my mom for new toys and she would creatively distract me. One particular day, I wanted THAT toy. She decided on a new tactic. "Toys cost money and we don't have any," she said, confident she had bought five minutes of peace.

Unfortunately for her, I was a five-year-old master of observation. "Go to the bank, they give you money!"

While I'm sure my mom wanted to commit child abuse at the time, she loves telling the story now. Obviously, they don't give you money at the bank, they return your own money to you.

Let's say banks do give out free money. Would all five-year-olds get all the toys they want? Obviously not, there's a finite supply. But since everyone had more money in their pockets, the cost of the toy would not matter as much. People would be willing to pay a higher price for them, and the price of the toy would go up.

What if banks only gave some people free money? The people who got money would be willing to pay higher prices while those that did not would not. The price would go up and only the people who received the free money would choose to pay the higher price and get the toys. This increase in price due to the increase in money is called inflation. You can see that inflation creates winners and losers. If you got money, you could get the toys, if you didn't, you were out of luck.

Ok. So you can't buy your kid a toy. No big deal, right? Wrong. If you are not one of the people receiving free money, you are worse off. And it's not just toys. Food. Rent. Gas. Inflation is the reason that the prices go up. Inflation is why your budget won’t balance.

Everyone experiences inflation differently, everyone has their own personal inflation rate. If you don’t drive, higher gas prices wouldn’t increase your personal inflation rate. However, if the prices of items that you buy increase, your personal inflation rate goes up. For example, if you love to bake and the price of flour goes up, your personal inflation rate has increased.

Ok, but you still haven't explained why this matters. I'm spending a little bit more on things each year, that's just how it is, right? Well, if financial security matters to you, you need to pay attention to inflation. Inflation raises the difficulty level of financial security to 11. Financial health means that more of your income comes from investments than a paycheck. Investments can be owning stocks, owning your own business, or real estate. This lets you make money without using your time. For example, if you own real estate, you can work eight hours at your day job and still get additional income by collecting rent on the side.

To slide more of your income from a paycheck toward investments, you need two things: time and resources. Time allows you to have space to learn, to build that prototype, to find partners. Resources can be money. It can be knowledge or effort that you use to build a new income stream.

Saving allows you to accumulate time and resources. If you have savings, you can find a job requiring less hours. If you have savings, you can get childcare. If you have savings, you can buy an online course to make you more productive. If you have savings, you can buy stocks or property. If you keep spending more and more each year, that means that you're saving less and less. Because of inflation, you can't save, you can't invest, you can't take risk, you can't bet on yourself. You're stuck in your premium mediocre job. You're trapped on a treadmill and your personal inflation rate is the speed.

The effects of inflation are even worse for the most vulnerable, lower-income earners. Historically, lower-income earners have a higher inflation rate than higher-income earners, because they spend a greater percentage of their income on high inflation items like housing, food, and medical care.

Lower-income earners are also affected by inflation more because they have less margin for error. If they're only saving 1% of their income and prices go up 5%, they're not only not saving anymore, they're either forced into getting a second job or they have to go without. The only way out is by saving, which inflation prevents.

So why is there inflation? Current government policy is to create inflation in order to "stimulate the economy". The US government historically has had an inflationary policy and currently aims for 2% a year. This number is an average across everyone in the USA. As we discussed, everyone has their own personal inflation rate. Using the average across the country for policy is nonsensical! I'm spending more on food, what do I care if that is balanced out by the cost of pet toys going down?

"A statistician had one foot in a bucket of ice water and one foot in a bucket of boiling water. He said, 'My feet feel great, on the average.'"

Almost every government in the world encourages inflation. The way governments create inflation is by lowering interest rates, which only corporations and higher-income earners have access to, just like the people who received the free money from the bank in our toy example. By saying inflation stimulates the economy, you’re saying corporations and higher-income earners are the most productive members of our society. This is the same as saying that my father, who actually builds houses people live in, contributes less to the American economy than the Wall Street firms that I used to work at.

So what does this mean for you? You can try to avoid inflation by limiting your spending to items that have low inflation. Since housing, food, and medical care have some of the highest rates of inflation, that's hard to do. Moving to a farm is not everyone’s dream. Most people have not and will not be able to avoid the negative effects of inflation as long as it remains government policy. Inflation has caused and will deepen inequality. People from all over the political spectrum have come up with solutions to the problem of inequality. Some may help, some may not. But until we stop a deliberate inflationary policy, these solutions will be like filling a bathtub with the drain open. There are no easy solutions to this problem. The only way to change this is by raising awareness. The more people that are aware of how inflation silently steals, the more pressure we can apply to change.

Down the rabbit hole:

WTF Happened In 1971?
Mises.org - Economics for Beginners Series
The Price of Tomorrow, by Jeff Booth
Cantillon Effect
Goodhart’s Law