What is inflation? Basically it is the rise in the price of goods and services. In turn it affects the value of currencies and our hard-earned savings. Wise governments dread it and try to prevent it because they know it can lead to bankruptcies, unemployment and social unrest. The worst economic periods in modern times have been characterized by high rates of inflation.
How can it affect us personally?
It can affect us in many ways. Imagine you have just retired at 65 and are drawing a fixed pension in the form of an annuity, let’s say worth $1,000 a month. If inflation is running at under 2% per annum it will be some time before the impact is felt. However, should inflation rise to say, 7% per annum, after just 10 years the purchasing power of your pension is halved. Should you live to 85 or 90 the pension becomes almost worthless.
What if you are so unfortunate as to live in Zimbabwe right now where inflation is running at 100,000% per annum and you are paid in the local currency? The pension you have worked hard for all your life becomes worthless after just a few hours!
Things have not been quite so bad in Indonesia but since I first came here in 1983 the Rupiah to the US Dollar has gone from Rp.600 to over Rp.9,000. Since prices have risen by the same or a greater amount it is clear that inflation has seriously eroded the value of the currency.
Inflation does not affect everyone to the same degree
Governments routinely publish inflation figures. Unfortunately they can be very misleading. They will incorporate a wide range of goods and services and might genuinely reflect the rise in cost of living for a reasonably well-off group. But for the poor it’s a different matter. Global food prices are reckoned to have risen 40% in 2007, yet no country publishes an inflation rate anywhere near this. If the cost of luxury cars, holidays, household appliances or other items are included in the calculation the impact of increased food prices is diminished in the official figures. This is of no consolation to those whose family budget is spent almost entirely on food. For them the inflation rate is closer to 40% than the official figures of perhaps 7% to 10%.
Where will inflation go from here?
The chances are high that things are going to get much worse, particularly in respect of life’s essentials. Agricultural commodities in particular are under severe stress due to population growth in developing countries, the huge increase in consumption in China, particularly of milk and meat, the conversion of food to produce biofuels and the impact on yields of severe weather and droughts. The price of oil has reached another record high and this has an impact on all areas of the economy. The well-off can cope with this. They will continue to be able to pay more for petrol, the price of which is now heavily subsidized in Indonesia, and can absorb the higher cost of food as it does not represent a major portion of their budgets. But for the hundreds of millions of poor in the world it is not looking good.
What can governments do about it?
Where food and energy prices are concerned, not a lot, other than to provide subsidies which in turn shift the cost to the tax payers or reduce spending in other areas. The standard solution to controlling inflation is to increase interest rates. This in turn causes people and companies to borrow less and hence spend less. But this solution in turn brings the risk of recession and makes governments very unpopular. In the US right now the government is reducing interest rates when in fact it should be increasing them. When a child is sick you can make him happier in the short term by giving him chocolate but by withholding the unpleasant medicine you are not helping him to recover. Unfortunately, governments are often more concerned with their own popularity than finding long term solutions. We can see the same thing on our doorstep. The fuel subsidies are largely benefitting the well off. In the UK where fuel is heavily taxed you think carefully before adding to clogged-up roads. Of course the UK, like other Western countries, can offer first class public transportation services, something that is sadly lacking in developing countries. Also, the government here is very much aware of the social repercussions of a large increase in fuel prices. One wonders why they have never been adjusted in small increments to reduce the impact. Where the food situation is concerned, governments in poor countries should be desperately seeking ways to curb population growth and to increase local food production without destroying the environment. Conversion of food to produce fuel should be banned internationally!
What can individuals do to protect themselves?
I would need a lot of space to answer this fully but over the long term you are likely to protect yourself from the hazards of inflation by investing in solid assets such as real estate, stocks and commodities. Of course, all of these asset classes can fall in the short term but over the longer term they will generally hold their value and in most cases beat inflation. This is what financial planning is all about.
Colin Bloodworth, Financial Partners
World Trade Center 8th Floor, Jakarta and
Jl. Sunset, Kuta, Bali.
colin.bloodworth@financial-partners.biz
