Inflation is one of the most difficult things to understand and forecast, although most crucial to allocate one’s investments.
First, forget looking at the price of items alone, especially mass manufactured goods. They have nothing to do with inflation. If we had no inflation at all, prices of most things would go way down since we always get more efficient through productivity.
I am using here the Austrian definition of inflation, i.e. “the supply of money and credit”. It tells you how much more prices go up compared to if there was no inflation. So if we have inflation of 7%, and some widgets are now dropping 10% per year, they would otherwise drop 17%! It therefore tells you clearly how much purchasing power your money loses “compared to a fixed asset”. You wouldn’t declare that if you keep cash under your mattress, and you can buy 10% more widgets next year, that your money has gained in purchasing power, when in reality there are 7% more dollars, and you are 7% behind compared to the government’s expenditures (with new dollars) or 7% behind your neighbor who has no cash but fixed assets.
The problem is, there are really no fixed assets, since everything is consumed or produced at some rate, and also fluctuates during bubbles and busts, see real-estate, oil, and gold. But in the long-run these three have worked out well to rise fairly well with inflation. I would say that a “working hour” should also be fairly fixed over long periods of time. I mean you hope that if you worked 30 years ago for one day, that you could now get someone else work for you for one day in exchange (despite him using some advanced machinery).
Ok, now that we got this out of the way, the more difficult questions still remain:
What is the rate of inflation, and what will it be in the future?
What can I do to protect myself or to profit from it?
