The definition of deflation when it comes to economy is that it´s a decrease in the general price level of goods and services. As you may already know deflation is...
Most people seem to believe that if you have a savings account with a lot of money in it, then you are wealthy. As long as you keep it there, that wealth can never be taken away from you, right?
While a person might be wealthy today and have a great amount in the savings account that wealth can go away very quickly and things like that has happened before and are happening right now around the globe.
While some countries are struggling with deflation, others are having problems with inflation. Now most people believe that inflation is when prices of goods and services are going up but in reality it´s the value of the currency that is going down. Most countries have given their central banks the task to keep the inflation rate at 2%. In reality this means slowly decreasing the value of the currency with the help of different stimulus and tightening strategies. Inflation is a way for governments and central banks to slowly steal the wealth from the public. It is also a way for them to lower their debt burden without having to pay down the debt. Inflation rewards debtors and punishes savors, if the value of your currency goes down that means the value of your savings goes down but also that value of debt. The biggest debtors are the governments so it´s not really rocket science to figure out why they want inflation. Governments sometimes do some “deficit spending”, that in everyday person language could be translated to “buying stuff on credit”. Things that may cause deficit spending are wars or natural disasters but it can also be as simple as they suck at economics. Either the incomes are too low, of the expenses are too high, just like for the everyday person. So what happens if the expenses are higher than the incomes is that the central bank will print up the difference and put it on the debt pile together with all the other government debt. This process increases the amount of currency in the economy and that to will create inflation. Central banks are meant to be able to control the rate of inflation but sometimes they might overreact and sometimes things get out of control, it has happened before, it is happening right now and it will happen again.
The thing is that it´s not only up to the central bank, the people that use the currency also play a very important role into the equation. Currency values are just fiction, they only have value because people think they have value (like all things), if the public loses belief in the central bank and the government issuing the currency then the purchasing power of it will fall. One thing that can be a cause of disbelief in a government is rapid increases in the currency supply like what happened in Germany between 1918 and 1923. The German government was broke after losing the war and had a lot of damage costs to pay for. Instead of just saying that they didn’t have the money available they took the “easy” way out and just printed the money to pay the debt. Of course those actions had enormous impact on the inflation rate. When the inflation rate starts to rise due to rapid currency creation people will try to get rid of their money as fast as possible, because they know that whatever they want to buy will be more expensive tomorrow than it is today. This will make the velocity of money transactions to rise (every piece of currency will be used more times) and that makes the inflation even higher. You could have been a multi-millionaire in Germany 1918 and if you kept all your wealth in German currency before 1923 you couldn´t even buy an egg with your millions.
And of course when you read this you might think “yeah but that was a hundred years ago, we are a lot smarter now, that could never happen today”.
The bill on the picture is a 100,000,000,000,000 Zimbabwe dollar bill, let that sink in for a while….
From the time those bills were ordered until they were delivered, the value of them had fallen below the value of the paper it was printed on. Those bills were printed in 2008.
I recently spoke to a friend from Indonesia and he told me that the price of street food (Where most of the low salary workers eat) had doubled in the last 5 years but the salaries are basically the same. I hear similar stories from other places as well. It might not be at the critical levels yet but it makes life a lot harder for the everyday person, It also destroys wealth quickly.
The yearly inflation rate of Venezuela reached about 100% in 2015. Today the rate is calculated to be over 160% for 2016 and the rate is rising rapidly. Rumor has it that three 747 airplanes packed with new printed bills landed in Venezuela last week. Wonder where that will end…
Of course any government and central bank can lose the public´s trust and things like this could happen.
Central banks throughout the world are in a war against each other trying to make their currency weaker than the others. If you like to travel to other countries you might have noticed it, some central banks are doing a “better job” than others. Of course there are a lot of other causes that weakens currencies than what the central banks can be blamed for but the point I’m trying to make is that the currencies can, if we are not protected, decrease our wealth.
Not so far from where I live here in Thailand there are a lot of Russians coming on vacation. Some of those Russians like it so much here that they decided to buy condos and houses. In 2014 the Russian and the Thai currencies were exchanging 1:1 so the value of the currencies were basically the same. Then in the end of 2014 the Russian Ruble started to fall in value but the Thai Bath started to increase in value, the exchange rate went from 1:1 to 1:2 in a matter of months.
So what effects did this have?
Some effects are of course a decrease in Russian tourists, resulting local businesses going out of business. But for some Russians it´s far worse that not being able to go on a nice family vacation.
Think about the families that decided in the middle of 2014 to buy a vacation home. They went with a project that was going to be ready in the middle of 2015. Usually a down payment is done of maybe 20% of the price. There are different systems that all the construction companies use. Maybe there is a monthly payment plan but it doesn’t matter, the final payment is at least 50%. The only problem is that those 50% in Thai Bath are now the same as 100% of the price in Russian Rubles. Maybe the family doesn’t have enough money to make the final payment. Maybe they have borrowed money from the bank and are now in debt. Huge problems can come from things like this.
Things like this can happen any time so it might not be a bad idea to spread the risks by owning more than one currency and maybe exchange some of your money for Gold and silver.
It´s not as risk-free as you might think to just keep your wealth stored in the bank.
If you want to learn some more about how inflation works and how it is manipulated, sign up for my free E-book.
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