Most people think that inflation is an increase in the price of goods and services, but it is not. Inflation is actually the increase in the currency supply – the amount of currency units in circulation. (Think "the number of dollars floating around in the world.") It is this expansion of the currency supply - inflation - which causes prices to rise.
Though it's very true that the average person is more concerned with rising prices at the grocery store and the gas pump, being aware of an expanding currency supply allows individuals to prepare for the effects of inflation and potentially prosper!
INFLATION DESTROYS PURCHASING POWER
Inflation affects consumers, businesses, and investors, alike, due to its impact on purchasing power. Inflation causes a decrease in purchasing power. Purchasing power is the amount of goods and services a unit of currency can buy. It can be thought of as how much bang (value) you get for your buck. Inflation reduces the value of currency. As a result, things get more expensive.
Here is an example:
The picture above shows a McDonald’s menu from 1972. Notice that in 1972 a Big Mac cost $0.65. Today, a Big Mac costs $3.99. That’s over six times the price in 1972!
Using Big Macs to demonstrate how inflation destroys wealth and purchasing power, $10 in 1972 bought fifteen Big Macs. $10 today will buy two Big Macs (with a little left over for fries).
The takeaway is that inflation, which is an increase in the currency supply, decreases purchasing power. The decrease in purchasing power of each currency unit is accompanied by an increase in the price of goods and services.
The larger the currency supply, the weaker the dollar (and the higher the prices of goods and services).
Let’s expand this concept:
The cost of a new median home in 1972 was $27,600. The cost of a new median home in 2010 was $221,800. In 1972, $27,600 could buy a brand new median home. In 2010, $27,600 covered just over 12% of the cost of a brand new median home. In other words, over 87% of the purchasing power was lost over 38 years.
If a person had $27,600 in the bank in 1972 – when they could’ve purchased a new home outright – and saved it until 2010, inflation would have destroyed the majority of its purchasing power. This is the essence of inflation’s stealth wealth destruction.