INFLATION is the rate of increase in prices over a given period of time. As a result of inflation, the purchasing power (value) of money decreases over time. Inflation affects the prices of everything that we buy.
What causes inflation?
Here are the factors that cause inflation:
1. Supply and demand. In an economy, when the demand for a commodity exceeds its supply, then the excess demand pushes the price up. The result is higher prices due to demand-pull inflation. On the other hand, when the factory prices increase, the cost of production rises too. This leads to an increase in the price level as well.
2. Government deficit. There are times when government spending increases beyond what taxation can finance. In order to solve this, government resorts to deficit financing such as printing more money which in turn adds to inflationary pressure.
3. Population growth. As the population grows, it increases the total demand in the market. Further, excessive demand creates inflation.
4. Hoarding. There is always the possibility that at certain times, the factors of production are short in supply. This affects production. As supply will be less than the demand, Opportunistic businessmen resort to hoarding to push the price up even more, thereby increasing their profit.
5. Non-economic reasons. There are several non-economic factors which can cause inflation in an economy. Examples are war or typhoon (flooding) where crops are destroyed. In effect, this reduces the supply of agricultural products leading to an increase in the prices of our basic commodities. A perfect example was the pandemic where the supply chain was disrupted, which resulted to inflation even if the price of oil was at its lowest.
With the world recovering economically from the effects of the pandemic, Russia invaded Ukraine and this man-made crisis plunged the world into another economic problem. Ukraine is a major exporter of food and Russia is a major oil exporter. Just imagine Ukraine’s food production hampered and the sanction of the West on Russia taking effect. The result is a world-wide inflation because another supply chain was disrupted. I felt it strange for certain groups to blame our current leadership since the crisis we have now is due to a defective decision by one foreign leader. We cannot control external factors but we can control on how we respond to this crisis. We all are affected by inflation and even if we cannot avoid inflation, we can minimize its effect on us. Below are some things we can do:
1. Spend only on needs. By spending less, we can avoid wasting our money on inflation. We must buy only our needs. Best is also to shop around and look for those with lower price (but of same quality). Make it a point to make a budget to keep our costs in control.
2. Avoid debts. As inflation surges, so do the interest rates. Banks need to raise interest rates in order for them to keep pace or outpace inflation. At a high inflation rate, it is the worst time to be in debt. Note that in the past where inflation was low, a lot of businessmen resorted to loans because the cost of money was low and it makes perfect sense for them to use other people’s money to make money.
3. Invest. Cash is not king. During inflation, keeping a lot of cash is not an option as inflation eats away it value. Keep some for emergencies and invest the rest in instruments that beats inflation. An example is the stock market. The stock market is low right now, but over a long rough time frame, that investment can earn a much higher interest rate in the stock market than it would in a savings account. Another one is bonds. It can be another place to put our money for diversification. We can choose from corporate bonds issued by private and public companies, municipal bonds from local governments, or treasury bonds by the government. Note that when stock market is down, bond market can be up.
4. Invest in REITS. Real estate is a good hedge against inflation but only a few can afford. Consider a real estate investment trust (REIT). A REIT is a portfolio of properties with everything from office buildings, hospitals, malls, and more. It’s a great investment if you want a more liquid real estate asset, and may be a smart fit for risk-averse investors.
In any crisis, there is always opportunity. We just have to open our minds. Panicking is not an option. Instead of the blame game, why don’t we do our own research and solution. Just as Jackie Chan said in the movie “Karate Kid:” FOCUS!
Edmund Lao is a registered financial planner of RFP Philippines. To learn more about personal-financial planning, attend the 99th RFP program this January 2023. To inquire, e-mail info@rfp.ph or text <name><e-mail> <RFP> at 0917-6248110.