More than just inflation
With prices up, price statistics that look preposterous to anyone who shops, and the Fed trying to thread the needle of preventing a recession without letting inflation run out of control, I want to make sure everyone knows that we're seeing at least two other issues besides inflation.
Inflation is when the money becomes less valuable. The visible result is higher prices, but it's important to remember that the higher prices are the result, not the thing itself. In general, inflation is happening all the time--sometimes faster, sometimes slower--but it's worth keeping in mind that there are other processes that affect prices, because the best strategies are different in different situations.
Changes in relative prices
One other thing that can look like inflation (but isn't) is changes in relative prices. Relative prices change all the time, of course: the price of text messages goes up, the price of milk goes up more, the price of flash memory cards goes down. Sometimes you get into a situation where the prices of things that everyone buys (food, fuel) go up, while the prices of things that most people don't notice go down. For example, the price of wool just lately has been so low that (except for certain specialty types) it's not even worth the trouble of marketing it, even for farmers who raise lambs for meat and have to shear their sheep anyway.
Relative prices change for many different reasons. Tastes change, leading to higher prices for whatever the hot, new thing is. There are seasonal changes in relative prices both because of what's available and what people want to buy. The weather affects relative prices (seasonal weather, but also short-term changes like a hot day and long-term changes like global warming). Changes in technology are a huge factor in relative prices. Not only technological improvements driving the prices of high-tech goods relentlessly downward, but also new, cheap high-tech goods replacing old expensive alternatives (such as plastic buckets replacing galvanized metal ones).
Changes in standard of living
Sometimes price levels just go down as people overall get wealthier. That's been the dominant trend of the past three hundred years or so. The combination of cheap energy (coal and steam engines at the beginning of the industrial revolution, oil and internal combustion over the past hundred years or so), globalization (letting goods, labor, and capital move to wherever it could be most profitably employed), economic liberalization (letting markets work), and technology have simply made people vastly more wealthy than ever before.
Other times prices levels just go up as people overall get poorer. That has always happened for brief periods--when drought or war destroyed the capacity of people to produce the necessities of life, and when bad government or a lack of government made it impossible for productive people to prosper.
Over the past few hundred years, declines in the standard of living have generally been temporary--often even brief--but that's just happenstance and not a law of nature. Two of the great engines of prosperity (cheap energy and globalization) may be just about played out. That could well mean stable or even falling standards of living, and not the continual increases that we've all grown used to.
Different things, different strategies
All three of these things are going on all the time, but the strategies for dealing with the them are different, so it's worth thinking about which ones are dominant at any particular time.
I wrote a couple days ago on How to live with inflation, which is actually the easiest to deal with, because inflation doesn't really change prices, it just changes what they're called. That is, the price of something was called $1.00 last year and this year it's called $1.10, but the real cost (in terms of hours worked or what other items you could exchange it for) is about the same--wages, salaries, and other prices have all gone up by a similar amount, so you're really in about the same situation you were in before. Each individual circumstance is different, so some people will fare better and others worse, but as long as you're aware of the situation and adapt to the changes, you can live with inflation okay.
Dealing with changes in relative prices
Changes in relative prices can be good, of course, if the prices of things that you buy go down relative to prices of things you don't buy. (People generally don't even notice when that happens, which is why changes in relative prices are so easily confused with inflation.)
For adverse changes in relative prices, though, there are really only two answers. You can adapt by changing your spending choices to buy less of the more-expensive stuff and more of the less-expensive stuff. Or, you can let your standard of living fall.
Everybody does both of these things all the time anyway--you go to the store to buy a roasting chicken, find that the fryer are on sale, and just buy a big fryer and roast that instead. Of course, a frying chicken is a pretty good substitute for a roasting chicken. Often there isn't such a good substitute: Beef gets more expensive so you buy chicken. Chicken and pork get more expensive so you buy lentils. Lentils get more expensive so you buy less. Making do with less is lowering your standard of living. Buying something that you don't like as much is also lowering your standard of living, although perhaps not by as much.
In cases where there simply is no good substitute (whether in an absolute sense, or just because of your family's preferences), changes in relative prices amount to the same things as a reduced standard of living.
Dealing with changes in standard of living
Putting aside reducing saving and taking on debt (which let you live at a higher of standard of living now, but at the cost of a lower standard of living later), the only answer to a drop in your standard of living is . . . to lower your standard of living. This is true regardless of whether the cause is a change in relative prices or a drop in standard of living across the board.
For example, let's say that oil prices go up. At first, this leads to a change in relative prices--gasoline and fuel oil prices rise.
People with a choice don't just take that lying down, of course. They switch to cheaper fuels. The guy who heats with fuel oil but also has a wood-burning stove will track down some wood to burn. A company might cut a production line at a factory that uses fuel oil while another factory that uses natural gas might add a second shift. The result of these actions is to raise the price of substitutes.
Whether they're paying more for oil, gasoline, wood, or natural gas, companies are all going to try to pass these costs on to their customers. They'll also try to hold the line on other costs (such as wages). To the extent that they can't manage either of those things, they'll end up producing reduced profits for the owners. These changes ripple through the whole economy, making everybody less well off--a decline in the standard of living.
The key to dealing with a decline in the standard of living is not to confuse it with inflation. If what's going on is inflation, you can just go on living much as you had been, with some confidence that wages, salaries, and investment returns will all adjust to make things come out even. If you try that strategy when standards of living are declining, you find your savings dropping, your debt rising, and your job unexpectedly at risk. Don't do that.
It's always hard to tell the difference among these things at the time; it only becomes clear after the fact. Fortunately, you can keep yourself on the right track by making the most cautious choices. If prices go up, look for alternatives. When there are no alternatives, buy less. Look for choices outside the money economy, or at least around the edges--grow vegetables in your own garden, make friends with your neighbors who have gardens, join a local food co-op, sign up with local Community Supported Agriculture, learn about wild foods that grow in your region and start to use them. Keep your saving on track and avoid taking on more debt.
To the extent that what's going on is just inflation and changes in relative prices, these choices may result in an unnecessary drop in your standard of living, because wages, salary, and investment returns will end up balancing the rise in prices. But, if what you're seeing is a drop in standard of living, then these are the choices that protect your family. If it's just inflation, then you're ahead of the game--a bit more money to save and invest. If it's not, then you're in much better shape than people who just assumed that everything would be fine.
There are worse things out there than inflation. Be ready to deal with them.
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