We don't lose 2% of our money when there is 2% inflation

Last updated: Dec 15, 2022 17:20:39

• Post

We lose only 1,960784% of our money when there is 2% inflation.

I like to see money as a medium of economic energy transfer. What do I mean by that? We - people in modern age - are creating some value for others and we use this ingenius tool called money, to store the value we created/provided for others, so we can exchange it later for something we want from others. ¹

According to Wikipedia (and I hope also common sense), it should meet following properties in order to work properly. Money should be:

• fungible: its individual units must be capable of mutual substitution (i.e., interchangeability) - dolar to czech crown, czech crown to yen, yen to dolar
• durable: able to withstand repeated use
• divisible: divisible to small units - 10-dolar bill to 10x1-dollar bills, dolar to cents
• portable: easily carried and transported
• acceptable: everyone must accept the money as payment
• limited in supply: its supply in circulation must be limited

Quick note: The only thing that cryptocurrencies are not satisfying from this list is the acceptability. Why do you think that is? I would also like to add another property money should meet: small overhead exchangeability (fast and cheap transactions)…

Interesting property for this post is the “limited in supply” one. It is truth that our modern government covered money is somewhat limited, usually by some central bank. But it is also not. More money is printed out of thin air when central bank decides to. ²

And this is, I think, one of the primary drivers of inflation ³, where inflation is basically process of things getting more expensive. We measure inflation usually by comparing actual prices of various goods and services to the prices of them one year later (annual inflation). ⁴

Well and when everything is getting more expensive, your after-inflation money are able to buy less than before inflation. You lose your stored economic energy.

Now, we often hear sayings like:

“Nowadays, the inflation is stable around 2%.”

“We experience high inflation of 10% due to economic crisis.”

“Crazy hyper-inflation exceeding 1 000 000% is crippling Venezuela people.” ⁵

But what do these percents mean really?

Imagine following example:

In year 4561, one Quackqua costs 10 ETH. If you make 100 ETH/month, you can buy exactly 10 Quackquas (100% of them) every month.

One year later, in 4562 however, after 10% annual inflation, one Quackqua costs 11 ETH. Now you can buy (assuming you don’t get a raise) only 9 full Quackquas for 99 ETH. You get left with 1 ETH which equals to exactly 1/11 Quackqua. So this year you can buy 9+1/11 = 100/11 = ~9,09 Quackuas.

This ~9,09 number is important. Before this thought experiment I would assume that after 10% inflation I would lose 10% of my money - I would be able to only buy 9 Quackquas. However, that’s not correct. After 10% inflation I would be able to buy 9 full Quackquas and I am still left with 1 ETH.

Now imagine even clearer example:

You have 100 ETH. 1 Quackqua costs 10 ETH. Inflation is 100% and is one year later. You still have 100 ETH. But now 1 Quackqua costs double (100% more after 100% inflation), so 20 ETH. How many Quackquas can you buy?

The answer is 5 (100 ETH / 20 ETH). So your money really just lost half of the previous buying power. Following table better ilustrate this phenomena.

As you can see, in low inflation rates (up to ~30%), the difference is negligible. So this concept is probably not that important. Although I find it interesting and not well known. Also, with 1000% inflation, you would be still left with ~10% purchasing power (opposed to -900% :D)…

I hope you learned something today and if something I wrote seems fishy or straight-up incorrect, please let me know.