How Inflation and Deflation Affect You

The definition of inflation is the rise in the average price of goods over a period of time.

Inflation occurs when the purchasing power of a sovereign’s legal tender decreases over a specific amount of time. In the United States, rarely does the price of a commodity remain the same year-over-year (i.e. a cup of coffee costs a bit more today than it did exactly 1 year ago and this is due to inflation). An extreme example is after World War I when German Government Financial Leaders assumed that the best way to pay its war debt is to simply print more money. This caused a tremendous crisis and eventually WWII. To give you a perspective of what is considered “Hyperinflation”:

• First half of 1921 -> $1 US = 60 German Marks
• November 1921 -> $1 US = 330 German Marks
• November 1923 -> $1 US = 4,210,500,000 German Marks (4.2105 Billion)

Just imagine if you worked ALL YOUR LIFE to save some money for a comfortable retirement and by mid 1920s, all the money you saved couldn’t even buy a glass of beer (which was priced at 4 Billion German Marks).

On the other side, if you had a lot of debt (at a fixed interest) because you purchased land or started a company producing goods, then inflation works to your advantage because, you could pay ALL your debts at a cost less than a glass of beer.

Inflation and especially Hyperinflation can deteriorate the people and the government.

Deflation is when the average price of goods falls. In other words, when the inflation rate is ‘negative’ it is considered to be deflation.

Deflation is caused by:

• A reduction in the money supply
  • printing of less money increases its buying power
• A decrease in the demand for goods
  • If people don’t buy oranges anymore, the price will drop …. A LOT!
• An increase in the supply of goods
  • In the United States, steel was becoming very expensive during the 1870s until Andrew Carnegie purchased a patent from a few British Scientists and started a mill in Pennsylvania to produce steel in a different manner.
    • This caused the price to drop tremendously and led the way for skyscrapers and railroads.

Deflation is horrible for people trying to pay a debt, because the amount of debt is effectively increased.

In the United States and many other nations, inflation is good and deflation is bad. The US financial system was redesigned in the early 1900s with the Federal Reserve System to help control inflation thru interest rates.

• When interest rates increase
  • Inflationary period occurs and the economy expands
• When interest rates fall
  • Deflationary period occurs and the economy contracts
    • Think about it… people & companies trying to pay debt have to effectively pay more.

If you have questions feel free to contact me @arberdoci

Please let me know what you think of this article. I’d like to hear if you have opposing arguments or if you agree.