Wednesday, March 04, 2009


My friend Jonathan got me thinking about building a solid financial foundation and made me concerned about those trying to do that in these times. Here is one worry.

Stagnant economy + high inflation = Stagflation… and you don’t want that. Let’s start with inflation first. Inflation basically means that one dollar today will get you less than that dollar got you yesterday. Sum it up as your grandpa saying “when I was your age a piece of candy cost a penny.” Well you can’t get that piece of candy for a penny now, today it will cost you 50 cents. That’s largely due to inflation, prices rise over time, and it’s due to a number of factors. A stagnant economy is one that does not grow, or that grows very slowly. We are currently in something worse than stagnation; we are in a contraction (i.e. negative growth) that has been escalated into a recession (defined as three consecutive quarters of contraction *I think*). But for the purposes of this discussion, we will assume that the economy will eventually stop contracting.

Let me tell you why stagflation is awful. Your money is constantly being devaluated and your resource pool is not growing. You are paid the same amount of money but everything you buy and live on gets more expensive. Which is no good.

Stagflation is very possible in our current situation. It will be awesome for the economic recovery to be quick and substantial but likely it will be slow and painful. These missteps and restarts will define how long our economy will remain stagnant. If Obama’s plan of developing American Infrastructure and creating a Green Energy economy work out, then the economy will have an engine for growth. If those plans meet political or economic hurdles and fail then we will likely be stuck in a stagnant economy for a while.

What is more likely than stagnation is inflation. These billions and trillions of dollars that you hear everyday on the news, these ‘bailouts’, are essentially the government printing money. Economic institutions, with banks in particular, are in a liquidity crisis… which means they have no cash. Think of a business as a person, who borrows money and makes something more valuable with that cash. The business pays back the lender and keeps some cash for itself and invests the remainder in ways of making more money. Well in this financial crisis, all the lenders have run out of cash. Now the businesses that were living paycheck-to-paycheck are SOL because they have no money saved up to continue doing whatever it was that made them money. Hence the credit-freeze, no money is flowing through the system. That is why the government is essentially printing more cash, someone has got to do it. The problem with printing cash is that it devalues the cash that’s already out there. If I give you a diamond, you feel special and think that its valuable. But if I pull out five more diamonds, all of a sudden it feels less special and its less valuable. That’s what happens with money too. It has a certain value when there is X amount of it. When there is X + Y of it, it is worth less per unit. And that is where you get inflation.

Currently things are fine, but what you all need to worry about is what may be coming. Right now inflation is not a big deal because the world is in this recession together and other countries are either doing the same thing (printing money) or are suffering from investor’s lack of confidence in their market potential. What will cause inflation is if America is in this deeper than anyone else (which makes intuitive sense to me). It will then cost us more than most of others. So while other people’s economies are growing, ours will still be stuck in the blocks.

What am I trying to say? Save up and put your money in something that ‘floats’ independently from cash. Consider diversifying your cash into something not directly tied to the dollar. Warren Buffet makes the case that stocks (equities) are a better place to put your money to shield yourself from an inflation hit. Others may say gold, real estate, or a global mutual fund. Who knows, but may be a good idea to look into it. Just try and put your money in something that beats the inflation rate which may be 5% in the future.


Anonymous Anonymous said...

Your blog keeps getting better and better! Your older articles are not as good as newer ones you have a lot more creativity and originality now keep it up!

7:14 AM  

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