|
|
Topic
Top news source/blog that we're missing
Why do you recommend this news source?
|
||
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 decreases 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.
There is an ongoing scientific discussion as to whether inflation is defined by rising prices or by the expansion of the money supply, a thesis represented by economists of the Austrian school of economics.
[edit] Hyper Inflation
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. Companies had to pay their employees twice daily as workers would lose too much purchasing power otherwise. In the end, it was cheaper to burn billions of Reichsmarks than to buy firewood for heating. Other pictures of the time showed ordinary Germans paying for a loaf or two of bread with a wheelbarrow full of currency. All savings were effectively erased, bankrupting more or less the whole country.
The root of Germany's slide into hyper inflation is attributed to overly harsh sanctions following World War One. In its efforts to service foreign debts, Germany issued more and more government bonds which were sold to the Deutsche Reichsbank. The new debts only accelerated the downfall of the currency which traded at 4:1 with US Federal Reserve Notes at the beginning of the crisis. At the end of 1923 one Federal Reserve Note had an exchange rate of 4.2 trillion Reichsmark.
At the end of the German hyper inflation - which was a precursor to Germany's great depression - only 1% of German government funds came from tax revenues while 99% came fresh off the printing presses. Germany, aka the Weimar Republic, then boasted to have set up 23 printing presses all over the country which were run around the clock.
While there is no strict arthimetical number that defines hyper inflation, it can generally be thought of as prices that are out of control. Generally, this would equate to at least a double digit rate per month, and at least triple digit on an annual basis. For a recent example of hyperinflation, one needs only to look to Zimbabwe since 2002.
Annual inflation in Zimbabwe was estimated to exceed 10 million percent in 2008. In a desperate move the government cut off 10 zeroes from all bills. This didn't help to rein inflation as the Zimbabwean government follows Germany's bad example from the last century. Cut off from external funding the Zimbabwean government has been relying on the printing press in order to finance its budget.
This highlights the importance of inflation as both an indicator of economic conditions and as a driving force behind changes in those conditions.
Historically, many fiat currencies (i.e. not backed by gold) ultimately suffered through some form of value deterioration, with hyper inflation being the most extreme example of rapid value destruction.
[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] Effects 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. Today, it is generally accepted doctrine that a relatively low level of inflation (1% to 4% annually) is acceptable or even beneficial, 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 to expect 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.
Infaltion generally harms most people in an economy. However, provided that economic activity continues at a respectable pace, inflation that is accelerating modestly does benefit those who hold relatively high levels of real assets (i.e. property, commodities, etc.) and similtaneously hold relatively high levels of fixed-rate debt. That is because the rate of inflation revalues the assets higher, while the relative cost of servicing the debt (and its relative value) decline.
[edit] Problems with Inflation Indicators
There is an ongoing discussion whether current US consumer prices (Consumer Price Index - CPI (CPIS) or PCE) [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. [1]
| ||||||
|
|
