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IFB150: Economy Basics Pt2 – Inflation, Deflation, and Currency

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You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion, and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Dave (00:36):

All right, folks, we’ll welcome to Investing for Beginners podcast. This is episode 150 tonight; we’re going to continue our discussion on the economy. Talk a little bit about economic basics. This is going to be part two. We’re going to talk a little bit about inflation, deflation, hyperinflation, money, some of those fun topics. And we’ll try to make it interesting for you guys, so you don’t go into a snooze fest. I was just kidding. So I’m going to start us off a little bit and talk about a few of the basics. So let’s talk a little bit about inflation and deflation. So basically, inflation is the increase in prices for supply and demand. So goods and services. So when goods and services and their prices rise, so that would be considered inflation. The opposite of that would be deflation. So that when the prices of supplies and, or I’m sorry, goods and services decrease, that would be deflation. Now, most people think that inflation is a bad thing, and it’s not a when prices are rising; generally, that’s a good thing because, along with that, typically then wages are going to rise at the same time.

Dave (01:50):

So inflation can be a good thing and the only, there are times when it’s going to be bad. So, for example, something like hyperinflation, hyperinflation is when the prices rise more than 50% in a month. And that’s not good because wages are not going to increase at that weight, at that rate, which means that things are going to cost more and we’re not going to be able to buy as much. And as we’ve talked about before, that all kind of feeds into the economy. So when we’re talking about inflation and deflation, we’re also talking about the monetary supply. So the monetary supply, how that impacts both of those is when there’s credit expansion, and there’s too much money in this system. Kind of like what’s happening right now is the cysts. They’re flooding the economy with a lot of money. And what they’re trying to do is they’re trying to tamp down on inflation by doing that because when there’s too much money in the supply system that just me or the monetary system, that means that there’s too much money chasing prices and it helps lower the prices.

Dave (02:58):

Now, if they contract the money, in other words, they make credit harder to get, and the money in the system gets harder to get out into the system. That’s when prices arose because there’s less money chasing the prices, and the prices of items will go up and go down. So let’s think about this on a more simple level. So, for example, let’s say that you’re going to the grocery store and you want to buy meat of some variety. Well, we’ve all heard recently that there’s been some drama going on with the meat supply. Yes, there’s either have been some issues with people, unfortunately, getting sick in some of the plants where they produce meat, and that has caused them to shut down the plants, which is causing there to be a possibility of a demand, a shock to the system. In other words, I’m sorry, it’s a supply shock to the system, which means that there won’t be enough meat.

Dave (04:00):

So when it goes to the grocery store, there’s going to be a price increase because there’s less of it to sell. And so people are going to start quote-unquote bidding up the price of that hamburger that we all want. And so those prices are going to start to rise and rise and rise. And that’s because of inflation. And so what happens with that is when the supply and demand kind of go hand in hand, so if there’s too much supply of something, it will lower the demand of a certain item, which will cause the price to decrease. And likewise, if there’s a huge demand for something and they can’t supply enough of it. Thinking back a month, a half ago of toilet paper, there are people out there probably would have paid an arm and a leg for, you know, a package of toilet paper because there wasn’t any.

Dave (04:50):

And so that’s a situation where there was this huge demand, but there wasn’t enough supply. And so it could have caused a huge increase in the price of toilet paper if there been any to be had. And I see now that it’s all gotten back into the system, but those are just kind of the basics of inflation and deflation and how the money supply kind of interacts with, with both of those. Now, I know Andrew has some, some thoughts on some of that. So I’m going to if, unless he has any comments on the basics that I just discussed, I’m going to turn over to him and let him have a little chat. I wanted to hear what you’re going to say next. Oh, okay. You wanted to hear what I was going to say next. Okay. Yeah. So one of the things I wanted to talk a little bit about was some of the things that Leo has taught us in me in particular, so Andrew and I were talking before we came on the air, and credit is money and one person’s asset.

Dave (05:52):

So what I own, the things I own, is an asset to me. If somebody wants to buy it from me, then that’s a liability to them because they’re going to have to take debt to buy it for me. And so that’s kind of how he views money. He views it as an asset or a liability. And debt is what creates money. And as the money supply rises and rises and rises as it has recently, it eventually will get to the point where it will be unstable, and our economy won’t be able to support that. And I’m not going to go into all the ins and outs of all that, but one of the things that he talks a lot about is how the supply of money will control what will happen with the prices of things. And like I was mentioning earlier when there’s a lot of money in the system like there is right now, it helps raise the asset prices of things.

Dave (06:52):

So, for example, like stocks, the stock market right now is having the best month has had since 1984, I believe. And it’s 15 or 16% for the month so far, and I guess we’re on the last day of the month, so that’s going to finish that high even though it didn’t have the greatest day today. So even with everything that’s going on right now, it’s crazy to see, to think that the stock market is up that high and a lot of it is because they’ve been flooding the market with money to try to create more assets for people that write to drive the prices up. But all that money supply that they’re putting into the air is debt, and that debt has to be paid back at some point, and that’s a liability to somebody else. And all right now, a lot of that liability is weighing with the government. But eventually, that will transfer to; we’ll have kind of works with the economy moves from person to person to person as we take on more debt to buy different things. So it’s going to be very interesting to see how this kind of unwinds over the next year to three or four years. I’m going to be curious to see how this all occurred.

Andrew (08:07):

I’m thinking at this point it might be helpful to do like a hypothetical example so we can knock down how to let’s say more money supply or less money supply. How can that inflect affect inflation? And then maybe for even more specific about how something, how things are moving with covert right now and how that could have either inflationary or deflationary forces. So maybe I’ll, I’ll, I’ll start with this example and see if maybe you fill in what I’m missing here. But you know, I think you hear a lot about the fed and the various programs that they are doing to try to stimulate the economy. And I think that can be confusing sometimes and misconstrued a lot of times. But let’s just take it, because they do a lot of different ways to make a stimulus. If, if we take the simplest one, which we were talking about before, Dave, with basically the federal reserve will buy assets from one of the big major banks.

Andrew (09:26):

And you know, you could probably describe this better than I can, but essentially what it does is it gives the bank more liquidity. So I almost think in this, in this situation, it would make sense to call them the reserve rather than the fed because they’re, one of the transactions they do is they allow the banks to build these reserves. And what that’s going to do, it’s going to prevent the bank from running out of money if there was ever a run on the banks. So without getting too in-depth, on how the banking system works, basically all of the banks around us at least the big major ones, they don’t keep all the money that we deposit in their bank. They only keep a fraction of it. And then what they do with the money, you deposit it in the bank as they lend it out to other either people or businesses.

Andrew (10:23):

And then that’s how they, they create earnings for themselves through that interest on those loans. So it’s not those overdraft fees or account management fees that make some money. It’s the loans. And so at a time like this where they, the bank can kind of look and, and you know, anybody after enough time, I think most of us finally start to get what’s going on. Fortunately a lot of the smarter people at you know, very high-risk places of responsibility, how we’re able to do this before, but basically if they understand that a lot of people are going to be taking out debt at the same time, then they try to increase the liquidity of the bank so that the bank doesn’t run out of money. So, you know the covert thing was going to happen. So I think you see a big example of it.

Andrew (11:19):

Now, if you look through any eight Ks, any of these announcements for management on some of the stocks you might own where they say, Hey, we have a revolving credit. And we just pulled let’s say a billion dollars from our, from our credit or agreement or a revolving credit agreement. So you know, the bank, you know, the bank had that ma, that credit line with this business, the bank might not have normally kept that much money in the reserves. So the, and so if you know, if one person, if one business does that, then that’s fine, but if a majority of their credit lines become pulled, then that could become a problem if they don’t prepare for it. So that’s what the fed has been trying to do. Do, do you know what that program is called? No. I don’t actually.

Andrew (12:15):

Okay. Sorry. I guess it’s always the concept that’s important. It’s not always labeled, so, right. So this is one way. Okay. So, we understand why the fed is doing that part. And so the way that money flows in through the economy is let’s say, you know, I got my pizza shop, and I had $50 million lines of credit. So I pull that out because I’m not getting hardly any customers and I have rent to pay, I have workers to pay, I have suppliers I need to pay. So that money came from the fed, went to the bank, now it’s in my pocket. And so now I’m paying it out to the worker, the supplier, the retail. Now, I’m getting words stuck in my head. Like it could be owned by are like a real estate investment trust. It could be a regular landowner.

Andrew (13:19):

And so the problem becomes when we have a lockdown like this, and you know, it’s, it’s hard for anybody to say that they would have prepared for a situation like this. I think it’s; it’s, we all try to prepare for emergencies. Still, I think it’s unfair to criticize businesses too, you know, what, what emergency business plan has you surviving, you know, with zero revenue. Like that’s, that’s never been seen before. And businesses like restaurants and airlines have to deal with situations like that. So at a certain point, you’re going to start to see these bankruptcies come through whether it was their fault or not. And so now, ideally, if a recovery were to work correctly, we would have money from the fed, goes to the bank, goes to the restaurant, the restaurant pays its bills, the economy comes back, customers come back, the restaurant stays in business.

Andrew (14:20):

The restaurant can now pay payments on the line of credit. He just drew from the bank, some money goes back to the bank, and now we see it all flows through nicely, right? And so in a booming economy, all of that, that, that sit, that circle right there, that all goes through. And then you get that with a lot of different businesses all at once. And then, you know, all the prosperity, all the extra wealth, it creates more incentive for other businesses to come in. You know, all it takes is a business having great prosperity to bring competition in. And then new loans come in. And so you have, it’s like an upward spiral of prosperity. And then so that can spiral up into inflation, which can become a problem or it can in the case of a crisis, it can spiral into deflation.

Andrew (15:17):

And that can be a problem too. So I’m stuck at a fork. Let’s take the deflation real quick, cause that still goes with my pizza example. So going back, if I’m the pizza store owner if the economy doesn’t come back if I don’t make enough revenue to pay my bills if I end up going bankrupt, well now the fed gave the bank 50 million, the bank gave me 50 million, I go bankrupt. So I can’t give the bank back their 50 million. And so the bank might send like a debt collector after me, and the bank will only get back maybe a couple million out of the 50 million. And so what you had there was instead of the money flowing through and creating the circle. I’m the part of the economy, you saw money, stimulus, stimulus came in, but then money got destroyed on the way out.

Andrew (16:08):

And so if we, if we understand the significance of the reality of a crisis where you have certain businesses not getting any revenue for an extended period, you’re going to have a lot of money, destruction at the same time that you’re having a lot of stimuli. And so when I see things in the newspapers and the headlines here, things on the radio, on TV, read things online with comments that make my head want to explode. What needs to be understood is that we have unprecedented stimulus because we have unprecedented shockwaves to our demand. And what we need to fear is maybe not necessarily the word inflation as much as how is, how is the whole economy working as a whole and is like as money getting stuck somewhere or is money flowing through and you know, we’re, we’re going to have a struggle. I think that’s clear, but is it going to be one that causes a bunch of pain conflict or is it going to be one that can be managed with a balance and, and hopefully, you know, flush out the bad, keep the good, that sorts, that sort of a thing. So hopefully, that explains how the money supply can go up or down. I think you; you get into a problem when it when there’s too much prosperity and too loose of lending, and I think that’s when inflation can become a real,

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Dave (18:01):

Yeah, it absolutely can. And, and the, the flip side of that, talking a little bit about more about deflation. Let’s think about Japan, for example. They’ve had a deflationary system since 1989. Back then, the bank of Japan raised interest rates. And what happened is it sent a demand for their housing. It crashed. And so as other prices in the area fell, the business started cutting back on expansion. People stopped spending; they started saving more. So that all sounds great. But as the population grew older, there weren’t enough young people to go out and replace the older generation that was retiring. And the demand for homes kept falling because young people, those are the ones that start families buy homes, they buy furniture and they really kind of put everything back into the economy. And so the government of Japan was the ones who quote-unquote created this quantitative easing that we’ve been near the QE that we’ve been going through.

Dave (19:10):

And they started the expansion of their balance sheet by buying debt and trying to put more money into the system. But all it did was double their debt. And it still has restored the confidence in the system. So Japan is still struggling with really kind of overall liquidity in its economy. And that’s one of the things that people are nervous about with what’s going on with what the fed is doing. And so their goal, if you remember, was to control inflation and to expand the workforce. And the problem can get into when they’re when too much money is going into the system. Like Andrew was very elegantly describing. If that money doesn’t get to us, then we can’t put it back into the system by buying things. And we can’t take out loans to buy cars, homes, a TV, whatever it may be, and put that money back into the system.

Dave (20:13):

The businesses that we buy things from can’t give their employees raises or even pay their employees if they don’t have any revenue like what’s going on right now. And so the concern is is that when too much money gets into the system, then it can lower. So right now, what’s happened is the fed has lowered their interest rates to zero to 0.25%, which is as low as they were during the great recession from 2007 to 2009. And because of that has caused the prices of, for example, homes are falling, and I’m trying to rent an apartment in Chicago right now where I live. And the prices here are falling on renting an apartment because there’s not, there’s no demand. There is a lot of supply. There are open places to live, but there’s no demand because people are struggling to find work. And the people that want to rent are, they need to pay their mortgages just like you and I do.

Dave (21:17):

And so they’re desperate to have people move in. And because of that, the demand is down, so the prices are down. And as the prices on those things fall, other prices will fall as well. And for those of you who us that are still able to work, it’s okay, but the people that aren’t working, it causes just as many problems. So when you have money to spend, but you don’t have it to spend on things, then that’s one issue. But then the other issue is, is that maybe you have too much money, but the prices are falling, and it’s harder to find things. So there’s, there’s a lot of different aspects to how this works. And I think one of the things that people don’t think about a little bit during the great recession, back in the early, the late twenties and early thirties right up to world war two was that was deflationary, and it was, it kind of had two things going on.

Dave (22:12):

Number one that the prices of everything fell, but then everybody’s wages fell along with that. And so people couldn’t afford to buy anything. Well, I’m sorry it was, it was a reverse of that. Excuse me. And what I just said. So prices Rose drastically on things. So if you wanted to buy a gallon of milk, it was too expensive, and you were getting pay cuts where you would work if you were even able to find work. And so things were just astronomically expensive for you. And it was, you know, a double-dip in inflation and deflation. And that is something that could be a problem with our economy now. And that’s what they’re, that’s what they’re afraid of. So that’s the biggest concern with what the fed is doing now. They just had their meeting a few days ago, and they have they announced that they weren’t going to change their policy.

Dave (23:03):

They doubt how much money they’re pumping into the system recently, but the other things that they’re doing as far as what the interest rates and that they’re not changing that they have no plans to raise the interest rates through the rest of the year. They’ll see what’s going to happen in 2021 as we get closer to that. So w they don’t know what’s going to happen with the economy in the next three to six months or longer. And I think those are things that we will probably discuss as we go along. But those are a few of my thoughts on deflation.

Andrew (23:38):

I’m glad you brought that up. And I think at the very end of this we’ll give some practical takeaways cause I know it’s kind of like from a fire hose, But it’s important to realize that there’s a big difference between inflation and diff. And this is where I wanted to take a next anyway. So it’s perfect inflation and deflation of goods and services and then inflation and deflation of the currency. And so I think the money supply can affect the goods and services and kind of simple ways. When you think about the currency, then that’s where people start to talk about things like gold. And so, and in situations like that, you have had the major currencies. Japan has the yen has zero great Britain has the pound, and there’s the German one too, I think. So, those are some of the big, major ones that are an index to each other. And so if one country goes too far into the inflation, into the devaluing of the currency, then that’s where you can get a problem with what you describe Dave in the thirties, where you had goods and services going up while wages were going down.

Andrew (25:04):

So I think a perfect example of that today is Venezuela. So, as of this week, their currency devalued by 20% compared to the US dollar. Now that’s significant because our dollar has stayed pretty steady even through all this massive stimulus. It stayed steady with the other major currencies. So the yen, the pound even whether it’s just the Australian dollar. So Venezuela, on the other hand, has been devaluing its currency through too much stimulus. And so what they’re having is exactly what you’re describing where things are still getting more expensive. So, like for Venezuela, they export a lot of oil. That’s there, that’s their biggest export. So that’s a problem for them. Oil prices have been so, so low. So, what they are selling to the world doesn’t bring in that much profit right now. So you’re not getting much back.

Andrew (26:07):

And then the government is devaluing your currency so much. And so when the currency is devalued, that means hard assets, commodities, things that you buy stuff at the grocery store, that all it relates to how, how your currency is. So that’s, that’s a huge problem for them. And it’s tough because you have a, what can determine a strong or weak currency is very complex, and it can do, can have a lot to do with imports and exports. It can have a lot to do with just the faith of the currency. And I think, you know, the vast majority of our listeners are from the US we do get a ton of international emails. Still, I’m in the US, so I’m going to talk about the US being, having the status as the world reserve currency that has a nice anchor for the US dollar and helps keep it strong.

Andrew (27:06):

So we’ve had some other things that help keep it strong for a time. We had some of the largest exports of oil. That’s how to cut the currency strong. And now what we’re seeing is we have a high demand for our government bonds. And so now you start talking about the ten-year yield and everything that goes into that. But, if you can keep a strong currency, and correct me if I’m wrong, but if you can keep a strong currency then relative to goods and services, you should, you should be able to, to at least avoid this situation of hyperinflation, like what Venezuela has, where their currency is worth nothing. And so there’s been like horror stories in the past about Nazi Germany. One is, is a, is a one that pops up pretty obviously there, there was another one, I can’t remember what the country was, whereby the time you got your paycheck and ran to the bank to cash it, your currency had devalued by like a thousand percent or something already.

Andrew (28:14):

So people were like trying to do transactions, you know, within seconds and it was like a mad rush to get some of this stuff done. So, I don’t know if that part makes sense. But I guess something to track as an investor and something to keep an eye on is if, if, if you start to see people fleeing the dollar, I think that that can become a problem because on its own, maybe that’s not the worst thing in the world. But if you have a lot of stimuli plus a fleeing of the dollar, now you can have, cause I think, you know, I could be wrong again, but I think goods and services, a lot of that is set by what’s going on around the world. So a reason, a big reason why we get a lot of our stuff from China, a lot of electronics and things of that nature is because they kind of set the price because they’re able to make it cheaper than other countries.

Andrew (29:14):

And so if our currency got way less valuable than China’s currency, then it’d be very, very expensive for us to buy computers. And so that’d be a problem for the US. So when you start to worry about devaluation of the currency and deflationary forces on your wages and inflationary forces on your goods and services, I think it’s important to keep the context. It’s all relative to where you’re at in the world and where your country is in the world. And so really I think you have a problem if your country slips compared to the other countries with their currencies. So Venezuela has a lot of problems. And then a place like Brazil where their currency has been devalued by about 30% over the year, I think it’s close to 40% now. And they’re very obviously having political issues if you look at their headlines.

Andrew (30:15):

So as for us investors, as long as the US has the world reserve currency, that will keep a strong demand for the dollar, which I mean, it’s not going to cure everything. And I think we will see both devaluations. We see a devaluation of the currency, and we’ll probably see goods and services go either up or down. And either way, it’s going to go. People are going to complain, so when you see these changes happening, try to keep it in context, and I would say they don’t freak out as long as your country is keeping up with the pack if that makes sense.

Dave (30:56):

All right, folks, well, that is going to wrap up our discussion for this evening. I hope you guys enjoyed our conversation about inflation-deflation and some of the currency aspects of how those are interacting and the economic basics. If you guys have any questions about any of this, please don’t hesitate to reach out to us. We will help you any way that we can go out there and be safe, invest with a margin of safety, emphasis on safety. Have a great week, and we’ll talk to you next week.

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