Do you remember when chicken rice used to cost you $2 during the 90s? Well, good luck trying to find those prices now. But why does this happen? Why does the price of almost everything go up over time? In this post, I’ll try to shed some light on this topic without getting too deep into technicalities.

1. Economic Growth

When a nation does well, unemployment rates are low and wages usually raise. People have more money in their pockets and are willing to spend it on both luxuries and necessities. This higher demand allows suppliers to increase prices, which in turn generates more jobs, which puts even more money in circulation, and round and round it goes. This kind of inflation is considered healthy and it’s called demand-pulled inflation.

I’m happier because I can buy things!

2. Money printing

Can money be created out of thin air? Absolutely, you just need a central bank and a good printer. If you remember from previous posts, money is just a construct – a social consensus that is accepted because we as a society believe in it. In modern societies, currencies are not backed by gold or another commodity with intrinsic value. To put it bluntly, the Singapore dollar is a piece of paper backed by the government only and it is valuable because the government says so.

As the Nobel Prize in economics, Dr Friedman explained, “inflation is a monetary phenomenon that happens when the quantity of money in circulation per unit of output rises”. But why? As you may understand, If there is more money in circulation competing for the same number of goods and services, the price of those goods and services will rise. So unless a nation is able to produce more stuff, it’s unwise to create more money.

Ok so, why on earth would someone print money then? Normally central banks do it to stimulate the economy. By giving free money to their citizens they expect them to spend them and create economic growth. Another reason is to pay their own debt. Governments borrow money by issuing bonds and then order the central bank to buy those bonds by printing money. Genius, right? Not quite!

If a central bank prints money at a higher velocity than the country produces stuff (aka goods and services), inflation soars. If that velocity is high enough it results in an economic nightmare called hyperinflation. Hence, money printing is a tool that governments should leverage very carefully.

During the Weimar Republic money was so worthless that kids were allowed to play with it

3. Exchange rates

When the value of the Sing dollar dips in relation to a foreign currency like the Malaysian ringgit or the Australian dollar, we lose purchasing power. In other words, imported products – the majority of the goods we consume in Singapore – become more expensive to buy. Their cost goes up. This kind of inflation is called cost-push inflation.

Conclusion

Inflation is not necessarily a bad thing. Sometimes it is just the result of a thriving and a healthy economy. In any case, we should hedge our investments against inflation choosing appreciative assets such as precious metals, real estate and Bitcoin.