HFC Investment Options Providing Higher Returns Discussion

You are required to make two posts: One post directly answering my discussion question (see below), and a second post as a comment on someone else’s answer  

Discussion Question: Inflation – past, present, future

Part 3 covers one of the biggest topics in Macroeconomics: inflation. And I am sure this is a topic on everyone’s mind right now, given that the rate of inflation spiked recently. And while the rate has come down some since its peak in June 2022, today it’s still higher than our average over the past several decades. For reference, the latest report from the BLS said the inflation rate in September 2023 was 3.7%, and our average of the last several decades has been around 2.5%. (report summary here: https://www.bls.gov/news.release/cpi.nr0.htm ) Hopefully after the chapter on inflation you can see why it should be a concern to you, whether it is high or just at its normal amount – in a modern economy where money is the medium of exchange, your ability to command (purchase) goods and services will depend on the purchasing power of the dollars you possess. Inflation will reduce that purchasing power.

Let’s put this important topic into perspective on this discussion board. You can pick any of the following three questions to answer (or more than one if you wish)

1. Inflation in the present

As mentioned in the introduction, the current rate of inflation is 3.7% (Sept 2023). That means the cost of living is 3.7% higher right now compared to what it was 12 months ago. But while inflation will reduce the purchasing power of each dollar you earn, it doesn’t necessarily have to reduce your real income. That is because nominal wages also tend to increase when there is inflation. If your nominal wages increase at the same rate as inflation, then your real income is unchanged. In other words, yes it takes more dollar bills to pay things now, but you are also being given more dollar bills when you work. So, the amount you have to work to cover your expenses hasn’t changed. There are 3 possible outcomes here:

• nominal earnings growth > inflation, so increase in real earnings
• nominal earnings growth = inflation, so no change in real earnings
• nominal earnings growth < inflation, so decrease in real earnings

You always want to pay attention to how your nominal earnings are changing relative to inflation. And not just earnings from labor, but also profits from entrepreneurial efforts, and gains from investments. You want to do this to see the real returns from your decisions. That will help you determine if the decision is worth it (compared to the opportunity cost) or if a change in behavior is warranted. For example, if you didn’t get a raise in the last 12 months, you are actually working for less now. You work to buy goods and services, right? Now each hour of work buys less goods and services, so you are essentially working for a lesser reward. Is the decision to keep working at the company or in that industry worth it? Only you can decide that. But you need to know about your real earnings to make the decision. Same with investments. Maybe you were willing to accept the level of risk that came along with buying a bond to get a 7% return. But after 3.7% inflation, your real return was only 3.3%. Do you still think that investment, at that level of risk, is worth it?

Question: How has this period of higher than normal inflation affected you? How have your earnings changed compared to inflation over the past year? Did you get any raises or bump ups in pay? Was it enough to keep up with inflation? If not, how have you been coping with the loss in real income. And don’t feel limited to just talking about labor income. You can talk about any form of earnings including enterprise and investments. Are your “real” returns satisfactory? Might there be better options for your time and money, based on real returns?

Please do not feel the need to discuss personal details regarding your salary, wages, wealth, etc… All we need to discuss are the growth rates.
2. Inflation in the future

There was something very important that you need to retain from chapter 11, that inflation comes from growth in the supply of money, and that the Federal Reserve, who is in charge of our supply of money, aims for 2% inflation a year – not zero % inflation, but 2% inflation. As you saw, they do so as a matter of macroeconomic stability. But for practical purposes, this means you will always be living in a world of some inflation. And when you are planning for the future, you need to remember this. Now, 2% may not sound like much, but remember this is compounding growth so 2% growth means the cost of living will double every 70/2 =35 years (using the rule of 70 from chapter 7). You need to plan your lifetime finances, for you and your family, expecting the cost of living to double every 35 years. Sounds scary, I know. But as explained above, this doesn’t have to mean a decrease in your real wealth. It just means you need to grow your wealth faster than inflation to preserve and grow your real wealth.

In the last discussion board on savings, so many people said they just put their savings in traditional bank accounts, because they are safe, and they don’t want to “gamble” with their savings. But now after chapter 11, hopefully you see why that is not a good financial strategy for all of your money. During normal inflation times, you can only earn 1% interest or so on deposits at banks and credit unions. That is not enough to outpace the Fed’s 2% inflation goal. So, you lose real wealth by holding money in those accounts. Now, you should hold some of your wealth there, to pay bills and have a very safe and liquid emergency fund. But recognize the loss in your real wealth is the cost of that liquidity. You need to put some of your saved dollars in the bond market, stock market, investment real estate, etc… if you want to preserve and grow your wealth, and eventually retire comfortably. (note that today bank rates are higher and you can find “high yield savings accounts” paying interest rates of 5%, but that was only because of inflation and the Federal Reserves actions taken to fight it. As inflation falls and the Fed lowers the federal funds rate (currently 5.3%), you’ll see those savings acccount rates fall too, back to lower than inflation rates )

Question: What are your strategies for dealing with the expected inflation in the future? What is your plan to ensure you can cover the cost of living later in life, or when you retire? Do you have any idea about how much you will need to retire – and is that number based on current prices or future prices with inflation? Based on expected real returns, do you know much do you need to save each month (or year) to reach that goal?

3. Inflation of the past

In the chapter on inflation, your textbook talked about real prices. Real prices are prices that have been adjusted for inflation, so that you can make an accurate comparison across time.

Let’s find some real prices and see what they tell us. Find a historic price or salary of something of interest to you. Then use this graph to get past CPI data: https://research.stlouisfed.org/fred2/series/CPIAUCSL/. The top of the graph displays the current CPI and if you just put your cursor over any part of the graph, you can see the CPI at that point in time.

For example, my father always told me he didn’t go to the movies because they cost too much now. He said in his youthful days, say 1960, the price of a movie was $0.50. That seems like a big difference compared to todays prices. What is that 1960’s price, expressed in today’s dollars?

Real price of Movies in 1960 = price of movie in 1960 dollars x (current CPI / CPI 1960)

Real price of Movies in 1960 (expressed in today’s dollars)= 0.50 x (307.481/ 29.37) = $5.23

(307.481 is the current cpi according to the graph at the link provide. 29.37 was the cpi from January 1960, found by looking at the same graph and moving backwards on it until I reached Jan 1960)

So, the price of a movie in 1960 would be equivalent to paying $5.23 today. Since we all know that a ticket at the movies goes for around $8-10 these days, I guess my father is right. I can’t argue with the old man about this one. The fact that the price of a movie has increased faster than the average price level says something about the relative price of movies and the supply and demand for movies. There has been an increase in demand fueled by an increase in household income that increased the minimum price the buyer is willing to pay, as well as an increase in the cost of producing movies that has increased the minimum price the supplier is willing to sell for. Both of these changes contributed to the push up in the relative price.

Question: Repeat this math for a price or salary of interest to you, and then comment on the real change in price you discover. It may be higher, lower, or the same. Then say something about supply and demand changes that could explain the outcome (as I did with the movie example).

Note that the provided CPI graph goes back to 1947. You can go back to 1913 using this Fed page: https://www.minneapolisfed.org/about-us/monetary-policy/inflation-calculator/consumer-price-index-1913-

The general form of the equation used above is: Real Price of Item = price of item then x (CPI today / CPI then)

If you are doing a salary or wage just replace “price of item” with “salary of worker” and the math is the same.

We should all be using the most recent CPI for the “CPI today” number. As I write this it is the September 2023 index which is 307.481 but it may be updated by the time you try this. The “CPI then” figure you’ll have to find from the graph or table(see link above). The data is given per month so just grab a month in the year you are looking for (I used Jan. 1960).

Again, you can pick one of the above questions to answer, or more than one if you wish.

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