Inflation and Deflation for Dummies

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Investing and Deflation

Investing for Dummies – UK, 4th UK Edition

Inflation – rising prices – has been the norm for around 70 years. This will have an impact on your investments. Prices have doubled since 1990, gone up 20 fold from 1960 and stand 35 times higher than in 1947. In the 1970s, some salaries increased monthly as the cost of living soared. For most adults, prices today bear no resemblance to those of their childhood. But in 1900, the price of staples such as bread and beer were easily recognisable from 1800 or even 1700.

Rule number one in investing is that nothing is forever. Currently, inflation is down to 0.5 per cent, which equates to prices doubling about every 144 years.

And now there is a ‘new’ word for investors to discover – deflation. This is where prices fall – some economists so hate the word they substitute ‘negative inflation’.

Economists say deflation is bad. They say it brings stagnation – or worse – as spending decisions are put off until a ‘cheaper tomorrow’. They have a point. Why would shoppers – and we live in a consumer-led economy – buy something today which will soon cost less?

But in investing, what’s bad for some, can be profitable for others. It all depends on your personal mix of borrowing, saving and investing, and spending. The other important variable is how price falls are driven.

Our current price drops are driven by the collapse in oil prices coupled with substantial falls in other commodity prices.

So investing in companies that make goods that are dependent on raw materials could work out well. Putting your faith in oil and mining companies is likely to be less successful.

The economists’ argument that falling prices defer spending until ‘tomorrow’ (which never comes) is both true and not true. Take computers and other electronic goods. Consumers keep buying them even though they know next year’s models will be cheaper and faster. There has been deflation in this sector for years, yet the world’s most profitable company – Apple – makes phones, tablets and computers.

Where it is true is in areas where we can just carry on – optional replacements like a new carpet. So tread carefully. Shares won’t carry on rising just because the value of money falls.

The other driver of falling prices is the supermarket price war. Supermarket shares are generally doing poorly – but there are other factors at play such as changing shopping patterns and the stores’ use of property and land.

There is a silver lining. Shoppers expect prices to be unchanged. Falling prices can help push up profit margins – pound shops will still charge £1 even if the goods on offer are now cheaper to source.

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Deflation makes the low returns on cash deposits and bonds look attractive. If inflation runs at 10 per cent, your money loses value even if you can get a 10 per cent return, thanks to tax. But if prices fall, money gains, even at 1 per cent.

It’s great news for retired people living on fixed incomes such as annuities – and bad for those pensioners who took a lower return in exchange for future ‘inflation proofing’.

But where deflation will be most noticed is in property purchases. Inflation in the 1970s to the 1990s was the home buyers’ best friend. Mortgages stayed the same but were paid back in devalued money. A £10,000 mortgage in 1970 cost around £1,500 (in 1970 values) to repay 20 years later. Despite high interest rates, buyers could often repay huge chunks of capital – many could afford to upscale properties every eight to ten years, good news for the home improvement industry and estate agents. Now, a 25 year loan will be hard work even if interest rates are lower.

Still, no one knows how long ‘negative inflation’ will last. Again, nothing is forever.

What Causes Inflation?

Macroeconomics For Dummies, USA Edition

When prices rise on average in an economy, it’s called inflation. In the recent past in developed economies, inflation has only been a few percent per year, but some decades ago double-digit inflation, even in developed economies, wasn’t unusual. One of the reasons that inflation has come under control is that economists now have quite a good understanding of what causes it and how countries can go about reducing it.

Although inflation (increasing prices) is the norm, some countries (such as Japan) have experienced prolonged deflation, that is, falling prices, which mean that people and firms often put off spending in order to wait for a lower price. This behavior puts more downward pressure on prices.

In some cases inflation has become so extremely high that economists have a special name for it: hyperinflation. Germany after the First World War is a classic example, but the most recent extreme case is Zimbabwe where — at the peak in mid–2008 — prices doubled every day.

When inflation occurs, the domestic currency is losing value. The fact that a candy bar used to cost 10 cents in the early 1960s and now costs $1, is a way of saying that $1 used to buy ten bars but now only buys one. The dollar has lost value. Alternatively, you could say that in the early 1960s, you could get a dollar by giving up ten candy bars while today, you only need to give up one. That is, the candy bar price of getting a $1 bill has fallen tenfold. Either way, inflation means the domestic currency is becoming less valuable.

The good news is that there are really just two underlying causes of inflation. One is that the monetary authorities print too much money. Like anything else, when its supply becomes relatively abundant, money loses value.

The second cause is the expectations mechanism n. If everyone expects money to lose value, everyone will try to get rid of it quickly, and the easiest way to do this is to spend it. But this is just a game of hot potato. Dick buys something from Jane and gives her money. But Jane doesn’t want to hold money either, so Jane buys something from Tom. Now Tom tries to get rid of the money by buying from Harry, and so on. Before long, all these purchases start to make prices rise, justifying everyone’s initial fear.

The two causes are not unrelated. Jane, Tom, Dick, and Harry may all expect inflation because they expect rapid money growth. Yet the two forces are logically distinct. Hyperinflations usually start with lots of money growth but are typically made worse by the expectations factor.

Inflation and Deflation for Dummies

Inflation and deflation are the two important economic indicators in the world of binary options trading. Inflation is the rise in the price of the asset in the market while deflation occurs when the asset’s price decreases. Inflation happens when there are a lot of demands for a product and it is during this time that the manufacturers and providers will grab the chance to increase the price to make more money. The problem with inflation is that when the price for these products increase and the income of people and unemployment remains the same, they will find it harder to afford these things. So, maintaining a balance in the inflation and deflation is crucial for achieving a good economy.

On the other hand, deflation happens when the manufacturer has produce much more products than the demand in the market. For example, the European Union just recently put a restriction on the import of goods from Russia so the Russian manufacturers are going to have problem clearing their inventory. Because they are not able to clear off these inventory, they have to cut cost by reducing the staff and the consequence is that many people will be unemployed and the economy will enter into recession.

Countries that have lower inflation rates have better currency values. The central bank will take action by increasing the short term interest rate to overcome inflation and balance the economy. The purpose of increasing the short term interest rate is to encourage people to borrow loans. Doing so allow the bank to play a role in influencing the price of consumer products and national currency’s values indirectly. The central bank has a mandate to keep the inflation to below 2% so they have a duty to take action before the money will lose value. Inflation rates here.

In the USA, the inflation rate is determined by a gauge called Consumer Price Index (CPI). The monetary policy of a bank is based on the CPI level. The U.S. Bureau of Labor Statistics will publish the CPI in between the 13 th and 19 th of every month. The prices of several products are taken into account when calculating the CPI including transportation, education, housing, food and beverage. As a binary options trader, you must pay attention to the CPI because the increase or decrease of the inflation rate can affect the demands of the goods. Usually, you can find the CPI for the economies worldwide in the economic calendar including USA, Europe, UK, Australia and Japan.

Other countries will also release their own consumer price index and they will be released at a different price. The way the Consumer Price Index (CPI) is calculated vary across the different countries. For example, the USA CPI is calculated by looking at the core inflation for example inflation on the core resources like oil and energy. Before you start trading, you should study the information in the consumer price index (CPI). The CPI gives a monthly overview of the fluctuation of the prices of the products. It will be best that you study the consumer price index as soon as it is released into the public.

If the inflation is higher than 2-3%, the value of the stocks will decline because the average consumer will not be able to afford the expensive products. When there are lesser people buying the products, the value of the stocks of the companies will also decline. Deflation will likewise reduce the value of the stocks. During a deflation, sellers will reduce the price to make it affordable for people because of the lay off situation and many people don’t have money to buy the expensive goods.

The binary options trading signal you receive will depend on the changes in the inflation rate. You must always monitor the financial news and pay attention to the inflation rate of the asset you are trading. Having a good understanding on the inflation rate of the forex, stocks or indices you are trading on will increase your chances of winning the trades.

In conclusion, it is crucial that every binary trader become familiar with the concepts of inflation and deflation. Understanding how inflation affect the prices of your financial assets can increase your winning rates.

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