The sword of inflation

July 11, 2022

The sword of inflation ‘slices’ cash and credit away from consumer spending. The latest rise of inflation rates, from 2% before 2021 to above 8% in 2022, reduces the purchasing power of money. Consider today’s dollar, which buys 25% less gasoline compared to one year ago. Relentless inflation causes families to either spend more income, withdraw more savings, or borrow money to pay higher costs of living.

Borrowers with good credit ratings are expected to repay loans with interest in a timely fashion. The Federal Reserve is currently increasing the difficulty of borrowing money [i.e., ‘tightening credit’] by raising the interest rates of loans. Corporations will eventually produce fewer goods and services in response to regulatory tightening of the credit needed to buy supplies and pay wages. Reduction of corporate productivity threatens stock returns and economic recession.

The rate of return from a stock investment, –or any other financial investment–, measures the face value [i.e., “nominal” value] of the investment’s profit; but the “real rate of return” measures the purchasing power of the profit. Inflation lowers the real rate of return, which reduces the purchasing power of a profit. The effect of a bear market on investment profit is bad enough; inflation adds an additional strain to profitability.

Copyright © 2022 Douglas R. Knight

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