1) The Silent Thief: Introduction to Purchasing Power Erosion
In this thought-provoking segment, we shine a spotlight on an often overlooked but pervasive issue: purchasing power erosion. As economies evolve, prices rise, and currencies fluctuate, the value of our hard-earned money diminishes over time. Moreover, I will try to discuss, in a nutshell, the far-reaching consequences of purchasing power erosion on individuals, families, and the broader society. From reduced standards of living to decreased savings and retirement funds, the implications of this phenomenon can be profound. We also explore the potential impact on businesses, investment portfolios, and international trade.
On the Top, you can observe the gradual erosion of the purchasing power of the US dollar over time. In other words, the value of a dollar earned today is significantly lower in terms of its ability to purchase goods and services compared to ten years ago. On the lower section, viewers can witness the substantial rise in commodity prices, primarily driven by increasing inflation. The main contributing factor to this phenomenon has been the implementation of quantitative easing (QE) by global central banks. While QE has played a role, it's important to note that the COVID-19 crisis, supply chain disruptions, the Suez Canal incident, War in Ukraine, etc. have also impacted commodity prices. These events and continued QE measures have collectively influenced the upward trajectory of prices.
As the cost of living steadily rises, the value of our money diminishes, impacting individuals, households, and economies on a broad scale. Understanding the mechanisms and consequences of inflation-induced purchasing power erosion is crucial for navigating today's economic landscape. It is worth reflecting on whether personal income increases have kept pace with inflation, as this can greatly influence one's ability to maintain purchasing power.
For many of us, the unfortunate reality is that the answer is often "No." Inflation has outpaced the growth of our incomes, leading to a significant deterioration in our living standards compared to the previous year. This discrepancy between rising costs and stagnant or insufficient wage growth poses considerable challenges for individuals and households, as it becomes increasingly difficult to maintain the same level of purchasing power and meet basic needs.
2) Balancing Act: The Implications of Central Banks Raising Interest Rates
Once the inflation genie is unleashed, it becomes a challenging task to rein it back in. Central banks often resort to raising interest rates as a tool to combat inflation. However, determining the extent to which they can raise rates depends on various factors. In recent times, the Federal Reserve (FED) had maintained near-zero interest rates (from GFC 2008 to very recent) but initiated a period of rate hikes during quantitative tightening (QT).
Typically, central banks aim to raise rates equal to or above the rate of inflation to curb rising price levels. However, pushing interest rates too high can have adverse effects and potentially lead to an economic collapse. Central banks find themselves in a challenging position, attempting to strike a delicate balance between containing inflation and sustaining economic stability.
As depicted in the figure, several central banks worldwide are currently increasing interest rates. This trend may indicate a global economic slowdown on the horizon. It is crucial to closely monitor these developments and their potential implications for the global economy.
3) Decoding the Inverted US Yield Curve: Insights and Implications
The inverted US yield curve has historically been viewed as a potential indicator of an impending economic recession. When short-term Treasury bond yields surpass long-term bond yields, it suggests that investors are anticipating slower economic growth and lower inflation in the future. This inversion reflects market expectations and can signal a loss of confidence in the economy.
While an inverted yield curve does not guarantee a recession, it has been observed to precede several economic downturns in the past. The logic behind this indicator is that investors demand higher returns for holding long-term bonds due to their expectations of weaker economic conditions ahead.
However, it is important to note that the inverted yield curve is just one among several economic indicators used to assess the health of an economy. Other factors, such as employment rates, consumer spending, and business investment, also play crucial roles in determining the overall economic outlook.
(I am not a financial advisor and this is my personal opinion. This is not financial advice and is only for educational purposes)
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