The basic principle behind
inflation is that as the money supply increases, so too does the relative price
of goods and services. A common sentiment for children to hold is “why can’t we
all be millionaires, then there would be no poor people”, or something to that
effect. The answer is inflation. In theory we could all be millionaires, but
this would drive up the price of consumer goods to reflect the increase in
money supply, essentially balancing out society’s new found wealth.
The above scenario is an
example of hyper-inflation, where prices rise in an exceedingly rapid fashion.
In reality, most modern countries with stable, or fairly stable, economies have
an inflation rate in the low single digits. The example of wage parity shares a
common connection with how savings are affected by changes in inflation. Your
savings must also increase at the same rate of inflation each year in order
hold their real worth. If prices are rising annually but your savings remain unchanged,
you are able to purchase less with the same amount as you were the previous
year. This is why keeping your savings hidden under a mattress is not the
smartest investment strategy, even if you ignore the security issues.
Banks have made for sound
investments, seeing as the deposit rate has traditionally been above the
inflation rate, at least in New Zealand. This means that your savings are
growing faster than inflation, effectively increasing the value of your deposit
within the marketplace. The problem is, following an increase in GST, inflation
has risen above the interest rates offered by banks.
Modern investors need to more
carefully consider their options when structuring a portfolio. Of course the
key advantage of a bank is that you don’t risk losing your investment, but if
your value is being eroded from year to year then you have to ask yourself what
the point is.
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