Some of the things discussed in this article may seem contrary to your intuition, please note that I am not an economist or an investment advisor. The following is an opinion piece which should be researched further if you feel it may affect your investment decisions.
Ten years ago if I told you that America would print trillions of dollars as an economic strategy, you would think I was mad. It seems we live in a time when inflation is the big gauge that everyone keeps their eye on. We also equip our central banks with all sorts of tools to keep it at the right level.
What is inflation?
When central bankers talk about inflation they usually mean the change in the value of money. At the start of a game of monopoly whilst everyone has a few thousand in cash we will find the value of the houses on the board to be in the hundreds.
Later on in the game if we introduce tens of thousands of dollars to the players, the houses will value at a much higher level, possibly in the thousands. As the supply of money increases the purchasing power of every dollar decreases.
Inflation in NZ
If we look inflation in NZ we can get an idea of how much value each dollar has lost. Roughly speaking hiring an employee would cost an employer nearly twice as much as 1994. The cost of a housing might be almost three times as much and the cost of food about fifty percent more. Of course there are other factors at play apart from the increase in the supply of money, such as limitations in the supply of commodities and land.
What does inflation do to savings?
It makes your savings worth less as you can buy less with the same money. Having returns which are better than inflation becomes vital for this reason.
What does inflation do to loans?
Inflation makes your loan worth less but of course there is a cost to borrowing. If we take overall inflation into account a loan taken in 1994 of $100,000 would feel like $60,000 in 2014 money.
This is one of the reasons an economy with ongoing inflation seems to reward borrowers and punish savers.
In fact after a look at the graphs above it would seem that buying a property for $1 in 1994 with 100% finance would have meant that the property may be worth more than double and the loan would be almost halved in today’s terms.
This article has been written by Hamish Patel, mortgage broker with mortgagesonline.co.nz. Ph: 09 625 4693, Mobile: 021 625 693, hamish@monline.co.nz
