Inflation is the increase in prices of goods and services, usually measured annually. It is of paramount importance that the value of your income or assets should increase by at least the same percentage as inflation to ensure that you do not have to use more of your income or assets to buy the same goods or services you bought a year ago. So, if you earned R1000 last year and you bought a basket of goods for R50, you would want your income this year to be R1100 if the same basket of goods would cost you R55 today. Not all goods and services increase in price at the same rate of inflation, which is why the inflation rate for your specific lifestyle will differ from that of your neighbours. Just look at the graph to see the inflation rate in the USA over the last 30 years for various products and services:
The graph shows clearly that your personal rate of inflation would have been much higher than the official Consumer Price Index level if a large part of your income was spent on housing, food, healthcare, tuition, childcare, and commodities. If we look at the current situation in the USA, we see that there is a significant difference between what the government perceives to be inflation (CPI) and actual asset price inflation, for example of property and equities. Buying a house in the USA is currently completely out of the question for someone who had not participated in the actual asset price inflation we saw in shares, property, commodities and yes, even Bitcoin. If you have been earning a salary with annual increases of between 1% and 3%, but property prices have risen at double the rate of the CPI and the S&P500 has risen by 13,6% per annum over 10 years, you have a problem.
If we stay with the situation in the USA, we see two problems developing. The first one is being created by the government. Because the Federal Reserve uses the official CPI figure as a measure to stimulate or deflate inflationary pressure via interest rate manipulation, they believe that with the current core inflation sitting at 1,6%, there is no inflation in the system. But if they look at asset price inflation, they will see that printing more dollars and keeping interest rates so low may create a big problem in future. The other problem lies with the consumer. Unless you had money in a mortgage-free property or in the equity markets, your earnings have not kept pace with the actual cost of assets and if you had your money invested in cash, the almost 0% return has devastated your purchasing power.
In South Africa our asset prices and inflationary pressures are a bit different but the same principles apply. The best hedge against inflation in order to maintain your desired standard of living will always be to invest longer-term funds in equities and to own a mortgage-free property that suits your needs. Another important factor to consider in South Africa is the value of the rand relative to the currency in the countries we import our goods and services from. If the rand weakens against those currencies, we effectively have to pay them more rands for the same amount of product.
