Inflation explained for the last time

Food price rises put onions out of reach in India

Food price rises put onions out of reach in India

Let me sound bit rude for a moment. Everyone is talking about inflation but no one really knows it’s meaning or what causes it. Most of the people when asked about inflation will tell you – “Onion prices are up, sugar is more expensive, prices of food have gone up. This is inflation” If this all you know about Inflation, it will be worth reading further.

Frankly, this is all I thought and knew of inflation, until recently I spoke to my cousin who has golden hand in explaining complex subjects in easiest and interesting way.

Point 1) Inflation is always read in relative terms. Price from past are compared to present.

Do this exercise: Take yourself back by 15 – 20 years in past. Try to remember how much money you paid to buy ‘Idli Sambhar‘ at local Udpi restaurant or ‘Vada Pav‘ near your house. And what is the price today at that same place. I am sure the present price  are way higher then what you paid in past. This also holds true for anything and everything around you. If your saving was 1 lakh rupee 20 years back, you were really rich. If your saving is 1 lakh rupee today, you have long way to go.

Point 2) If point number one doesn’t make much impact in your mind here’s a stronger point. Inflation occurs when there is lot of money in market and less products.

An experiment was done in a school using fake money. 25 small kids were given 100 rupees each. A toy was kept in front of them and they were asked to bid for it. Whoever bids maximum price will get the toy. Bidding quickly reached 100 rupees. most of the kids got ready to pay 100 rupees. It was decided to cancel bidding.

Now, kids were given 1000 rupees each and same toy was kept in front of them. It took less than 2 minutes before bidding reached 1000 rupees. Most of the students were now ready to pay 1000 rupees for same toy.

This simple experiment explains core of inflation. If there is lot of money flowing in market, people tend to spend more and prices go up.

Point 3) Who pumped extra money supply? Where is the money? I didn’t get any? Well go back to 2008 slowdown, globally each and every country was adding stimulus package to save their economy. Reserve Bank of India allowed banks to give easy loans. Our Government invested in new infrastructure and power projects which would create new jobs and pull country out of recession. All that extra money pumping is now visible on street in form of inflation.

Point 4) Corporate India is the culprit. They are raising prices and killing poor people. Not True! Not True! Not really True!

Companies buy raw material, make products and sell in market. They pay taxes on profit they make. If raw material becomes costly, they have increase prices. Eventually they have to pay more taxes. Companies do not really advantage of price increase, infact they loose customers due to price hike.

Point 5) What happens next? Our government and Reserve Bank of India is putting pressure on banks to avoid lending money(loans) to people. Banks are increasing percentage hike on EMI on existing loans. Many non-crucial projects will be put on halt.

Point 6) I am trader. What should I do with my savings? Always take professional help/guidance. Historically it is found that in inflation money sitting in your bank account looses value for no reason. Experts recommend to put some part of money in to equity/stocks of stable companies who have pricing power(power to increase price if they have to). example: A telecom service provider doesn’t have pricing power, but a company selling or processing food does.

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