INFLATION - Where everything Costs More
In simple terms, inflation is where everything costs more. In other words, the buying power of the dollar decreases.
The rule of 72
When 72 is divided by the percent of increase or decrease, it yields the years it takes to double or half the initial amount. The early IRA models touted that with an 8% annual gain on your IRA account, the money would double in 9 years. What was not mentioned was that the buying power of that money was also decreasing by the annual inflation percentage. If one utilizes the desired inflationary rate of 2-3%/year, that would yield a 5.5% rate (8%-2.5%= 5.5%). This means that it actually would take 13 years for the effective buying power of your IRA to double.
Inflation works like the IRA, only in reverse. Based on the records, over the past 107 years, the AVERAGE rate of inflation has been 3.25% meaning that every 22 years, the buying power of the US dollar is cut in half. At the same time, if government spending increases an average of 5-6%/year, which it historically has, then after adjusting for inflation, government spending increases about 3%/year or doubles every 24 years. Thus, by 1940, the government had doubled in size from 1916. Then by 1964, government spending had doubled again, or was now 4 times what is was in 1916. And in 1988, it doubled again, now 8 times 1916 spending. And in 2012, it doubled again, now 16 times the government spending in 1916. And in another 15 years, if the same growth rate is maintained, it will double again to 32 times the spending in 1916 – after adjusting for annual inflation. This is a logarithmic increase.
Highest Inflation in 40 years
When the news states that our current rate of inflation is the highest in 40 years, they are referring to the 1970’s. From 1973 to 1982, the annual inflation rate exceeded 4%. On average it was 8.75%. In 1980, it peaked at 13.5%/year. What that meant is that if in 1973 one was preparing to retire, by 1982, everything would cost twice as much. Or your retirement savings could now only buy half as much as it could 10 years prior.
What causes high inflation? Spending, particularly by those who can essentially ‘print’ the money.
