“The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislature. The inflation tax has a fantastic ability to simply consume capital. It makes no difference to a widow with her savings in a 5 percent passbook account whether she pays 100 percent income tax on her interest income during a period of zero inflation or pays no income taxes during years of 5 percent inflation. Either way, she is ‘taxed’ in a manner that leaves her no real income whatsoever. Any money she spends comes right out of capital. She would find outrageous a 120 percent income tax but doesn’t seem to notice that 5 percent inflation is the economic equivalent.”
Warren Buffett
My grandmother is a lovely lady. She always looked out for others, and always kept our family and her finances in order. And she would always talk about not investing in the stock market because it was a virtual casino. Her argument was it was too volatile, her house was paid off, she’d be on Medicare, she would qualify for senior discounts, she would be on Medicare, and she would have that nice social security and pension check.
Fast forward 10 years later…
She is having difficulty paying for increased insurance premiums on the house, increased maintenance and raw material costs for the house, health care expenses have increased, transportation costs have increased, and now that social security and pension check doesn’t pay what it once did.
Grandma Neely wasn’t the only one hit by the inflation tax. Inflation is an issue that effects billions of people throughout the world. So it’s essential us to have an understanding of how inflation effects our purchasing power over time.
Inflation is the general increase in prices. And even if prices stagnant, it’s likely that the value of paper money will decrease over time. This will have an effect on investments made over time, as well as your purchasing power. This hasn’t been the case of late, but if history is any judge — we should be prepared for it in the future.
Trends in Inflation / Deflation
Inflation / deflation trends can have a drastic outcome on the value of businesses.
During an inflationary environment, stock investors can do very well. Think about it — as investors we are always trying to purchase future free cash flows or assets at a discounted value. If the value of goods and services, as well as tangible assets increase over time (which they more than likely will), you will be in a great position and it affords you an even greater margin of safety. Real estate, as well as various commodities, tend to increase over time with inflation.
