If You Have Any Money, It’s About to Lose (A Lot) of Value
The Federal Reserve is expecting to set inflation at 4%, up from 2%. Inflation can be higher depending on how you calculate it.
The money you have in your bank account or wallet right now is about to lose a lot of value. This is not something to be fearful of. It’s a concept to understand and learn about, so you can avoid the problem.
It has taken me 10 years of studying money, a career in finance, and many startup failures to understand how money really works, so I can stress less. Only recently did what I’m about to explain to you make sense in a practical way I could implement in the management of my personal finances.
You can learn how to get more done in three hours than most achieve in a week and it won’t matter. Time equals money, yes — but there’s more to it.
You can become a passive income badass too and it won’t matter unless you get what I’m about to explain in the simplest terms you’ve ever heard it.
Every year the inflation target is around 2%. The Federal Reserve in America is looking to change that to 4%, according to CNBC. Other central banks around the world are looking to make similar changes.
The reason why inflation matters to you is that when inflation goes up, prices of the stuff you buy goes up — asset prices go up too. Here’s the killer idea you need to understand:
If you measure inflation from the 1980s, then in reality, until recently, we were already averaging 10% inflation — not the 2% you read everywhere else.
Calculating inflation is controversial, according to Investopedia. Inflation is controversial because if people understood it, they wouldn’t be happy about how much prices are really rising every year.
Whenever a concept in finance is complex, it divides people into two categories:
- Those who understand it
- And those who don’t
The second category have the money they earn eroded away.
Those who understand inflation in real terms do incredibly well — I want you to be one of those people, hence this article.
The Simplest Way to Think About Inflation Versus Deflation
Personal finance YouTuber, Graham Stephan, makes the comparison better than many others I’ve heard explain it. I’m going to take some of his concepts and make them even simpler for you.
When you hear inflation, that translates to demand for products and services. When you hear deflation, that translates to less demand for products and services.
When there is more demand for products and services, prices go up and so does inflation. When there is less demand for products and services, prices go down to create more demand again.
Now here’s the mistake I made: you want prices to go down, don’t you?
You want real estate prices to go down. You want stock prices to go down. You want your home loan interest you pay the bank to go down. I get it.
The big idea
If you know your money is worth less in the future then you’ll spend it now.
If you know your money is worth more in the future you won’t spend it.
When people spend their money on products and services then inflation occurs. Businesses revenues go up slightly more — thanks to inflation — and that means they can afford to pay their employees slightly more each year.
When people don’t spend money, deflation occurs. Deflation typically happens around or during a recession. A recession means people lose their jobs, your retirement savings get smashed, and banks who hold your money could face financial trouble like they did in the Global Financial Crisis of 2008. When banks face trouble they get bailed out using your tax dollars.
Or the bank can be forced to do a bail-in. This is where all the deposit holders of the bank have a percentage of their savings taken away to save the bank. As a depositor of a bank, you are legally an unsecured creditor in the event they go down.
When deflation occurs and a lack of spending results, prosperity suffers. The rich get richer and the poor get even poorer, leading to inequality that often leads to social unrest.
Deflation leads people to spend less money and save more. When nobody spends money, the economy suffers and businesses like the ones you and I work for start to fire people.
Now you might think central banks like the Federal Reserve in the US can step in and save the day. (Don’t fight the Fed they say!)
Here’s the difference this time around: the way the Fed manipulate inflation, mostly, is through adjusting interest rates. With interest rates already at zero or below in most countries, they can’t pull this lever like they normally do.
The Federal Reserve wants inflation because it helps the economy grow again. As the economy grows and inflation goes up, central banks can raise interest rates again to make people spend less money and control inflation. There is another hidden secret of inflation:
Inflation makes the debt you owe go down over time.
People who have debt want inflation for this reason. The Federal Reserve wants inflation because America has $26 trillion worth of debt. As crazy as it sounds, inflation can help the US government pay off its debt — slowly.
Printing money should fix the problem, shouldn’t it?
As we’ve discussed before, governments can print money out of thin air. When you hear that stimulus checks are going to be handed out, that’s just secret handshake talk for “printing money.”
Printing more money should make people spend more. But what if it doesn’t?
What if all the free money that has been and will continue to be handed out isn’t spent, it’s saved? When people are fearful like they are right now, they typically want to save their money, not buy useless consumer goods to get the economy going again.
Printing money is pointless if it doesn’t get spent.
And if a government prints too much money then they create hyper-inflation like what happened in Venezuela when their currency inflated 1,700,000% in 2018.
The argument I get about hyperinflation is this: America has the US dollar which is the world’s reserve currency. In other words, there is a huge demand for dollars. The US is mostly immune to hyperinflation.
Now here’s where things change again. China and Russia are already planning to abandon the US dollar as the reserve currency. Europe has hinted at doing the same many times.
Source: Russia’s Central Bank and Federal Customs Service, Izvestia
So as you can see, the illusion of money printing is probably not the answer.
The Hidden Tax You’re Paying
If you have any amount of money right now you are paying the hidden tax of inflation. If inflation does in fact rise from 2% to 4% like the Federal Reserve is hoping, then that affects your money.
If you go down the rabbit hole of seeing how inflation is actually calculated then you may find that 2%-4% inflation is more like 4%-8% inflation.
Let’s do some numbers. If you have $100,000 dollars in the bank right now then you might be getting 1.5% interest (In Europe you will probably already be getting zero).
Now 1.5% interest sounds good when you don’t understand inflation. The advertisement of being paid interest is false, though. With the target inflation rate previously being 2%, that 1.5% interest you’re getting is actually -0.5% adjusted for inflation. And you still have to pay tax on any bank interest you earn so you’re even more behind than you perhaps thought.
Let’s say you decide that the real inflation rate is closer to 10%, then the interest you’re getting on your bank account may be closer to -6.5%.
Bonds as a replacement for a savings account
You might decide instead to put your money in bonds to earn interest that way. Traditionally that would have been a good idea. Except this time the amount of interest you get on a bond is heading towards zero, too (and perhaps negative).
Bond yields are the truth [of what is happening in the markets] — Raoul Pal
Bond Yields heading towards zero. Source: Bloomberg
Solution
As you can see there are many ways the money you have is losing value. The hard part is finding a solution.
Everyone’s situation is different. What determines how you solve this problem comes down to a few things:
- Your beliefs
- How you see the world
- How you think
- Your goals
There are four asset classes to choose from to fight the value of any money you have losing value:
- 1) Gold 2) Stocks 3) Real Estate 4) Digital currencies
The option(s) you choose is individual to you.
1. You can sit in cash temporarily
In my case, as mentioned recently, I have sold my entire investment portfolio.
I am paying the tax of inflation by sitting in cash. This not only allows me to stress less but it allows the financial markets to have the correction they need. When bond yields are performing badly it’s often a sign of what is to come.
Cash can give you options.
Cash can let you watch the chaos rather than be caught in the middle of it.
2. You can take advantage of inflation
An idea financial guru Graham Stephan brings up is this:
Inflation may *not* be in goods and services. Inflation may be instead present in investments like stocks and real estate.
When there is loads of money being printed, free money being given out, and trillions of dollars looking for a home that will allow growth, assets like property and stocks can benefit from inflation.
Property can have good returns, although it can’t be offloaded easily. It costs money to sell property and if everybody is selling their properties at the same time as you then you might get far less for it.
The challenge with both options is whether a prolonged economic downturn could hold stocks and property prices down if markets collapse like they did in 2008. Nobody knows the answer.
3. You can choose a safe-haven
Another solution to the value of your money going down is to look at gold or digital currencies. They don’t pay you any interest for owning them but they can benefit from uncertain times created by fear from a health crisis.
Older people tend to choose gold. Millennials tend to choose digital currencies. The risk with safe-havens is two-fold.
Gold has underperformed in the long term. There was even evidence to suggest that the gold price was manipulated.
Digital currencies can have capped and predictable inflation rates — but could be banned by governments, rendering them worthless.
4. Choose a combination
The final solution is to combine a few of these strategies. You can diversify amongst a few different assets to get exposure to the upside and risk of each asset type. (There is always risk when there is upside because there is no such thing as a free lunch.)
Crucial Takeaway
The point of me explaining that your money is about to lose a lot more value is so you understand inflation and deflation.
When you hear that inflation is 2% it’s highly possible it’s a lot more.
When the Federal Reserve is likely to double inflation or print even more money, you need to know so you move your money between stocks, gold, digital currencies and real estate, based on your beliefs and view of the world.
How much money you make doesn’t matter. Compound interest is useless if you don’t understand inflation in real terms.
Making passive income like a badass can make you an accidental dumbass if you don’t understand the value of the money you’re earning.
The final point to consider is that if you crave prices to go down (deflation) it could have devastating effects on the society you love and are a part of. Be careful what you wish for.
Work your butt off to understand inflation and deflation, so the value of any money you have doesn’t cause you to lose a lot and have to work harder than you need to.
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.
