Inflation

Most people think a market crash is the biggest danger to investors.
Think again!

Nowhere on your bank or brokerage statement
are you likely to get a report on what inflation is doing to the real value of your holdings.
So if your money is stowed in a "safe" investment, like a savings or money market account,
you'll never see how inflation is gobbling up virtually all of your return!

Inflation is the rise in price of goods and services.
We all know that things seem to cost more every day,
but how many fully realize just how much that thief called inflation steals?
Even with relatively low inflation, you steadily lose buying power of any money you just hold on to!

To stay even, you must invest at rates of return that at least match inflation rates.
Your real rate of return, in terms of buying power of your money,
is your savings or investments rate of return less the inflation rate.

If inflation is 4 percent per year and your return is 5 percent per year after taxes
you have managed only a 1 percent gain in real buying power.
If your after-tax return is only 3 percent, you lose 1 percent in buying power.

Inflation occurs when demand increases relative to the supply available.
During periods of economic growth moderate inflation is expected.
However, hyperinflation which is inflation of 100% a year or more
is a major concern as people lose confidence in the currency.
During hyperinflation hard assets like gold and real estate rise
as they usually retain their value in inflationary times.

Cost-Push Inflation: Is inflation caused by rising prices of raw materials.
When demand exceeds the supply of raw materials manufacturers pay higher prices.
The manufacturers then charge merchants more for their finished products.
The merchants then raise the prices they charge consumers.

Demand-Pull Inflation: Occurs when supply is not adequate to meet demand.
This causes higher finished goods prices
that merchants must pay leading to higher consumer prices.

Deflation: Is a decline in the prices of goods and services.
Deflation is the opposite of inflation.
When prices are falling due to deflation,
economic activity is negatively effected
as the price weakness is usually due to very weak demand factors.
Deflation is a significant aspect of economic depression as economic recession
is accompanied by declining prices and a shrinking economy.

Stagflation: Is the term used to describe an economy
that is growing very slowly accompanied by high inflation.
Usually when the economy is growing slowly the inflation level is low.

How The Central Bank Controls Inflation?

The Central Bank attempts to control inflation
by adjusting the cost of money to member banks
by raising or lowering interest rates.

Low interest rates tend to stimulate economic growth
as the cost of money is less and leads to increased borrowing
which encourages additional economic activity.
High interest rates tend to depress economic growth
as the high cost of money limits economic activity.

During periods of low inflation the Central Bank allows interest rates
to remain low and monitors economic activity
to keep growth at a sustainable but non-inflationary pace.

During periods of rapid economic expansion and high inflation
the Central Bank raises interest rates to slow the pace of economic activity
and limit inflationary pressures.

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