Inflation: the invisible tax on savings

Inflation is the rate at which prices rise — or, seen from the other side, the rate at which money loses its value. Central banks in the US and Europe aim for about 2% a year. That sounds small, but 2% a year cuts purchasing power by a third over 20 years.

Where it comes from

• More money — when credit and the money supply grow faster than the economy, more money chases the same goods.
• Strong demand — a booming economy, low unemployment and rising wages push prices up.
• Supply shocks — energy crises, wars, broken supply chains. 2021–2022 combined all three: US consumer prices rose 9.1% in the year to June 2022 and euro-area prices 10.6% in the year to October 2022, the highest in about four decades.

There is also shrinkflation: the price stays the same, the package gets smaller. The official number does not always feel like what you see in the shop — inflation is different for every household.

Why it is a tax on savers

If your savings account pays 2% and inflation is 3%, you are losing 1% a year in real terms — and you may still pay tax on the 2%. Borrowers, on the other hand, benefit: inflation shrinks the real value of debt. Governments with large debts are among the biggest beneficiaries.

What has kept ahead of inflation

Historically, owning productive assets has been the most reliable protection over long periods:

• Stocks — companies can raise prices, so their earnings tend to grow with inflation over time. In the short run, high inflation and rising interest rates often hurt stocks.
• Gold — no income, but a long record as a store of value when trust in currencies falls.
• Commodities — often rise during inflation spikes, but are very volatile and have long flat periods.
• Long-term bonds — the most vulnerable: fixed payments lose value when inflation and interest rates rise. 2022 was one of the worst years for bonds in modern history.

Related: asset classes explained · interest rates and central banks

By Dr. Harry Hamann · 5 min read