Inflation harms dollar hegemony – an increase in demand depletes the value of the dollar

The impact inflation has on the time value of money is that it decreases the value of a dollar over time. The time value of money is a concept that describes how the money available to you today is worth more than the same amount of money at a future date.

This also assumes you do not invest the money available to you today in an equity security, a debt instrument, or an interest-bearing bank account. Essentially, if you have a dollar in your pocket today, that dollar’s worth, or value, will be lower one year from today if you keep it in your pocket.

Inflation increases the price of goods and services over time, effectively decreasing the number of goods and services you can buy with a dollar in the future as opposed to a dollar today. If wages remain the same but inflation causes the prices of goods and services to increase over time, it will take a larger percentage of your income to purchase the same good or service in the future.

Here’s a chart of the inflation rate from the late 1600s to today. Notice that since the 1950s, the rate of inflation has been positive for nearly every year.

So, for example, if an apple costs $1 today, it's possible that it could cost $2 for the same apple one year from today. This effectively decreases the purchasing power of money over that period, since it will cost twice as much to purchase the same product in the future. To mitigate this decrease in the time value of money, you can invest the money available to you today at a rate equal to or higher than the rate of inflation. Consider the chart below, which lays out the buying power of $100 from 1799 to today. So, in the example above, if we had $100 in apples in 1799, those same apples would cost over $2,000 today.

What Impacts Inflation?

Basically, inflation is caused by a rise in the price of goods or services. Now, that is driven by supply and demand. Holding all else constant, a rise in demand can push prices higher (if the supply of goods and services is stable), while a supply reduction can also drive higher prices.

Demand can rise because consumers have more money to spend. More spending increases inflation, in particular, higher consumer confidence. When wages are steady or rising, and unemployment is relatively low, inflation is likely to rise. As well, manufacturers are likely to raise prices if consumers are willing, or capable, of spending more.

Then there’s the supply side. Lower supply can drive down demand, pushing prices higher. A decline in supply can happen for a number of reasons, such as disasters that disrupt the supply chain or manufacturers’ capabilities. Or assuming an item turns out to be very popular, it can sell out quickly, such as the case with iPhones.