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Inflation Pickpocket:  How Scott Used Inflation To Separate Peter From His Net Worth

Inflation is not an even game, it is not a fair game, and we are not all in this boat together.  For inflation is not about destroying everyone’s wealth – it is about redistributing that wealth, and if you don’t understand this, then it will likely be your wealth that will be getting redistributed. 

Take A Walkabout Into Your Future, In The Shoes Of The Person Buying Your Investments....

ACT ONE:  Smooth Economic Sailing

To illustrate how inflation redistributes wealth, we will use a simple morality play with two investors, in three acts.  Peter is our virtuous hero, for he understands that a penny saved is a penny earned.  Peter has been diligently saving for retirement, and that saving has taken two forms.  The first was paying down all his debts, and the second was building up retirement assets.  So Peter contributed to society through his work, was paid for his contributions, controlled his spending, responsibly deferred his gratification, and built up $100,000 in hard-earned savings.

Scott is our irresponsible villain.  Scott is not the kind of guy who appreciates the wisdom of being debt-free, indeed, Scott doesn’t assign any moral implications to how he manages his money at all.  Scott has a use for $100,000, he sees that Peter has the money ready for investment, so Scott borrows $100,000 from Peter.

So, in the smooth economic waters of the present, virtuous Peter has a $100,000 asset with no debt, and irresponsible Scott has a $100,000 debt.

(Both hero and villain happen to be Baby Boomers, for there are aspects of this play that are particularly appropriate for investors of the Boomer generation.  However, the lessons apply to all investors, and indeed, some aspects are even more applicable for many investors outside the United States than they are for American investors.)

ACT TWO:  Picking The Pocket

The Boomers start to retire, and begin simultaneously trying to convert their bountiful paper wealth supply of dollar denominated investments into a quite limited supply of real goods and services, even as government deficits reach all new levels in attempting to pay for Social Security and Medicare.  The Chinese and Japanese stop buying US treasury bonds (and thereby stop supporting the dollar), and instead directly buy oil, which is in much tighter supply than it used to be.  The US scrambles to simultaneously find buyers for the Boomer’s securities, buyers for the bonds needed to pay for Boomer retirement promises, and hard currency to buy oil from exporters that will no longer accept dollars.  (A concise description of some complex issues, but this is a short play and illustration, not an econometric model.)

The dollar drops 90%. 

The former dollar is nowonly worth ten cents.  What you used to be able to buy for $1 now costs $10.  Whichever way you care to look at it, 90% of the former value of the dollar is gone.  And so is 90% of the value of the debt which Scott owes Peter.

In real (inflation-adjusted) terms, the $100,000 investment that constituted Peter’s loan to Scott is now only worth $10,000.  So Peter has lost $90,000 of his investment, in purchasing power terms.  Scott, on the other hand, no longer owes $100,000 in real terms.  He only owes $10,000 in inflation-adjusted terms, meaning he his personal purchasing power is $90,000 ahead in real terms of where he started (or $900,000 ahead of where he was in nominal terms, keeping in mind that it now takes a dollar to buy what ten cents used to).

By borrowing $100,000 in pre-inflationary dollars, and paying back (in full) $100,000 in post-inflationary dollars, Scott has used inflation to redistribute $90,000 in real wealth out of Peter’s net worth, and into his own net worth.  By better understanding that inflation destroys debts even as it destroys dollar assets, Scott has used inflation to take $90,000 directly from the virtuous and cautious Peter, just as effectively as if he had picked Peter’s pocket. 

ACT THREE:  Real Assets & Pieces of the Pie

To more fully understand what happened and how Peter was separated from his net worth, let’s take a closer look our “villain”, Scott, and the chart below. 

(The rest of this article is available as the sample initial reading for the free Mini-Course, "Turning Inflation Into Wealth".  The article has been placed in context as part of a series of ten to fifteen minute readings that will cumulatively build your understanding, in an educational process that will lead you towards uncovering new opportunities for personal actions and profits.  More information on the free course can be found here.)

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