Weapon to fight Inflation
We normally play three roles saver, borrower and investor; keep on switching between these three.
Savers: the saved money is used in future for satisfying needs when the earnings get stop and rainy days starts.
Borrowers: spends more than his earnings. He hopes in future he will earn enough to fulfill his primary requirements and also repay his creditors.
Investors: have sparkles in their eyes. He invests in his business and figures out that he has taken up the biggest challenge and has to prove himself.
Let’s see the example to see the relationship between the borrower, saver and investor.
You have Rs 500; you have two options either buy shirt or buy it after six months. It’s true that the same shirt will cost you Rs. 550 after six months. So, what to do? First answer will be to buy a shirt today; thereby you will save money by buying shirt of Rs. 500.
Now, assume that your friend needs that Rs 500 urgently and willing to return Rs 550 after six months. What will you do then? You will give him Rs. 500 and buy the same shirt when he returns money back.
Now, assume that your friend promises to return you Rs. 600 instead of Rs. 550 after six months. You will give him Rs. 500 without a second thought and buy same shirt after six months at Rs. 550 and save Rs. 50.
In the example, borrower is willing to repay higher sum to compensate lender for the loss of his purchasing power. Hence, from this we learnt that:
• Savings does not make any sense if it does not compensate inflation.
• You need to be compensated at least for the loss of your purchasing power to boost you saving instinct. Here you compensate for inflation.
Now, let’s have a look on simple arithmetic:
In first assumption, you lend Rs. 500 to your friend and he returns Rs. 550 after six months; thereby he gives you Rs. 50 extra when he returns your money. While in second assumption, he returns Rs. 100 extra. The money you lent him is “principle” which Rs. 500. And the extra is the “interest”. Interest paid on the principal is the percentage of the principal. In first assumption, interest rate is Rs. 10% and in second it is 20%.
Hence Interest Rate is the aid to the saver by compensating the damages caused by inflation. While borrower has to think twice before borrowing as he has to pay the cost.
Now, what is the relation of Investor with the borrower in inflation? Investor uses his money to invest in his business. In above example, we have seen that investing is uncertain as many things may go wrong. Hence investor will go ahead expecting rewards offset the risk. Hence he will opt to lend his money to borrower to make as much as profit out of interest.
Conclusion:
Borrower rush to borrow more to spend now; Investor finds higher profit from its business. Saver is at the receiving end and insists on higher Interest Rate reestablishing the balance. Borrower and Investor have a distinct advantage when Inflation rises and interest swings the balance of power back in Saver’s favor.
