The evil, ever present, value eroding effect of inflation on...Gameshows

A lot of people know about inflation in the economy, and many people know, and may even remember, the damage it can cause a country. The “Great Inflation” of the 1970s was a period of stagnant (real) corporate earnings and share prices, sluggish at best GDP growth, and could only be halted by the severest recession that America had seen since the great depression.  The hyperinflations of Germany and Hungary rendered it more economic to burn money than to burn wood to keep warm because any amount of money would burn longer than the amount of wood you could buy with it. In order to avoid such catastrophes the RBA each year aims to neatly engineer a price increase of about 2.5% on average throughout the whole economy (it actually aims for between 2% and 3%). But this begs the question: why aim for any at all? Why not just have stable, unchanging prices? The truthful answer is, because they’re not very good at it. What the RBA really doesn’t want is deflation, that is, prices falling in the economy (the opposite of inflation) and it tries to bring about a little bit of inflation each year, just to make sure that prices don’t fall. Since the inflation target was introduced in 1993 the RBA has been able to keep the inflation rate (year on year for those interested) within the target band just 39% of the time, so it makes sense for it to give itself a bit of a buffer*. Now the next question is always “What’s wrong with falling prices?” We all like cheaper things don’t we? Well the RBA doesn’t. What it doesn’t like specifically is for you to “expect” lower prices. If you expect the price of your new shoes (or whatever) to be lower in the future, you won’t go out and buy them now. You’ll wait and spend in the future. For those not familiar with the circular flow of goods, your spending is somebody else’s income, so if you don’t do it then income in the economy declines, and the government and the RBA certainly don’t like that. Deflation also does some funny things with interest rates that make it very hard for the RBA to get you (and businesses) spending again.


While the RBA likes to induce small amounts of inflation each year, it does its best keep it nice and low, inside that 2-3% range. It does this for one simple reason, so you don’t notice it (specifically so that it will not “materially distort” your economic decisions). While the RBA has decided for you (and it’s still a controversial topic) that a little bit of inflation is good, it will still slowly but surely erode your wealth. And governments know that you won’t stand for this, so they try to keep inflation just low enough so you won’t consciously feel it gnawing away at your savings.

Last night Rob Mariano received a million dollars after winning the 22^nd season of survivor, a prize whose nominal value has not changed since the show first aired in 2001. Not bad for a months work, although rob had in fact been on the show several years earlier, where he met his bride to be who herself won the million dollars. Since then he has returned twice unsuccessfully, and finally in his fourth attempt went all the way to claim the same prize his wife won in 2004. Or did he? It turns out that, based on inflation data found on the Bureau of Labor Statistics website, Rob’s prize is worth 16% less than his wife’s only six years later? Yet Rob’s excitement is no less jubilant than his wife’s, who actually received, in “today’s money”, $1,196,308.51, nearly $200 000 more! A testament to the RBA’s skill at eroding the value of the currency over time. In fact, going further back, Rob’s prize gets even smaller! Richard Hatch received the same $1 000 000 in 2000 for winning the first ever survivor, and measured in “2000 dollars” Rob received the slightly less appealing sum of $761 651.53.

Another way of saying it is that Rob’s wife could buy more “stuff” with her million dollars (specifically she could buy more of a representative basket of “stuff” as described by the all-knowing RBA). $196,308.51 more worth of stuff. These values measure not nominal amounts of money, but “purchasing power” and they reveal alot about the true value of the currencies which underpin our economies. Because the price of goods has slowly risen over the last seven years, Rob and his wife can receive the same amount of money, but what he can buy with that money has fallen significantly, so it is to say that his purchasing power has decreased along with the value of the currency.

So what’s the best way to hedge against inflation?

*The target the RBA follows is actually the "underlying inflation rate" however since the CPI is what your worried about when you buy gold thats what I've focussed on. What's more it should be said that the target that the RBA sets itself is the average of inflastion over the medium term cycle. Since the inflation target was instituted the inflation rate has had an average of 2.7%, so by this metric its possible (depending on how long the medium term cycle is) the RBA hasnt done too bad. However the point of the paragraph still stands. The RBA incities a small amount of inflation to ensure that deflation doesn't take hold.