Inflation is an insidious risk because it is invisible most of the time. We do not see it because it happens slowly over a protracted period. We don’t see it because it changes in very small increments that go unnoticed, but that mount up to substantial losses over time. We do not see it because everything in our financial world is denominated in dollars, and those don’t seem to change within our mental framework. We trick ourselves into thinking that the dollar is a benchmark when in reality it is a commodity subject to the laws of supply and demand and constantly changing in value.
I hope that the seeds of financial literacy being sewn by a few educators will grow into a movement that will change the way that Americans think about money and economic policy. We tend to back terrible policies that harm people because of our economic fallacies. We embrace nationalistic, isolationist policies because we don’t understand the engine of economic growth. Much of social justice is a matter of economic justice, and that will never be subject to equal protection if voters do not understand how economies work. The chains of poverty can only be broken by the generation of income that in turn generates wealth, and that can’t happen in a capitalist society where the masses don’t understand capitalism.
Aside from the treats of bad economic policy (tariffs are inflationary and are to be avoided, for example), inflation is part of the economic cycle, and small, steady growth is to be welcomed as a sign of a strong, healthy economy. It is when inflation growth gets out of control, and the FOMC cannot stop it that the real problems begin. For individual investors, this means that inflation risk is a major risk category that must be included in your investment plan. The most important weapon in the investor’s arsenal against inflation risk is to hold some bonds, and arguably, some inflation-protected bonds. In this way, you are hedged against spikes in inflation that can spawn higher interest rates and declines in equity prices.
References and Further Reading
n.a. (2018). How Do Interest Rates Affect the Stock Market? Investopedia.