Inflation And The Erosion Of Purchasing Power

February 27, 2008 at 1:16 pm  ·  Category: Economics, Federal Reserve, Gold, Inflation, Retirement Investing

Inflation is poised to become a serious threat to the world’s economic well being – and not enough people are talking about it.

While Wall Street whines and whines about how the Fed is behind the curve, they need to cut rates more, etc.., a much more serious danger than recession lurks. 

It is not widely enough understood that our whole complex, globalized, specialized, division of labor society depends on a stable medium of exchange.  That is, it depends on a monetary unit that can be used as a measure for economic calculation i.e. economic decisions. 

Without confidence in a monetary unit that is durable, divisible, transportable and a reliable store of value, people are loathe to accept it.  And when people lose confidence in the monetary unit, business transactions slow and we stand on the verge not of an economic slowdown but the destruction of the economic system.

I mention this because while official government numbers peg inflation at 4%, there are reasons to think it is even higher.

A wonderful article in today’s Wall Street Journal by economist David Ranson, “Inflation May Be Worse Than We Think” (subscription required), explains why this may be so.

In his article, he shows that even if we avoid catastrophic inflation, which in all likelihood we will, inflation at current rates of 4%, 5% or 6% is hugely destructive of purchasing power (Inflation And Purchasing Power Chart).

This is an especially big problem for older people with fixed incomes and a high percentage of their investment portfolio in fixed income instruments.

I recently did an analysis for a woman wanting to know if she would have enough money to see her through retirement.  On a nominal basis, it appears like she’ll be okay.  But, even assuming 3% inflation, she’s looking at a massive erosion in purchasing power (Nominal Income And Purchasing Power Chart).

This is a serious problem especially for older people.  Don’t count on the government to protect the value our currency.  You need to have a substantial portion of your portfolio in assets whose value will not be eroded by inflation: gold, stocks, real estate, commodities.

Posted by Greg Feirman  ·  Trackback URL  ·  Link