I’ve been reading a lot about inflation lately and wanted to write a quick post about what inflation really is. How the government reports inflation is grossly inaccurate, so I attempt to provide a clear example of how inflation is a cause of higher prices and not the other way around.
In order to understand the effect that inflation has on prices, we need to understand three relationships:
- The relationship between an item and its value
- The relationship between supply and demand and prices
- The relationship between dollars and prices
Once these three relationships are understood the overall effect of inflation on prices will be clear.
What’s the Real Value of Something?
This is a question that is almost always left out of a discussion of inflation and prices, but it is essential to understand that there is a difference between value and price.
If there was a world without money, the value of an orange would be expressed in terms of how great it tastes, or the nutritional benefits of the vitamins it provides. In the same vein, the value of a gallon of gas would be measured in the number of miles that can be driven in your car when that gallon is poured into the tank. If that gallon of gas allows you to get to your job for a couple days, then the value would be quite high.
While the value of an orange or a gallon of gas could be different to every individual person, it is important to see that value is not based on, or even related to money. If there was no money, things still have value.
Supply and Demand and Prices
Before we get to the relationship of inflation on prices, we need to understand supply and demand.
From our example above, if there is a frost and the orange crop is damaged, the price of oranges will go up. It’s important to note that this raise in price is not inflation. It is a common misunderstanding that inflation is a result of rising prices, but this is false. Inflation can cause prices to rise, but so can many other factors — the most notable of which is supply and demand.
The way governments measure and report inflation is actually flawed for this reason. If the Consumer Price Index (CPI) goes up, as a result of the price of oranges or other products going up, then the government reports inflation, but it would be more true to say prices are increasing, and it may or may not be caused inflation.
Dollars and Prices
Finally we can look at the relationship between the cost of an item and number of dollars available in the economy. In order to create a manageable example, we’ll take our orange and imagine eating it on an island country where the sum total of all money available is only 100 dollars.
If we go back to the “value” of an orange in this economy we could express that value (which is based on the benefit derived from eating the orange) as 1/100th of the total value of all the goods available on the island. Obviously this is just an arbitrary figure, but in reality, since our money is finite, the principle is sound… everything has a price which is a reflection of its value, that can be expressed as a fraction of all the money available to spend on any possible item for sale.
Now let’s double the total amount of money available on the island, due to the island government creating a stimulus package.
Now there is a total of 200 dollars available on the island, but the value of an orange has not changed. It still has the same great taste and health benefits. Therefore still has a value, when expressed as a percentage of all available money or 1/100th.
But now there are 200 dollars so 1/100th of 200 dollars is $2. The price of an orange, due to the government stimulus package which doubled the amount of money available, has also doubled from $1 to $2.
This is the essence of inflation as a result of money supply. This should help us understand what MUST result from the government’s recent bailout package.
This post is the second post that resulted from my curiosity about what is happening as a result of the economic meltdown. Yes, we hear a lot about it on the news, but that’s all about big banks, auto company bailouts and governments trying to flood the country with “liquidity” to unstick the credit markets.
But what I was curious about was the stories the don’t make it onto CNN; what effect is the credit meltdown and global recession having on normal people in their day to day lives..
So I asked 5 strangers to write down what they had learned as a result of the tough economic conditions. Like I did, I think you’ll find the stories very engaging, and you’ll see how powerful of force money is to shape people’s lives.
Lesson #1. Hiring People who are Over-Qualified
This past year has been an eye opening experience to say the least. Everywhere you look, people are being laid off. My family owns several small retails businesses in the midwest and had to do some hiring to find new employees this past year. We advertised for both manager and sales associate positions in both local newspapers and Craigslist. We found that the people responding to our ads were not just retail experienced individuals, but people who had been laid off at major factories in the areas.
When we were calling people for interviews, we found people who were desperately looking for full time management positions offering full time benefits and pension plans. This response was kind of amazing to us until we had the pleasure of actually sitting down and discussing the position with these folks. We heard stories from women who were in desperate search to find work while their husbands were laid off. We heard stories from men who applied for our positions with the hopes that we were a major retail chain offering management positions. One lady explained to us that about 75% of her town was employed by either of two local factories, both of which were doing heavy lay offs.
I felt bad that we did not have more positions to offer.
Jayda, St. Louis, MO
Lesson #2. I’m Happier Now
First of all, I saw this coming. With the Bill Clinton era lowering the qualifications on home mortgages and the home lending bubble being ready to burst I knew what to do. Fuel prices also showed me to hold onto money as hard as possible. So, at the point when I knew, due to past years trends, to bail out of the stock market, that let me keep the whole worth of my money. While other people were loosing money each day in their 401k, I was internally laughing, telling them they should have listened to me.
This whole time since fuel prices came up, I have been cutting back in every way possible. I learned how to cook more kinds of meals. Though attrition, I’ve replaced incandescent bulbs with compact florescent or LED lights. So I stayed ahead of the curve, in cutting costs. And I love coupons now, I can’t get enough. I do still eat out some, but it’s two for one now. And forget fast food meals almost all together, they are too expensive for the quality of the food. So the quality of my life went up, while the cost of it went down.
Sad thing is, it usually takes money to save even more money. So I did spend where it would help the most. On other things that didn’t cost money to cut costs, I lowered the normal temperature to save on heating. I purchased window fans, to cut down on heating and cooling as well. This economic downturn has done a world of good for me. I have a greater net worth, lower debts, and I’m happier. Now the only issue is when to reinvest to take advantage of the last gold mine of the downturn–the stock market.
KB – Greenville, USA
Lesson #3. 101 Ways to Server Mac ‘n Cheese
I remember the days when I was able to open the freezer and gaze upon the abundant choices of meats I had. These days, the recession days, I open my little chest freezer and stare down dispiritedly at the little shriveled frozen green bean that had escaped from the bag before I had a chance to boil it. I haven’t yet managed to work up the energy or desire to crawl into the freezer to retrieve the lone bean, or the money to fill the freezer with more meat, but I have managed to become a creative cook.
If this recession has taught me anything at all, now that my freezer has been relieved of all of its meat, it is the value of a food product that has been in existence for as long as I have been alive! I have discovered the amazing things a creative parent can do with a 79 cent box of macaroni and cheese! In the recent months I have managed to make this cheesy carb into a main dish, a side dish, a cold dish and even a dessert!
For 79 cents and a splash of milk you can serve this age old favorite spread neatly beside a pile of whatever vegetables you have available, a slice of buttered bread and a tall glass of Kool-Aid. For a bit more you can create a masterpiece casserole! Simply make the macaroni ‘n cheese like the directions say, toss it in an oven safe dish with a handful of vegetables, a few cut up hot dogs, sprinkle on some crushed corn flakes, warm in the oven and Viola! A feast fit for, well, maybe not a king, but definitely fit for my hungry family.
Maybe macaroni and cheese was created for a depression, maybe it was created to withstand a recession. In any case, it has become a staple in my family and will doubtless stay that way for a long time to come.
Tina, Mayville, USA
Lesson #4. Recession = Simplifying
During this current recession, I have had time to sit and think about what I really want to do with my life and the things that are important to me. My husband is in the construction business, mostly residential, and I am a stay at home mom to two sweet little girls. We have learned to stick together as a family and ride out the bumps together.
Although we have lost a third of our income, we really cannot complain. We can still put food on our table and although we may be forgoing the amusement parks, we can go to the zoo and pack a yummy lunch. Who said being poor put you at a disadvantage?
We are using our limited financial funds to find resources that are more valuable in our community. We are no longer eating at upscale restaurants, instead I have learned to cook, which my husband just loves. We are cooking Cornish hens at home with tomato and mozzarella salad and it is literally only costing us a few dollars.
I still worry about our future, and being able to provide our children with the best, but for right now I am enjoy a simpler life.
A.R. – Louisville, u.s.
Lesson #5. Daddy’s Advice Saved Me
If someone asked me what I’ve learned from the recent economic downturn, I wouldn’t hesitate in answering. I’d say that the lessons I learned from my father served me well. I was able to take all of the practical advice he taught me about money and put it to good use.
“Never buy anything on credit if you have the cash,” my dad would say. “Save your money for a rainy day.” As a child of the depression, he knew what it was like to be poor. His father – my grandfather, was a wholesale produce distributor in New York City. They always had fresh fruit and vegetables on the table, though not much more.
So over the years, I saved my money diligently. I invested conservatively – mostly in bank CDs. I maxed out my 401k at work and participated in employer cash match programs. I didn’t take elaborate vacations, buy expensive cars, spend money on the latest and greatest electronic gizmo or max out my credit cards. Except for a modest mortgage on my house, I do not owe anyone any money.
I’ve learned that even though my job was recently eliminated as part of the recession, I still can make it – for several years, if necessary, just by relying on my savings. I don’t need a handout from anyone and I’m not frightened about my future. I know I will make it – because I heeded the advice my dad gave me. “Never buy anything on credit if you have the cash.”
Thank you, Daddy.
SuzyQ – Glen Allen, Virginia
If you’ve learned any personal life lessons as a result of this economic crisis, please leave a comment. I’d also like to thank the people who bravely stepped up to tell there stories for us all to learn from.
[This article is part of the Carnival of Personal Finance (#200) at MoneyNing.com]
This post is result of my curiosity about what is happening as a result of the economic meltdown. Yes, we hear a lot about it on the news, but that’s all about big banks, auto companies, and bail out package.
But what I was curious about was the stories the don’t make it onto CNN; what effect is the credit meltdown having on normal people.
So I asked 5 strangers to write down what they had learned as a result of the tough economic conditions. Like I was, I think you’ll find the stories very engaging, and you’ll see how powerful of force money is to shape people’s lives.
Story #1. Money is No Object
Money is no object. Until you realize you have none. I’ve seen this coming for a long time and I’m no stranger to adversity. But I never thought it was going to hit me all at once. I lost my job last month. There’s nothing like instant poverty to give you an unpleasant wake-up call and teach you a few things about how far you can stretch your budget and your imagination.
For instance; I learned that the bills and junk mail I shred make an excellent subsitute for kitty litter if you run out and can’t afford more. Who knew?
I also realized that once you get used to the after taste, the “government cheese” isn’t so bad after all. Besides, if you get really hard up, you can heat it and use it for caulking. Who knew?
Did you know that Top Ramen is only .12 cents a package in fine grocery stores nationwide? I didn’t, until it became a main staple in my household. Apparently people have been eating this stuff for years. Who knew?
I found out that you can get a $3.00 haircut by a student at the local beauty college. I also learned that you need to buy a $7.00 hat to cover up the apocalyptic catastrophe that once kept your head warm. That wasn’t totally cost effective after all.
I also learned that thrift stores sell used goods for twice what they are worth in their present condition; but half of what you’d pay for them new. Also, since everything you buy from a thrift store smells like grandpa Joe’s house, which hasn’t been cleaned properly since grandma passed away in 1972; Febreeze is a must-have. Or should I say; must-half.
I now know 27 different ways to prepare macaroni and cheese. I also found out quickly just how much weight you can gain on a constant diet of starchy foods. Thankfully, the thrift store also carries clothing. The eighties will be making a comeback in my wardrobe. Hello, acid washed denim!
In the end, the most important thing I’ve learned through all of this, is humility.
Stephanie, Kingman – USA
Story #2. Nevermind saving your finances, how do you save your marriage?
During the economic downturn, I was preparing myself for our own budget crisis, but not prepared for the marriage crisis that would ensue. Previously, I vowed that adultery or abandonment would be the only cause for divorce, but as I later learned – most sources say that finances are the #1 reason for divorce. Even when the words, “I want a divorce” were first uttered, my first thought was preparing myself financially, rather than involving myself emotionally. How did this happen?
I thought it sad to know that before adultery, before abuse, before addiction and before the loss of intimacy, most persons would divorce over finances. My husband and I thought that we loved each other very much. However, the technicalities of our budget and the stresses of securing our finances took precedence over emotional needs. How could we focus on saving our love when we needed to save the home that physically housed our love?
Our love wasn’t expressed with lavish material gifts or expensive evenings out. Yet somehow, it found it’s conditionality with the bad news that my company was no longer offsetting our insurance premium and when my husband’s hours were reduced to a part-time position. It’s difficult for an “I love you” to cure the frustration of having to look for a second job or when you drop $500 for just one doctor visit, one lab test and one bottle of medication.
Finding the strength to stay true to your vow “For Richer or Poorer” can’t be taken on by one person alone. If we weren’t both willing to see this financial uncertainty to the end, then the life we had together wouldn’t survive. However, we both know deep down, that there’s no price that can be placed on ending our love.
Althea Deveaux, Los Angeles – USA
Story #3. What really matters
During this economic downturn, I’ve learned what’s really important in my life and that isn’t the possessions I own but the people who care about me. Thanks to this economy, I’ve lost enough freelance gigs that I barely have money to eat. Things like Sunday brunch, going out for drinks or even seeing a movie are luxuries that I can’t afford right now. The people who were around me because they wanted to “do things” seem to have vanished. My true friends have stayed and we’ve learned together how to do things for free or on the cheap.
Speaking of my possessions, I’ve learned in this economy how to shop at thrift stores and E-bay. Do I really need new winter boots that will get scruffy after a walk in the snow? Do I really need to buy the latest gadgets and other fun devices? How many coats do I need? I now make a list of items I plan on purchasing, so I can decide if I truly need them or if I am just being greedy. Along those lines, I’ve been selling items on Amazon.com and E-bay. If I haven’t worn it in a year, the item is being sold. Also, once I read a book, I either pass it on or sell it. This has served to free me from my need for possessions, thus allowing me to focus on those who truly matter to me.
Michelle, New York – NY
Story #4. Credit is the devil
I have learned that we as an American nation should not be at all surprised that we are in this mess up to our necks. In recent years, we have redefined the “American Dream” as a method of living beyond our means.
The economic downturn is the result of one thing and one thing only: credit. Credit is the devil. Because of credit, people are granted false wealth and false security. Sure, in principle, it sounds like a bowl of ice cream. But when that sweetness melts away we are left with more than we can handle. I for one made this same mistake. Fresh out of high school I was offered a new credit card at every turn.
Now I am in so much debt I can’t see straight. I have learned that credit cards of any type are bad and if I can’t afford it with what is in my pocket then I don’t need it. I can only hope that every person adopts this mentality. If we continue to live beyond our means, we will only fall further into economic crisis.
I wish that I could wave a magic wand and eliminate all credit card companies in the blink of an eye.
Unfortunately, I would have more success discovering that Unicorns really do exist. Things will not get better until we wake up and realize that nothing comes without hard work and dedication. I don’t foresee that happening anytime in the foreseeable future.
bb, jasper – usa
Story #5. downturn vortex…
The recent unfolding of economic events in the past 1 and half years has left everyone crippled. The start of the housing crisis surely was gonna bring out the worse parts of economies, but the fall of giants like Lehman, Merill, AIG and others has shown to what extent many of these companies have invested in toxic assets just for expectancy of more gains.
I personally had invested heavily in these companies considering them to be world leaders and stable. But they have shown what kind of leaders they are and what precedent they have set for others.
In spite of facing heavy losses, one thing is clear, one’s portfolio always needs to be diversified, as in not only equity but bullion, bonds and FDs if you really want to stay afloat. I have known many friends who invested all their savings into markets and lost heavily.
Millionaires turned paupers by losing in oil slump. I personally have also decided to refrain from commodities for now when the financial downturn is taking its toll. Though I am feeling soon I will find the best of deals in real estate. One of my colleagues million dollar home sold for mere 3lac USD, Reason is he badly needed money and had no choice but to sell it.
If you’ve learned any life lessons as a result of this economic crisis, please leave a comment. I’d also like to thank the people who bravely stepped up to tell there stories for us all to learn from.
[this post was featured in the 195th Edition of the Carnival of Personal Finance at Stock Trading to Go]
Okay, this is an easy one, right? Of course the media is somewhat to blame for our tough economic times.
At least a decent portion of the economy is based on consumer confidence. And what is biggest factor that contributes to consumer confidence (or lack thereof)… the media. That’s right!
If the evening news is talking about the price of gas rising, the cost of food rising, layoffs, and overall gloom and doom in the economy then you’d have to be an idiot to continue to have confidence in the economy. Or you’d have to be so flippin’ rich that you just don’t care.
So of course the media is to blame for consumer confidence and somewhat for the economy too. But that’s not to say they are wrong or that it’s their fault. After all, they do have to report the news, right?
But there is one other little thing that I do completely fault the media for.
And that is the way they report on credit card debit.
We are a nation buried to our eyeballs in credit card debt. Yet we can’t seem to dig our way out or even pretend to try.
And why is this? Because of the media, of course.
Let me explain…
For years the media has been reporting on the alarming trend of credit card debt in this country. In fact, as far back as I can remember the media has been letting us all know what the average credit card debt is per family. And they’ve also been letting us know the percentage of families that are in debt.
Of course both those numbers (the average debt and the percentage of families) have always been huge. But instead of families being horrified, I think it’s had the opposite effect.
People saw those numbers (and continue to see those numbers) and they felt (and still feel) better. Misery loves company, right? So when people see it constantly reported how far in debt everyone else is too, they feel better about themselves.
I know this may sound crazy but think about it.
Really, it’s the same effect that happens when anything like this is reported. I mean, I may be 10 pounds overweight but when I hear the average American is 20 pounds overweight (or whatever) then I smile and get-up and grab another piece of cake.
The media reporting on credit card debt has the same effect. Every time the evening news reports how filthy America is with credit card debt, people all over smile and begin planning their next shopping sprees.
Of course they won’t be smiling for long, but the credit card companies will be. Because the major credit card companies are the only real winners here. They rake in massive profits at the expense of all the hardworking families.
But as for families held hostage by credit cards, losing to the credit card companies isn’t so bad when so many people are losing with them. Right?
Well, at least it doesn’t feel too bad. And every time the media reports on it, it feels just a little bit better.
[this article was featured in the Carnival of Personal Finance, 173rd Edition, on Girls Just Wanna Have Funds]