Inflation

Question 2: Suppose over the next 10 years the prices of the things you buy double. If your income also doubles, will you be able to buy less than you can buy today, the same as you can buy today, OR more than you can buy today?

Answer: same

This case seems to be clear – when you earn 1000 EUR monthly today and the stuff you buy in a month is 1000 EUR, then a doubling of your salary and prices in 10 years makes it 2000 in, 2000 out – no further questions.

But the question in the survey is very, very theoretical, not to say unrealistic. In practice, it’s something different and inflation is important. That’s why we stick for a moment on the subject.

As outlined in chapter 2, the term inflation is often misunderstood. Higher prices are not the cause of inflation, but the effect. The cause of inflation is the central bank who – by cutting interest rates – inflate the money-circulation. Thereby money looses in value vs goods and you need more money to buy the same item than last time – prices are rising.

Now back to the question and why it’s a very theoretical approach. Prices never rise across the board in the same magnitude.

Sometimes, they even fall in period of overall inflation. This has been the case in technology-items as PC’s or digital cameras since these products were outdated by innovations.

And there is the competition angle that can lower a price-level, even in a period of general inflation.

The first time I travelled with CFR a few years ago, I had to pay over 100 RON for a roundtrip Bucharest-Brasov-Bucharest. This year, the fare for the same trip was 70 RON since I took the Hyperion, a newly emerged CFR-competitor.

Now, we move from the consumer’s to the investor’s view. When we are in a period of inflation and a company is nonetheless faced with falling retail-prices through rapid technological changes or competition – this is very bad for earnings and the stock-price.

Much better is an investment in companies who compensate eroding margins through innovation. In technology, Apple is the poster child. Or in stocks of enterprises who maintain a strong pricing-power despite competition.
Nike, Novartis, Walt Disney or Altria (the producer of Marlboro) are companies in his category.

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Next topic: question 3 to 5 (Money & Percent) http://www.theleader.ro/money-percent/