Find Out Who Is Hurt by Inflation Most Often and What You Can Do to Hedge Against Its Effects.
Inflation is an important economic indicator. It indicates how fast prices are changing across the economy, and it can impact everything from the interest rate on your savings account to your grocery bill.
With inflation at 6% as of March 2023, the current inflationary environment in the U.S. is giving some market watchers the jitters.
Read on to learn who is hurt by inflation in their daily life and how you can help better protect your wealth from the effects of high inflation.
What Is Inflation?
Inflation is the rate at which prices for goods and services increase in an economy over a period of time. Inflation can be measured in multiple ways, with one of the most common being the Consumer Price Index (CPI).
The CPI tracks the prices of hundreds of everyday items, from loaves of bread to movie tickets, and then reports on their price changes on a year-over-year basis.
“If CPI is 3.0 percent, this means that on average, the price of products and services we buy is 3.0 percent higher than a year earlier. Or, in other words, we would need to spend 3.0 percent more to buy the same things we bought 12 months ago,” reports the BBC.
What Does Inflation Affect?
Many people want to know: What does inflation do to an economy at large, and what does it do to individuals? You can see inflation at play almost everywhere, even in the dairy aisle. In February 2020, for example, a gallon of whole milk cost about $3.20 on average, according to the U.S. Bureau of Labor Statistics. Just two years later, in February 2022, a gallon of whole milk averaged around $4.16—an increase of 96¢, or 30%.
That doesn’t mean the rate of inflation is 30%, though. Milk is just one part of the equation. The Bureau of Labor Statistics looks at pricing data for thousands of items across the United States to get the most accurate sampling and account for significant price swings in individual items or locations.
Economic Conditions That Cause the Effects of High Inflation
Inflation isn’t the result of any single economic factor. Instead, inflation is usually the result of a combination of factors. Common factors that can lead to an increase in inflation include:
- Demand outpacing supply
- An increase in wages
- An increase in the money supply (demand-pull inflation)
- Disruptions in supply chains/supply shocks
- Increases in the cost(s) to produce goods
- Changes to fiscal policies and regulations
The economy doesn’t always experience high inflation. There’s also no designated benchmark for what’s considered high inflation, but many financial experts and the Federal Reserve have said that an acceptable inflation level is 2% or less year-over-year, which has been the case in most years.
The current economic conditions, however, are unique and have led to high inflation that has proven difficult to slow. For example, the COVID-19 pandemic had a hugely negative effect on supply chains across industries, which persisted even as lockdowns eased and consumers began spending again; demand for higher wages helped increase salaries and expendable income; and unemployment has been extremely low. These, along with other factors, have contributed to a large imbalance in supply and demand that is widespread and thus not easily corrected.
The conflict between Russia and Ukraine has also contributed to inflation by adding to destabilization in the energy and food sectors, two commodities people can’t do without. The result has pushed economies around the world to the brink of recession.
One other unique component of the current period of inflation is consumer expectation. If consumers aren’t sure when inflation will ease and are concerned that prices will continue to rise, they may purchase more expensive items to safeguard against even higher prices down the road. This can effectively establish a new higher price point for certain consumer goods and reset seller expectations for how much consumers are willing to spend. In other words, concerns that high inflation will continue tend to be self-fulfilling prophecies that contribute to an economic environment in which high inflation does, in fact, continue.
The Role of Central Banks
Central banks play a crucial role in inflation because they have control over economic policies that affect inflation. One of the most significant ways central banks influence inflation and try to make it more predictable is by raising or lowering interest rates. Higher interest rates increase the cost for borrowing, which decreases demand and slows down production. However, there are risks involved in this strategy: Slowing things down could curb inflation, but if economic growth slows too much, such a slowdown could be the tipping point that pushes an economy into recession.
The Federal Reserve, the central bank of the United States, can influence inflation in other ways. For example, it can sell or buy assets to increase or decrease the money supply. Government aid given out during the pandemic also played a role in increasing the supply of money, which may have contributed to the current period of inflation.
Is Some Inflation Good?
As noted above, the Federal Reserve considers an inflation rate of 1–2% to be acceptable. This small amount of inflation is thought to be beneficial for the economy because slightly higher prices are balanced against economic growth. A lack of inflation, meanwhile, could indicate a stagnant economy or one that may soon easily tip into negative growth (recession territory).
Who Is Hurt By Inflation and Why?
Inflation is typically a bad thing for the average person’s wallet, notes The Simple Dollar site. In that sense, every consumer is hurt by inflation to some degree.
However, the consumers who are impacted the most by inflation are those who have little in savings and live paycheck to paycheck. Even if these consumers see an increase in their wages, inflation may still make it difficult for them to afford all their necessities without incurring debt.
Those who live on a fixed income also tend to be heavily impacted by inflation for these same reasons. Unless their fixed income comfortably significantly exceeds their expenses and allows for a rise in the cost of goods and services over time, consumers experiencing a high-inflation environment may need to find additional sources of income, spend less, or use credit that costs more in the long term to meet their financial needs.
“Inflation that is persistently too high can hurt the well-being of households, especially when it is not offset by comparable increases in wages, leading to reduced buying power,” states White House economists Jared Bernstein and Ernie Tedeschi.
Does Inflation Weaken Your Buying Power?
Inflation, at the most basic level, is a loss of purchasing power. In a high-inflationary environment, you simply can’t get the same amount of goods for the same amount of money as before.
“In periods of high inflation, your standard of living declines hand-in-hand with your relative purchasing power,” explains Bankrate, which notes that this is especially true if your income doesn’t increase (or increases at a slower rate) than general inflation.
Here’s an example: Two things many Americans buy on a regular basis are fuel oil and eggs. In February 2023, the Bureau of Labor Statistics (BLS) reported that the year-over-year increase for fuel oil was 9.2%. If it took $100 to fill your gas tank in February 2022, it took $109 or more to fill it in February 2023. The increase in egg prices was even greater. In 2022, egg prices increased nearly 60% year-over-year. The amount you paid for a dozen eggs a year ago wouldn’t even get you a half-dozen eggs today. Both are a result of disruptions in supply chains, but while those issues are being corrected, prices aren’t coming down as quickly as they rose.
Inflation Means You Have Less Disposable Income
“Higher food, gasoline, and utility costs mean less money remains once these necessities are paid for, leaving little for savings or discretionary spending,” writes Investopedia.
To compensate for the rise in prices, you may find yourself buying less, switching to cheaper substitutes, or driving farther to find bargains.
Inflation Complicates Retirement
If the past is any indicator of the future, you can expect to be paying more, not less, in retirement to maintain the same standard of living that you have today.
Inflation does more than erode your purchasing power. It's also a benchmark the federal government uses to determine contribution limits to qualified retirement plans or raise Social Security benefits.
How much could retirees lose to the effects of inflation? LIMRA Secure Retirement Institute constructed a model demonstrating the effect inflation could have on the average Social Security benefit over a period of 20 years. According to its research, a 1% inflation rate could swallow up $34,406 of retirees’ benefits.
Use this calculator to see how inflation could impact your retirement income.
Inflation Pushes Interest Rates Up
When inflation is high, interest rates on home loans, credit cards, and other loans tend to increase. Overall, this encourages people to spend less, but is it a good thing for your savings account? Only if your savings account has a higher interest rate than the rate of inflation. Unfortunately, the minimal returns most of today’s money market and savings accounts tend to offer aren’t enough to account for inflation, so parking your money in one of these accounts is not likely to protect your purchasing power.
What can you do to maintain, if not strengthen, your purchasing power over the long term? One answer may be that you can diversify with physical precious metals like gold.
“Gold can protect against currency weakness and stock market volatility,” says World Gold Council’s Alistair Hewitt. For long-term gold owners in the U.S., “[Gold] makes them money: around an average of 10% per annum since 1970.” Make your move into gold today and sign up to receive your free Gold Information Kit from U.S. Money Reserve.
How to Protect Yourself From the Effects of High Inflation
You can help better protect yourself from the effects of inflation by diversifying your portfolio with a variety of assets and asset classes, including non-paper-based assets like physical gold, and by increasing your financial literacy.
Diversify Your Portfolio With Assets That May Respond Differently to the Same Market Factors
No matter how diverse your portfolio is, you may not be as well-protected from inflation as you hope if all your assets move in parallel with the dollar, or if they respond to inflation in the same way.
You may wish to consider diversifying into a variety of asset classes, including physical precious metals. Doing so may help protect your portfolio from bubbles in any one asset class, including paper-based assets like stocks or cash.
According to Bankrate chief financial analyst Greg McBride, commodity prices track the inflation rate closely, and buying storable commodities such as gold can be a good hedge against inflation.
Buy Physical Gold
In the long run, gold returns have outpaced the U.S. CPI, reports the World Gold Council. Historically, gold has not only preserved capital but helped it grow.
“Gold stands out as a key portfolio component when identifying a long-term portfolio diversifier,” notes the World Gold Council, citing information from an April 2020 report. “Historically, gold has shown that it acts as an effective hedge and a useful part of the larger [risk] picture,” the Council says.
A relationship between inflation and gold prices exists, but is indirect. According to Forbes, “As prices rise across the economy, [consumers] may buy more gold and other precious metals to preserve the purchasing power of their dollars.” This increased demand may help push gold prices higher.
As you can see in the chart below, in years when inflation has been higher than 3%, gold’s price increased by more than 14% on average.
Continue to Educate Yourself
Every portfolio owner must navigate a variety of risks, regardless of which direction inflation swings.
One way to keep pace with, or even outpace, the rate of inflation is by increasing your earnings potential through education and training. Increasing your knowledge and understanding of the financial world—and portfolio management in particular—may help you create and implement a more balanced or risk-averse diversification strategy.
To learn more about the benefits of physical gold ownership, call 1-844-307-1589 for a one-on-one consultation with an experienced Account Executive and to request your free Gold Information Kit today.