Inflation

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See all Bulls Reasons Bulls Perspectives Value of profit will increase with inflation 0% agree Value of profit will increase with inflation Rising prices will inflate both revenue and cost, so even if margins don't actually improve, the actual amount of profit will rise due to inflation thus increasing stock value. Another way of looking at it is that, it's not necessarily the company that's doing better, but simply... read more View or Edit Reason 1 votes 0% agree See all Bears Reasons Bears Perspectives U.S. stats understate inflation in the U.S. 100% agree U.S. stats understate inflation in the U.S. Growth of the U.S. economy is lower than reported. - from the May Edition of Harper's This is the result of constant " tweaking" of the measurement standards by each successive government. The most egregious example is reporting " Core Inflation " ... read more View or Edit Reason 4 votes 100% agree Send the authors a comment or suggestion Be the first to make a suggestion See All Suggestions

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This article describes a concept which could impact a variety of companies and industries. The article lists companies that could benefit or be harmed by the trend. To see what companies and articles reference this concept page, click here.

Inflation is a measure of how much the general level of prices for goods and services is rising over time. As inflation rises, the purchasing power of every unit of currency is decreased as a result. Some inflation is to be expected, though countries' central banks usually try to prevent excessive increases in the prices of goods and services. One famous example of sudden, severe inflation occurred in Germany from 1922 to 1923. By some estimates, prices in Germany during this time period doubled every two days, on average. Needless to say, such rampant inflation decreased the average German's purchasing power significantly, resulting in economic disaster. This highlights the importance of inflation as both an indicator of economic conditions and as a driving force behind changes in those conditions.

A more recent example of boundless hyper inflation is Zimbabwe where annual inflation runs into millions of percent. In a desperate move the government cut of 10 zeroes from all bills.

So far in history all fiat currencies not backed by gold have returned to their intrinsic value, i.e. zero. Until the introduction of the Federal Reserve as the USA's third central bank prices had remained virtually the same for a century.

[edit] Companies hurt by unexpected inflation

Lenders

Banks and other institutions that lend money at fixed rates are negatively impacted by unexpected increases in inflation. The reason for this is that at a fixed rate, the amount of money that a borrower has to pay back to the lender is essentially fixed as well. The rate that the lender charges is supposed to be enough to cover inflation and still provide some profit; the difference between inflation and the rate banks charge is called the lending spread. If inflation suddenly increases or increases more than was expected, lenders can be faced with the situation in which the money borrowers pay back, while the same in nominal terms, is much less in real terms. For example, if a bank charges 2% on a loan but inflation increases to 4% after the loan is completed, the bank will actually lose money on the loan.

• Citigroup (C), Bank of America (BAC), HSBC Holdings (HBC), J P Morgan Chase (JPM), and Wells Fargo (WFC) are all leading banks, providing lending services to both personal and commercial customers. The profits on these firms' fixed-rate loans could be significantly hurt by increases in inflation.
• Federal National Mortgage Association (FNM), Freddie Mac (FRE), Bear Stearns Companies (BSC), and other firms engaged in financing mortgages could be harmed by inflation. Higher inflation would decrease the profits on their fixed-rate mortgages.
• Vornado Realty Trust (VNO) and other Real Estate Investment Trusts (REITs) are negatively affected by inflation as costs for mortgage and debt interest expense and general and administrative expenses could increase at a rate higher than rents.

[edit] Effect of inflation

Inflation represents an increase in the prices of goods, as well as a decrease in the purchasing power of every unit of currency. Some inflation can be good, reflecting economic growth and the related increase in prices. Too much inflation, or unexpected increases in the rate of inflation, can be harmful, however. Inflation can hurt a variety of companies and industries, particularly lenders. Additionally, people living on fixed incomes, like retirees or the disabled, can be harmed by the reduction of their incomes' spending power. Payments from government-sponsored programs are readjusted periodically for inflation, but this often occurs only once a year. In the time between adjustments, sudden inflation can result in lower spending power for people on fixed incomes, lowering their standard of living and decreasing their consumption of goods and services. Fixed incomes from private sources, such as employer pension plans, may or may not be readjusted for inflation at all, subjecting people dependent on these payments to inflationary risks.

In addition, higher rates of inflation can cause general uncertainty about the future direction of the economy as a whole. This can lead to hesitation among individuals and corporations to spend money until they feel comfortable about future economic conditions. The resulting decline in spending would further impact the economy, hurting providers of goods and services. At the same time, rising prices often leads workers' unions to demand higher wages to compensate. This demand for higher wages, combined with the decrease in demand for goods and services, can lead to higher unemployment as firms are forced to lay off workers. Also, companies can incur what are known as "menu costs", or the costs of changing the prices for goods and services. This includes recalculating the actual costs themselves as well as updating any signs or price lists to account for the changes. While seemingly insignificant, this can amount to a significant cost across the economy.

[edit] Problems with Inflation Indicators

There is an ongoing discussion whether current US consumer prices (CPI) [1]appropriately reflect the real increase of consumer's costs. US consumer prices indices are undergoing so called hedonic changes[2] that can substantially alter the effect on the CPI. Shadowstats.com [3] offers a free chart series where official CPI changes are compared with two earlier calculation models that arrive at a significantly higher inflation figure.

References: [4] Shadowstats.com alternative CPI calculations (and other important data)