inflation-2013

Inflation. The word used by every person you know. Because they all believe themselves to be experts in finance. Don’t they?

I’ve heard some people even shout out things like “the inflation in that country is 20%!!”. And then I asked, oh so naively: “alright, but what makes this happen?”. The answer was always an arab-like philosophical absurd tale of industrial growth, political control, or even once it was: God’s way to keep us running!
Inflation grows when there’s too much money in a market, compared to the supply of goods in that same market. So yes, when people say that inflation in Dubai, for example, is high, it’s because that economy is built solely on thriving businesses, with high wages, and so a very high availability of money, which is constantly growing (the 2008-2012 “incident” excluded). Banks in Dubai will come to your home to give you financial facilities and “smart loans”. Which makes you think: how much should the supply of goods be, to beat that level of supply of money? And so you find anything and everything in that market. Malls and luxury shops and custom-made versions of very expensive items… and still, the supply of money is very high. Which results in a higher inflation, or a fast-paced increase in the price of goods.

Central Banks are able to control inflation by controlling the supply of money. If they can. This happens by increasing the cost incurred by the banks to borrow money from the central bank. This is what people have been hearing about lately out of the U.S.: the Federal Interest Rate. When the cost of borrowing for banks becomes higher, their cost of lending to the public increases, they will borrow and lend less, and so the supply of money does not out outweigh the supply of goods. At least not enough to shoot inflation up the roof. This may not really apply in Dubai, but in the U.S. it’s a totally different story.

People ask us why are the stock market, and the value of the U.S. dollar affected by the “Fed Rate”. This is actually interesting. It’s called The Ripple Effect:

The Fed (or central bank) increases the cost of borrowing for the banks. The banks increase the cost of lending, which affects “balloon-based” loans, and loans with variable interest rates, as well as credit cards charges… This decreases the amount of money customers can spend, and so they will have less Discretionary or Disposable Income (which is meant for luxury or leisure spending…), which will affect revenues and profits of businesses. Businesses will then declare less earnings, which will affect the price of their stock.

The same goes for companies, whose cost of borrowing will be higher, they will expand less, and spend less, which will surely affect their profit.

And there you have it. A small increase in the Fed or Central Interest Rate, and inflation goes down, but the stock market along with it. This in turn affects the value of the U.S. Dollar (or local currency), which would probably affect any forex pair the USD is involved in. Like Euro/USD. And then you might also hear that “the Euro is up”, although nothing particularly interesting might have happened in Europe.

If you think about the above a bit more, you can imagine more ripple effects, not only in the U.S., but also in Europe, Japan… all related to the U.S. Federal Rate.

Can you answer this question: if you don’t account for inflation, how much would $100 saved today be worth in 20 years?
Now that you understand the above, you should know that every financial decision you make might greatly affect your quality of life one day. What you know today, and what society has taught you is most probably wrong. Most of us are buying investments from bank tellers, saving policies from agents of life insurance companies, fake financial consultants, or even worse: brokers.
Stop relying on salespeople of financial products and Hire a Financial Architect! 
Same cost (if not less), but a million times more reliable results.