It’s T-2 days and counting until Operation “Undisclosed Lake in Michigan” begins…stay tuned!
And I just learned today that Kung Fu Finance was named the “#1 Personal Finance Blogger of the Week” on a site called QuizzleWire (I love their tagline: “Don’t Guess. Know.“).
They did a very nice write-up on me and I now feel like that book, “Get (Slightly) Famous”…it was a complete (and very nice) surprise. Many thanks to the Quizzle crew!
We have more great questions this week and also some wonderful responses and help from the Kung Fu Finance community to some of last week’s questions, too, so I’ll get right to it!
First, Reuven asks,
Love your website! Been printing a bunch of your blog postings and filing them away.
Have you made any blog posts yet explaining how inflation (or increasing of the money supply) actually increases the cost of every day things such as food, gas, home prices etc?
Hi Reuven! Welcome to Kung Fu Finance and thanks for your question. You ask a lot of great questions, so I’m going to take them one at a time (your other questions follow…).
I have written a bit about inflation so I will give you some links and also tackle it below in case I haven’t answered your specific question.
I first wrote about inflation here:
I include a link to a little DuckTales YouTube clip that shows Hughey, Dewey, and Louie using their uncle’s “Magic Money Duplicator” machine to “make” (print) more money…it’s hilarious and probably explains it better (and visually) in a quick two-minute clip than I could in several pages of text.
Basically, though, it comes down to supply and demand. Inflation is caused by an increase in the money supply.
Imagine if you lived on a desert island with no fresh water, completely surrounded by the salty sea. You are stranded there with two other people and happen upon a thatch hut owned by a native who has mysteriously discovered a source of fresh water and will give you each one jug of fresh water (which you are desperately thirsty for) for one dollar (which he finds intriguing and prefers to use over leaves for wiping his nether regions).
Unfortunately, though, there are three of you dying from thirst (you and the other two people) and the native only has two jugs of fresh water.
Desperately thirsty, the three of you scramble to come up with precious dollars to exchange with the native for his two jugs of water. You each find two dollars in your pockets, but the other two people suddenly remember they each have two more dollars in their backpacks…now they have four dollars each and you, you poor soul, only have two dollars.
If this were a fun choose your own adventure book, we could take this in all sorts of directions, (what do you do?), but since this is an inflation example, we’re going to take it this way:
The native, wanting to maximize his profit and desperate for dollars in order to relieve the horrid itching and problems that come from using leaves to wipe his nether regions, sells his two jugs of precious fresh water to the two people with the most dollars. You, sadly, are out of luck, unless they take pity on you and share.
So what about inflation…
Now, let’s go back to the beginning of this story and imagine that suddenly all of your money has doubled—your supply of money has increased, and you personally now have four dollars (instead of two) and the other two people have eight dollars each (instead of four).
What happens to the outcome?
Nothing…except that the native is able to sell his two precious jugs of water for sixteen dollars instead of eight. You and the other two people are desperately thirsty (for a scarce resource—water), and scramble to find all of the dollars you have to “win” the water from the native. The other two people now have eight dollars each, lucky them, but you still have less (even though your personal money supply has also doubled) so you are out of luck.
This is an extremely simplistic example, obviously, but it’s a basic example of inflation and what happens to prices of scarce resources (jugs of water in this case) when the money supply is increased (doubled in this instance) and demand stays constant (you are all still equally thirsty and desperate for the jugs of water).
In modern times, you can see this in all sorts of places and examples—one close to home for me is the price of houses here in Palo Alto. We happen to live in an extremely affluent community, filled with Stanford professors, Stanford hospital surgeons and doctors, Internet wizards like Mark Zuckerburg (who just bought a house a few blocks away), etc.
This has the effect of raising home prices here in Palo Alto, because there is more money “chasing” the scarce resource of housing than there is, say, in a more moderate-income location like Tennessee (just an example).
Here in Palo Alto, there are bidding wars for houses (yes, still, even post-housing “bust” which barely caused a ripple here), and sellers consistently receive multiple offers on their houses.
It’s slightly more complicated than simply “there are just more dollars here chasing the same amount of houses”…but not really!
We could argue about why people want to live here or why people have more money here or why they want to pay more money for a junky house in Palo Alto than for a mansion in Tennessee…but at the end of the day, the “why’s” don’t matter—we simply have a lot of dollars chasing a limited amount of resources (housing in this case).
I also talked about how this has the effect of devaluing the currency (dollars in this example) here:
I hope this makes sense… please let me know and I can explain further in a future post!
Onto your next question(s):
I understand that when the Federal Reserve has been partaking in QE, it has been injecting money into the banks, but I do not fully understand the story of how that extra money actually causes prices to go up. I keep hearing that even though they have printed trillions of dollars, the inflationary effects haven’t yet been fully felt because the banks are still sitting on that cash and not lending it out. Will inflation start to rear its ugly head once the banks start to loan again? And if so, how so? Why is this?
Great question… if we return to our previous example this will hopefully make sense.
Imagine in the second scenario, where you have suddenly come into two extra dollars and the other two people have suddenly come into four extra dollars each, that actually you haven’t.
Why don’t you have your extra two dollars to spend? Well, because there is a new thatch hut on the island (actually this one is quite a strong edifice, built with wood and clay and strong native locks), which is a bank.
The magical money-giving powers that be, who magically gave you your extra two dollars in the previous example, instead this time don’t give the two dollars directly to you—they instead give them to the bank.
You don’t even really know they are in the bank (unless you are a financial dork like me who constantly reads obtuse technical money supply charts from the money-giving powers that be…) because you don’t “see” them or have them in your possession—they are not even in your special personal “account” at the bank; they are simply in the bank’s vault.
In this case, even though the money supply on the little desert island has doubled, you still only have two dollars in your possession to spend, and the other two people only have four dollars each.
So, the native selling the jugs still only gets eight dollars…none of you can feel the effects of inflation because the new money isn’t in circulation—it’s not in your possession to spend, it’s sitting at the bank.
This is what is happening today, more or less…the Federal Reserve has printed trillions of new dollars, but these dollars haven’t made it into circulation at a very fast pace—the vast majority of them are still sitting in the vault at the bank.
Let me know if this makes sense…I’m also talking here mainly about price inflation, which is slightly different from income inflation, because I gather that’s what your question is really aiming at (let me know if that’s not the case!).
I’m also curious about the dynamic behind who actually feels the inflationary effects and why. For example, I keep hearing that it’s only the ones at the bottom of the “money flow” pyramid (for lack of a better description) that really feel these effects. If true, why is this? How is it that the Fed/Banks don’t feel these inflationary effects as much as the small business owners and fixed income folks (like me)?
I think it helps to keep the example in terms of apples to apples (e.g. “people to people” and “corporate entities to corporate entities”) so let’s first talk about how inflation is felt by people at various ends of the spectrum.
Basically, those on fixed incomes and those at the “lower end of the economic pyramid” do feel the effects of inflation more intensely, because under inflation the prices for scarce resources, and those needed for survival, go up.
So, again using our previous example, if you are the “lowest man on the totem pole” (e.g. you only have four dollars but others have eight dollars), who gets the scarce resource? That’s right…it’s those with the most dollars, so you are left thirsty and your wealthier island-mates get the scarce water.
If you take the example a bit further, maybe you only have four dollars and your wealthy island-mates have 10,000 dollars each. In this instance, perhaps the water vendor will be ecstatically happy receiving sixteen dollars for his water jugs, but you are still thirsty while your island-mates still have 9,984 dollars each to spare.
It is you, the poorer man with fewer dollars, who feels the pinch of inflation more than your wealthier island-mates who can more easily “ride out the storm”. Even if the water jug vendor increases his prices tremendously, to 500 dollars per jug, your wealthy island-mates might grumble a bit, but they can still easily afford to drink water.
We can argue over whether this is “right” or “wrong”—in a perfect world, I believe that value creation is the essence of wealth and therefore those wealthy island-mates of yours have presumably dutifully slaved away at other endeavors to earn their precious dollars, creating lots of value for other people (perhaps they have toiled away for months at the coconut trees, painstakingly climbing the trees in the hot sun, blistering their hands, knees, and feet in the process, enduring sunburn and all sorts of other maladies, etc., to earn their dollars), while in comparison you have just lounged on the beach, doing nothing for nobody, complaining about being thirsty.
That’s how it should work “in a perfect world”, but of course, we don’t live in a perfect world. Our world is filled with industrious, hard-working, value-creating wealthy people…but it is also filled with plenty of crooks and too much corruption, and unfortunately the old adage about “one bad apple spoiling the bunch” really rings true.
Because it could also be that your wealthy island-mates simply stole or conned you out of all of those dollars that in fact were really YOURS to begin with! Or maybe they beat you up and cornered the only coconut tree on the island, thus depriving you of the opportunity to create wealth for yourself.
Unfortunately, because we don’t see many examples of the positive “value creation” side of the story on the news, today it’s seen as “unfair” for wealthy people to have “more” wealth than not-so-wealthy people—it’s almost assumed that they didn’t “come by it honestly” or “work hard for it”, and we unfortunately have far too many examples where that is in fact the case (I think most of us would argue our wealthy Congressmen and women, for example, don’t create enough value in the world to deserve their fat salaries and benefits…now perhaps if they were paid based on results, we could change a few things!).
What I am describing is in essence the difference between true capitalism, which I am absolutely 100% in favor of, and “crony capitalism”, which of course simply sucks (for lack of a better word).
But I digress…
Back to your question, I hope that explains it—inflation is felt more intensely by those with fewer dollars because they must use more and more of those precious dollars for basic survival, and don’t have as many “extra” dollars to use as a cushion.
Please let me know if that makes sense!
Shouldn’t the banks feel it somewhat? I imagine they would since the money used to pay back their loans will be worth less (provided there is an inflationary environment over the term of the loan). Isn’t this why people say that if you feel that inflation will be rampant for a long while, you should accumulate debt (since that debt won’t be worth as much as the years go on, thus making it much easier to pay off in depreciating currency).
It’s true that if you feel inflation will be rampant for a long time that you can take on fixed rate debt and pay it off in the future with “cheaper” dollars. However, in the past this hasn’t always been the case…banks have been known to revalue loans in new currencies if the old currency hyper-inflates out of existence, but yes, in theory this is true.
Thanks and I hope you respond. I didn’t see any other way to directly contact you through your site – Reuven
No problem, and I hope I answered all of your questions! If you want to send me an email, just get on my email list (you can enter your email address in any of the boxes on my website) and hit reply to any email you receive from me… I’m working on an official “Contact” page but just haven’t gotten to it yet!
Next, I received some great follow-up international questions from Anton, and I have good news—Brandon Rowe from International Man has agreed to an interview, so I will do that within the next few weeks and please send in any international questions you have that you’d like me to ask him…thanks!
In the meantime, Brandon gave Anton this link to tide you over until the interview:
And also several readers from our Kung Fu Finance community wrote in and commented and offered their expertise (thank you!) to both Anton and Scot so I’d like to post those here for those of you who don’t check the website comments often:
First was Gary from Australia, in response to Anton:
I am a New Zealander currently living in Australia. Even though I can live in Australia indefinitely, own property and own a business, I cannot vote or have access to the dole or financial assistance through Centrelink (Aussie benefit provider).
I am also over 45 years of age so cannot apply for Australian citizenship. You must be in residence full time for 10 years to be able to gain access to the age pension.
1) How would one go about determining which countries MIGHT make for good second citizenship choices? And why?
Look at English speaking countries first or be prepared to spend time learning a second language. This takes time and costs; have you the ability, time, patience, money to achieve this?
Look at stable economies and political systems.
Look at residency requirements to gain a Passport.
Some countries like New Zealand offer residency to people who are prepared to put money into a local business. I believe this is around 2 million dollars and a qualifying period of time to gain residency and a New Zealand Passport.
2 Which countries (or currencies) MIGHT make the best choices for diversification?
The world must eat and be clothed. Look at countries with sound agricultural development. Australia (wheat, dairy, beef, sheep, wool,cotton) also closely aligned with America.New Zealand (worlds largest cheese producer, dairy, sheep, beef, wool). Not as closely aligned to America as Australia. Canada (beef, wheat, cereals,coal, oil, dairy) Also these countries export coal, gold, minerals giving strong economies.
3 Which countries MIGHT be good prospects to own property?
A lot of Americans have bought property in New Zealand and Australia.
Property values are higher in New Zealand especially around tourist areas like Queenstown.
4) How best to go about owning gold and other metals?
Buy precious metals with a certificate (good for delivery) as when you go to sell it you do not need to have it assayed (an additional cost). We buy ours through the Perth Mine for this reason.
Don’t store it in a bank vault. We have stored ours in plastic sealed water proof tubes buried deeper than 1.2 metres (4 feet) to avoid metal detectors finding it.
Thank you Gary! That’s great information and I really appreciate your help and insight into Australia and New Zealand.
Next we have Kung Fu Finance reader Ryan, helping Scot:
Great info! I want to offer my two cents on the last question regarding newsletter overload.
I have scaled back on my newsletter subscription in the past for the same reason, although I still subscribe to about a dozen daily/weekly/monthly publications. When I first started reading newsletters, I got overwhelmed myself, especially since I had little capital to invest. Now that I have been in the financial world for 4 years, I realized you MUST develop a plan.
Before putting any money into any investment, I think an investor/speculator must develop a plan. Why are you investing?
- Are you just trying to live off the interest/dividends without withdrawing the principal?
- Are you saving up (or building your wealth chest, as you so appropriately -and awesomely- explained recently) for a specific purpose like retirement?
- Are you striving to become financially independent in 5 years time?
By determining the purpose of investing, this will guide your investment decisions in a more focused manner.
Thank you very much Ryan!
Next we have Sudhir from India (Bangalore),
Hi, My name is Sudhir from India (Bangalore). Just stumbled upon your website and the blog site a week back. I predict this will be life -changing.
I am an insurance agent. Just reading one of the Q&A that today we are interconnected and interdependent that if it rains in say USA, we do hold an umbrella here in India, take it from there-the current deposit rates on average is hovering around 8.5% for 180 days with a few offering 9-9.5% in the whereabouts.
I believe the high inflation has something to do with it. What do you foresee in the future, let’s say 20 years down the line in India, will the deposit rate trend down, as in USA and Japan now?
Hi Sudhir, welcome to Kung Fu Finance and thanks for your question! I’m assuming that you mean “the interest that you earn on your deposits” and not the “rate of deposits” (e.g. the number of deposits in India), so I’ll look at it that way—let me know if that’s not what you intended.
Unfortunately I don’t have a crystal ball and can’t really guess what interest rates in India will do in the next twenty years, but from my recent reading it does look like India is suffering from inflation (theme of today’s QnA, apparently!), and a high one at that…double-digits in food inflation (some 10.74%) and 7.55% overall, and if India’s government is anything like the U.S.’s, I’m quite sure that is understated.
It will be interesting to see if the Reserve Bank of India (RBI) will cut rates next week (apparently 25 bps was “widely expected”…), due to the high inflation:
Your government is playing with the same fire that ours is, unfortunately—trying to keep interest rates low to spur the economy (India apparently had the worst growth in GDP in 9 years…) and yet not so low that inflation runs even more rampant and the currency suffers.
(As a quick aside, I’m sure 8.5% interest rate on your deposits sounds amazing to most Americans, but if your inflation rate is the same or higher, you’re not really getting “ahead”, sadly).
Eventually, in order to curb inflation, I would expect rates to increase, but I have no earthly idea when that might happen…I had thought our U.S. interest rates would have had to increase by now, too, but you can never underestimate the power of the central banks (and governments) to fight madness with more madness!
I’m going to shout out to our community on this one and see if anyone who is more of an India expert than I am (that is not my area of expertise, I’m sorry!) can help us….does anyone have some good intelligence on the situation in India? Thank you!
I can dig into it more next week, too, but I would love to hear from someone who’s got more experience in the area than I do.
That’s it for this week! I’m off to pack and get ready for our crazy three-month sojourn…I hope you have a fantastic weekend!
Let’s watch what happens on Sunday…those Greek elections ought to be interesting.
To your financial success,
— Kung Fu Girl