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Inflation… Someone’s Got Their Hands on my Money!

As we’ve talked about before, one of the biggest, if not the biggest downward drag on your savings and/or portfolio is inflation.  Sure, you’ll be sitting on a big pile of dollar bills, but they’ll be worth about half as much as they are now 15 years from now.

Before we can talk about inflation-beating, it’s important to have at least a basic understanding of what inflation is, and why it exists.

Imagine you and three and your friends at work have chipped in and bought a pie.  You each plan on having an equal sized slice… one third of the pie.  Then your boss comes along and decides that he’s going to take a share, too.  Now, even though only three of you paid for the pie, you still have to cut it in four pieces.

Well, that’s what inflation is.   A dollar represents one share in everything that comes under the influence of that currency.   Everything that is owned by US dollars (land, possessions, services in places that use the currency) is the pie.    When more dollars come into existence, but the pie stays the same size, the amount of pie each previously existing dollar is able to buy is reduced accordingly.

And guess who the boss is.

For every dollar that the government spends that it does not have revenue to pay for (which is close to one trillion in the US this year), it has to issue a dollar of debt.  Debt that is bought up by anyone that wants the interest rate that is paid out.  Banks, individuals, corporations… and more increasingly, the Federal Reserve, the institution that controls the money supply. 

Basically, the Fed has the power to create money, or shares of US influence, out of thin air, without adding anything to the pie to make up for it.   And at the moment, the Federal Reserve is buying up about half of the debt that USgov prints up.  (For the sake of comparison, Chinese interests hold about 7%.)

But doesn’t that basically leave the government at the mercy of their debt?  Not really.  Here’s the clever bit.

Let’s say that you buy $1000 of US debt with a 1% interest rate for a period of 1 year.   If the rate of inflation (the rate at which the Fed has increased the amount of money over and above the growth of the US pie) is above 1%, THE GOVERNMENT MADE MONEY.

Well, not exactly money, but they made value.   They paid you $10 a year later.  But a year later at 3% inflation, that $1,010 of 2019 dollars is now only worth $979.70 of 2018 dollars.   The value of the debt has been shrunk.   Anyone

So does that mean the Federal Reserve is being ripped off?  No… they just made the money to buy the debt out of thin air in the first place.  But it DOES mean that everyone that bought US debt with real money IS losing value every year that inflation outpaces their interest rates.    So who sets the interest rates?   Again, the Federal Reserve. 

Which basically amounts to a tax on every dollar you save every year.   

And people simply holding dollars in savings accounts don’t even get the courtesy of an interest rate, so the value of their money declines even faster.  If the rate of inflation is 3%, then the value of a dollar in a chequing account goes from $1 to .97.  The next year, it goes down to .941.   And on, and on.  Pull up a calculator and type 1 x .97.  then hit the equal sign.  Hit the equal again, 19 more times.  That’s what your money is worth after 20 years.

And THAT is probably the single biggest reason why saving doesn’t work worth a damn.  Because the Federal Reserve is going to sneaky-tax the holy hell out of it.  Every.  Single.  Year.  Aaaaaaaah!

So what can we do?   For now, two things…  a)  Don’t go spending everything you’ve saved because it’s all hopeless.  It isn’t.     b)  Stay tuned.  It’s about to get good.

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