ECONOMIC pain is everywhere. The main culprit is rising prices of almost all goods and services or inflation.
Why is inflation so important? Why are central bankers united in their fervour to (almost) extinguish its flames? Inflation makes all of us poorer by eroding our purchasing power.
Say your family goes out for a nice, relatively modest, meal at a food court. If the total cost of all the dishes and drinks comes to RM100 today, then consider what will happen one year from now if these three scenarios play out:
- Inflation runs at 10%;
- Inflation creeps up at 2%; or
- Inflation turns negative (this is called deflation) at -10%.
Since high inflation is bad, then surely low inflation is good while deflation is wonderful. Not quite.
To get a handle on what we are talking about, let us re-examine our three scenarios through a mathematical lens:
- If inflation runs at 10%, then a year from now the identical meal will cost a princely RM110 instead of RM100 – your purchasing power will have eroded by quite a bit;
- If inflation creeps up at a slow rate of 2%, the same meal will cost RM102 – your purchasing power will have eroded by a little bit; but if …
- If inflation flips into deflation which causes prices to fall by 10%, the same meal will just set you back RM90 – your purchasing power will have gone up by quite a bit.
Note: What the world is experiencing now is not hyperinflation which typically runs at 1,000% a year or much worse yet, perhaps 50% a month or about 13,000% a year.
Depending on which part of the world we consider, what we are facing now are annual inflation rates in the 8% to 15% range.
So central bankers are applying the brakes on inflation by raising official interest rates on cash. Their goal, oddly enough, is to reach muted inflation rates of, say 1% to 2% a year and not deflation.
The reason they don’t want the world to tip into deflation is we will all slash our spending today because our money will buy more stuff next year. If this cascades throughout an economy, it screeches to a halt.
So, as clever central bankers do their job, we should instead focus on earning more money, ethically, so we may raise our families’ quality of life from one year to the next.
How do we do that?
By raising our per hour productivity through working smarter, and by working harder by increasing the total number of hours we work each day, week and month.
The question is will we pay those steep prices? – July 17, 2022
Rajen Devadason, CFP, is a licensed financial planner with Manulife Investment Management (M) Bhd and CEO of RD WealthCreation Sdn Bhd.
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
