Rising prices are undoubtedly the indicator which speaks to the most people. Depending on its geographic location and its position on the economic value chain, inflation can be either a positive sign or a worst nightmare. In short, to paraphrase Les Inconnus (a French comedy group): inflation, you’ve got the good one, and you’ve got the bad one. But how can you tell them apart? Well, read on, and we’ll explain it to you!
Photo credits: Reuters
What is inflation?
It is the increase in the cost of goods and services. A euro can buy less in periods of inflation. It is often seen in increases in the price of petrol. Before, €50 would fill up my car, but now, I am a few litres short. In other words, the price of fuel is higher.
The Fisher equation: Inflation eats away at personal savings
This is one “Fisher price” which is absolutely no fun. The economist Irving Fisher brought to light the difference between the announced interest rate on savings and the actual increase in wealth. The root cause of this being, of course, inflation. For example, the rate for a French Livret A savings account in 2019 is 0.75%. This means your savings earns you 0.75% in interest. But Fisher reminds us that we need to subtract the rate of inflation from that percentage. So, if you earn 0.75% but the cost of living is increasing as it currently is at a rate of 1%, then how much are your assets really bringing in? Fisher, what does that mean? Today, the return on your Livret A savings account is: 0.75 – 1 = -0.25! Meaning, you are losing 0.25% of your wealth!
Why isn’t inflation good for the economy?
It all depends on its level. In certain countries in crisis, like Venezuela but also Turkey, when the Turkish lira collapsed under attacks from the US, or Argentina in the midst of its financial crisis, it can become unbearable. The illustration of this is consumers going around with “barrowfuls” of local currency just to buy something to eat. This is hyperinflation with, in the month of July for example, an 82,700% increase in prices in bolivars! Imagine that, between the time when you leave your house and you get to the bakery, the prices have risen several times over.
Photo credits: Reuters
No inflation isn’t a good thing, either
Reasonable inflation is also a sign of an economy’s good health. Growth is happening, companies are doing well, they are hiring, wages are rising and so prices are going up. This is the basic equation for our modern economies. Today, there is cause to wonder at the situation of developed countries, which all report near full employment, with the exception of France. Normally, there should be a little inflation all over, which is not the case now. Interest rates have never been so low, and money has never been so readily available, with the Fed and the ECB pouring billions into bank coffers (or, as we used to say, setting their printing presses racing). Inflation remains contained, at close to zero. This is astonishing, to say the least.
How is the inflation rate calculated?
A “basket” of products and services is analysed. Naturally, the choice of what goes into that basket is a subject of great debate. For example, in France in particular, the population feels like “everything is getting more expensive”, and yet in 2019 INSEE (National Institute of Statistics and Economic Studies) released an inflation figure close to 1%, suggesting on the contrary stable prices. The consumer price index (CPI), which forms the basis for calculating inflation, covers multiple families of products and services. This yields a fairly broad view of everything we might consume: food, housing, energy, equipment, clothing, tobacco, and so on. So, if rents are rising while energy (especially the price of petrol) drops, then the CPI could be close to zero.
Why is everything getting more expensive when inflation is almost nil?
INSEE, which has, for decades in France, been responsible for gathering pricing information and producing the consumer price index, continues to defend its methods and opposes the relativity of popular perceptions. Without taking a stance in this debate, it is still easy to imagine that the “basket” might evolve less quickly than consumer habits. For example, urbanites who no longer use cars to get around only see regular rises in the price of public transport and not the decline in the price of petrol. And there are plenty more parallels which could be drawn.
Is the price of gold affected by inflation?
Gold is considered to be a safe haven. So, what happens in a case of hyperinflation like in Venezuela or Turkey? Conversely, does gold lose value in a situation of deflation?
It should be noted first and foremost that, to ensure their monetary independence, countries tend to prefer to reinforce their gold reserves rather than disposing of it. This was true of Turkey in 2018, but the Chinese, the Russians and even the Poles bolstered their stocks in 2019. Those countries are sending a strong signal: they are doing this to reduce their dependence on the dollar.
Gold retains the same buying power over the years
This is probably the best answer to the previous question. At the turn of the 20th century, you could buy a velocipede with one Sovereign gold coin. Today, with €270 (the price of a Sovereign), you can buy a bicycle. In between, there has been a rise in GDP, two world wars, changes in currencies, devaluations, the move to the euro, economic and stock market crises, and alternatingly strong and weak growth. Yet still, a century later, you can buy the same thing with the same coin (or its cash equivalent). The same demonstration could be made using an ounce of gold or its equivalent in euros. Before the Industrial Revolution, it took the equivalent of an ounce of gold to buy a cow. And that’s still the case in 2019, give or take a few dozen euros. We’ll give one last example, that of the Ford Model T, a major travel innovation in its day. Well, the total sum of silver and gold coins needed to purchase such a machine in 1910 is almost exactly the same as the price of a Tesla today.