Until recently, we didn’t talk about inflation, and rightly so. In the summer of 2021, however, inflation began to take over our conversations again as consumer prices made their biggest annual increase in more than 13 years.
After that, inflation continued to rise. US headline inflation was 4.7% in 2021 and peaked at 9.1% in June 2022. Since then, inflation started to moderate due to rising interest rates.
However, we have seen worse times of inflation, but what does it really mean? How does it affect our daily lives and what can we do to protect ourselves against it?
Are inflation and cost of living the same?
People often use the terms inflation and cost of living interchangeably, but they are not entirely the same, although they are closely related.
Inflation is the rate at which prices change. Rising inflation means you have to pay more for the same products and services. This can help you reduce income or asset inflation, such as housing or inventory inflation. If you owned property before the price increase, but your income does not keep up with inflation, your purchasing power will decrease. Over time, inflation increases the cost of living. If inflation is high enough, it will also hurt the economy.
This all depends on the type of inflation. For example, walking inflation is 3-10% per year; creeping inflation is milder than persistent inflation, while persistent inflation means more aggressive price increases, which can be a precursor to hyperinflation.
However, rising prices can be a sign of very rapid economic growth. People buy more than they need to avoid higher prices tomorrow, increasing the demand for goods and services. As a result, the prices of everyday goods and services are beyond the reach of most people.
The cost of living has another effect on our daily lives. This value represents the average cost of an acceptable standard of living, including food, housing, transportation, taxes, and healthcare.
Cost of living is often used to compare minimum income requirements in different places. For instance, New York’s cost of living was 155% higher than the national average by the end of 2022. In comparison, the cost of living in Chapel Hill, North Carolina was 8% higher than the national average.
The cost of living is much more difficult to determine and varies considerably between different population groups and regions. In 2022, the Social Security Administration increased cost-of-living adjustment (COLA) benefits by 5.9%. At the beginning of 2023, it grew by 8.7%. Whether your own housing costs increase or decrease depends on how and where you live.
How does inflation affect us and what can we do to hedge against it?
Inflation does not affect everyone and everything in the same way. For example, the price of gas can double, but the house value can increase. The opposite happened during the 2008 financial crisis: apartment prices fell by almost 20%,but the price of oil was in inflation.
Since the price of oil affects the price of gas, this has also increased, impacting the cost of living. Driving to work has become more expensive and stressful at a time when many employees are afraid of losing their jobs. Heating in the winter is also impacted by the high price of gas.
The costs of building a new home have also risen significantly as the prices of copper pipes and plywood have skyrocketed. Eventually, supply will increase to match demand, but resource-rich companies now have pricing power not seen in decades.
Another example is that car manufacturers struggle to produce enough cars because the assembly is part of the semiconductor chips. The price of space insurance for storage containers and cargo ships is rising sharply. These additional costs are passed on to the consumer.
Most economists expect this inflation to be temporary. If supply returns and the remaining demand is met, supply and demand should balance again. When that happens, inflation should hypothetically drop, but until it does, we can expect higher prices for groceries, restaurants, and gas stations.
What consumers can do is keep extra money to cover unforeseeable additional costs. When buying groceries, if there is a non-perishable product on sale, take into consideration buying more and stocking up, as it may be more expensive next time.
Another solution could be to buy more reliable assets such as gold or crypto products ahead of time. Some asset classes protect against inflation better than others like gold and other precious metals, inflation-protected Treasuries (TIPS), floating rate stocks, real estate and some commodities. By including some of these items in your portfolio, you can hedge yourself against inflation.
In general, the acceleration of inflation also increases the total cost of living, and if wages do not rise in line with the prices of goods and services, the value of fiat currency will decrease. That’s why it’s always good to prepare ahead of time with a well-developed asset portfolio.
