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Question:


I keep hearing about inflation and how it's supposedly eating away at the money in my savings account. First of all, what is inflation? Secondly, how do I beat it?
-RoyHandler


Answer:


Inflation is an increase in the price of a product or service used by consumers or businesses. When discussed by economists or in the media, it typically refers to a basket of consumer items. Inflation results ultimately when the money supply rises faster than the amount of material goods in the economy. The immediate cause can be anything from rising wages in a tight labor market (not much chance of that for the foreseeable future) to a shortage of a critical commodity like oil.

Inflation is fairly mild now. The core consumer price index, a measure of inflation compiled by the Commerce Department that excludes volatile items like food and energy, rose just 2.0 percent in the 12 months through September. That was despite the massive printing of money by the Federal Reserve as part of its effort to stimulate economic growth. One reason that the rise in money supply has not contributed significantly to inflation is that the freshly printed money had gone into assets like Treasury bonds and not into wider circulation in the economy.

Inflation was a significant problem in the 1970s, when oil prices skyrocketed suddenly, but Fed action in the early 1980s brought prices under control throughout the economy, and inflation has been mostly a non-issue since then. Another factor keeping prices quiescent - one that consumers often take for granted - is great advances in technology. Think of what sort of computer or television you can buy for $500 now and what that same amount used to buy 20 or 30 years ago.

As for how to beat inflation, even if there isn't much to beat these days, gold is the classic hedge. The relatively fixed amount of the metal has made it a store of value for millennia. In the last few years, though, fear of inflation has sent gold skyrocketing, potentially limiting its value to investors. Besides, other assets, like common stocks, have shown better long-term returns than gold, and they tend to perform well when inflation increases - as long as it happens in a moderate, orderly way - because higher prices mean higher revenues and profits. Gold aficionados like to point out that companies have difficulty coping with periods of rampant inflation, as in the 1970s. What they are less inclined to mention is that those periods are rare.

-Conrad de Aenlle



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