When I was a struggling intern more than 15 years ago, I’d buy a carton of milk for 4 ringgit (roughly 1 US dollar). Today, the price has doubled to 8 ringgit. Sigh.
(Hang out with enough old people and you eventually get the same old story: “X years ago, it only cost Y to buy Z… Sigh.”)
Sorry for sounding like a boomer, but I wanted to explore the topic of inflation.
In case you missed the headlines, inflation in the USA just hit 8.5%. The second highest it’s been in 40 years. Some other inflation stats across the world:
- UK: 9.4%, the highest in 40 years
- Australia: 6.1%, highest in 20 years
- Singapore: 4.4%, highest in 13 years
- Malaysia: 3.4%, highest in 5 years
Why do the prices of things keep going up? What’s gonna happen next? How do you prepare for high inflation?
Here’s five important things I’ve learned about inflation:
1. WTF Is Inflation?
“Milk price go up. Bad.” My first thought whenever someone mentions inflation.
Of course, inflation’s more complicated than that. Let me try to explain.
First, the number you see in headlines is a year-on-year number. So if it says “Inflation in July 2022 was 8.5%,” it means the cost of living in July 2022 is roughly 8.5% higher than in July 2021.
This number raises all kinds of vicious objections. Most commonly:
“Bullshit. Cooking oil just went up 10% last week, so how can it be 8.5% for the past year?”
Answer: inflation rates commonly refer to something called a Consumer Price Index (CPI). Which is a way of calculating price changes across a large number of goods and services that most people use. The index is weighted, meaning things that people spend a lot on will affect the index more.
For example, the two largest components of the United States CPI (May 2022) were 32.3% for housing and 13.4% for food. Different countries use different methodologies for CPI, but I think most people will agree that food and housing are their biggest expenses.
In other words, the inflation rate can’t tell you exactly how much one thing went up, but paints a picture of the overall cost of living.
2. What Causes Inflation?
“A moderate amount of inflation is generally considered to be a sign of a healthy economy, because as the economy grows, demand for stuff increases.”– Richard S. Warr, NC State University –
In short, the way the modern economy works, inflation is supposed to happen. Prices are supposed to go up.
I know. Not a popular opinion. In a fantasy world, only our salaries would go up every year, but everything else would remain the same. But think about that for a moment — it’s not logical. For salaries to go up, your employer needs to make more money. An easy way for your employer to make more money is to raise prices, which is basically inflation.
In fact, everyone agrees that rising salaries, rising standards of living are good things. But these things also cause inflation.
If I could propose a crude analogy, inflation’s kinda like salt.
A little bit is good, essential for a healthy body. But too much of it will kill you.
How much is too much?
Most advanced economies target 2% inflation per year. Ideally, your salary increase would be higher than that. So too dividends on your retirement savings. Everything up in a stable, balanced way.
But as we’ve seen, inflation is way over target right now.
3. What Happens When Inflation Goes Too High?
One practical way to look at inflation is: “How much weaker did my money get?”
At 2%, this means you can buy 2% less things versus last year. Not a problem if your salary increment is 3%, and your retirement dividends are 6%.
But if inflation reaches 9%, and your retirement dividends remain at 6%, you’ve actually lost 3% of your retirement money. Bad.
Left unchecked, this can lead to hyperinflation, which we’ve seen in countries like Venezuela and Zimbabwe. Where crime goes up, people lose their jobs, and families go hungry.
To prevent getting into this kinda shit, governments and central banks take action whenever inflation flares up. The most popular thing to do: raise interest rates.
To “cool” the economy. Raising interest rates makes it more expensive to borrow money. This encourages people to save instead of spend.
Reduced spending = less demand for goods and services = less inflation.
What interest rates go up? Everything goes up together, meaning you have to pay more for your home loans1, but on the investment side — fixed deposits and bonds will return higher rates too.
4. Sounds Like Economics Is Pretty Easy…
I’ve tried to explain in simple words, but economics isn’t as easy as “If X, do Y” statements:
- Milk price go up. Inflation here
- Raise interest rates. Demand go down
- Inflation back to normal. Everyone happy — drink milk
Instead, it’s a fine balancing act, where small decisions can have devastating effects.
Raise interest rates too high, and the economy might slow down too much. This can lead to a recession, where crime goes up, people lose their jobs, and families go hungry.
“Wait, that sounds like the effects of hyperinflation. Exactly what we wanted to avoid right?”
Right. Of course, on the ladder of economic hells, a recession is better than hyperinflation. But the point I’m trying to make: In economics (as in life), there’s usually no 100% right or wrong answer. Swing too far either way and you’re fucked. Rather, it’s making trade-offs to find a reasonable solution.
Crucially, nobody can tell for sure what will happen next.
Nobody can guarantee a 0.75% interest rate increase is better than 1.0% right now. Even an exact science like physics is filled with uncertainties. Economics is not an exact science. So managing inflation is a never-ending cycle of taking action, monitoring the effects, then deciding what to do next.
Central bankers, please do your job well. 🙏
5. How To Deal With High Inflation
We’ve spoken a lot about inflation from a macro view. But what can you do as an individual?
One common suggestion is to “tighten your belt.” Reduce expenses to deal with higher prices.
(I guess this works from a macro perspective. In theory, if everyone reduces spending, demand goes down so inflation goes down.)
On an individual level though, it’s problematic. Especially if you’re not rich. I’m all for spending money wisely. But if you’re already struggling — as many people are — how much more expenses can you cut?
The other problem: despite what your favorite politician might say, prices generally don’t come down2 once they’ve gone up. It’s not like if you wait till next year to go out, restaurants will suddenly charge you 2010 prices. Rather, people get used to higher prices and life moves on.
Here are some other suggestions for fighting inflation which don’t involve cutting expenses:
1. Make More Money at Your Day Job
I spent my 20s trying to squeeze the maximum benefit out of every dollar I made. Optimization’s a useful skill.
But if I’m being honest, the biggest improvements to my finances came when I got promotions and salary increases. 10% inflation doesn’t hurt so bad if you just got a 30% raise.
How to get good raises? You have to be valuable to the company, and you have to be seen as valuable. Sorry if that sounds political, but it’s true.
Don’t be afraid to aim for a promotion. Prove you’re worthy and ask for it. Or if you’re stuck in a hopeless job with bosses who’ll never appreciate you, look out for better opportunities.
I know, “climbing the corporate ladder” has a bit of bad reputation nowadays. But for most of us, it’s a reasonable way to build wealth. Bonus points if you enjoy much of your job and have good friends at work. That’s what makes it sustainable.
2. Make Money Outside Your Day Job
The downside about building wealth at your day job is you need patience. What if you can’t wait till next year for that promotion?
Consider side hustles to boost your income. What skills do you have that people would pay for? (Hint: If you’re not sure, ask your colleagues.) It could be as “simple” as driving for Uber/Grab or as complex as writing code. It’s never been easier to sell your skills online, but you’ve gotta be brave enough to put yourself out there.
With the rise of remote working, you could even get international gigs. For example, if you live in Malaysia like me, why not aim to earn US dollars, since it’s so strong right now?
Bonus points if your side hustle is so successful, it eventually becomes your main gig.
Personally, I’ve spent eight years and thousands of hours working on this blog. I don’t monetize much, but it eventually led to a fulltime job that I love.
3. Invest in Inflation-Resistant Assets
What about investing?
First, a caveat: Unless you have a huge amount of capital, investing’s probably not gonna replace your main income. So it’s still important to find ways to increase income.
Investing well however, is critical to preserving wealth you already have.
How should you invest to avoid losing money to inflation?
Historically, stocks and real estate (properties) have done well even in high-inflation times.
Which makes sense. Businesses (i.e. stocks) can raise prices along with inflation, so they’ll be okay. Many industries will continue to make good money. Meanwhile, people will always need places to stay, hence there’ll always be demand for properties.
BTW I’m not suggesting you sell everything else and go ALL-IN on stocks tomorrow. Personally, I haven’t adjusted my investment strategy one bit. A well-diversified portfolio will have money in both stocks and properties anyway.
For more on this, I highly recommend Nick Maggiulli’s article: How To Invest Your Money When Inflation Is High. For detailed investment advice, refer to a licensed financial advisor.
Will You Be Okay in a Changing World?
“The world’s best inflation hedge is having a highly sought-after skill that gives you leverage.”– Jack Raines –
Inflation sounds scary, but we’ve actually been here before. No matter where you’re from, your country has probably been through periods of high inflation. Painful, but survivable.
Will you be okay?
One thought experiment I like: If society went through some kind of freak Armageddon scenario and our modern world got wiped out. If we had to rebuild everything from scratch, would you be able to find work? Would you be able to adapt and contribute?
If you can confidently say yes, I think you’ll be fine.
Because inflation can devalue many things, but it cannot take away the most valuable assets you own: Your skills, your knowledge, your experience, your relationships.
Even money may lose its value, but some things will always be valuable.
– – –
- Assuming variable interest rates
- Except volatile things like gasoline/petrol and flight tickets
Pic from Pixabay
Aaron, any thoughts/ advice for how to calculate proper salaries to keep pace with inflation? I try to meet or rise above market rates – but every recruiter study/ survey differs as to what is fair value.
Sadly, I also don’t think can match what remote work & international currencies are offering… not sustainable right now to try and match.
The “simplest” way to do this is just to benchmark salary increases based on CPI.
But this is super basic. Perhaps need to get more insights from salary benchmark/surveys done by the HR consultants…
I am coming off a month of personal inflation (high expenses), so while I will be tightening the belt, it’s relative to my own spending habits and not necessarily a reflection of the inflation rate.
I agree that you just gotta fight fire with fire and focus on making more money–increasing salary and investing in assets that should outpace inflation over time.
Thanks! Appreciate you dropping by.
Looking at how fast prices are increasing, I think earning a bigger income is the sustainable route for most people…
One way I explained inflation is that it is a phenomenon of people disagreeing about the value of their work and raising prices on each other, i.e. the fisherman say”I do back breaking work all day, I should be compensated better, let me raise my price”. Then the baker and butcher and farmer and etc. all also think they are undercompensated and raise their prices.
Not sure whether this makes sense. Most people approach inflation as a conspiracy theory, which appeals to a central villain narrative.
Thanks for sharing Heng, I think it makes a lot of sense 😀