Modern money is paper money since the world came off from the gold standard in early 1900. One problem with paper money is that it is based upon confidence and trust, which can be fickle and fleeting sometimes. When the confidence is suddenly gone, then you have an Asian currency crisis or Mexican Peso crisis. The other serious problem with paper money is that government can print it in unlimited quantity. Pretty much with any forms of government human can conceive of, all forms of government leads to monetary inflation. The basic reason is that money can translate into power, and all forms of government are power-hungry. With more money, politicians can please their voters in various ways they choose. And so they either choose to print more, or borrow more, and both ways are inflationary. The cycle of more money more power, and then more power more money is self-perpetual. In this process, paper money gets debased constantly, and therefore you have inflation.Monetary inflation complicates the savers’ goal. Without inflation, the savers can simply save and store his or her wealth in whatever form he or she chooses. He or she does not need to worry about losing purchasing power of his or her dollars in cash. However, with constant inflation even when it’s gradual, over time government dilutes the value of the dollar and steals from savers.
With inflation, the price of everything goes up, including the wage of the labor. The lower class people who have minimal savings don’t have much to lose. (Forgive me to use this political incorrect word “class”. ) Their wage is usually behind the curve of inflation, and therefore, their lives are a constant struggle to catch up with the last payment that is due. The middle class people who have some savings face similar situation as the lower class people. In a low inflationary environment, they can try to maintain their purchasing power with the limited venues of investment choices that they have. But the most distinct advantage of middle class compared to lower class is that their major asset is their home which goes up in value via inflation. Since their mortgage debt gets devalued relatively speaking versus the prevailing wage, servicing the debt gets easier over time. The upper middle and upper class people, because of their more plentiful resources, usually have substantial wealth invested in assets and/or owning business that will go up in value in an inflationary environment. Inflation always benefits more to the people who get their money first, such as businesses or government, while the inflationary effects propagates last to the wage earners.
From the calculator provided from US Federal Reserve, you can see that from 1913 to 2006, the value of US$1 is equivalent to $20.45 today’s dollar, an astounding 95.1% loss in purchasing power, but only about 3.3% inflation rate compounded annually. Is your bank account yielding more than 3.3%? And government does not forget to tax you on this imaginary inflated value, be it the capital gain or interest or dividends. At a marginal tax bracket of 35%, you need to have a return of 5.07% before tax to beat this gradual inflation rate. That is why if you don’t put your money in some inflation-hedged assets, you can seldom get ahead.
