Money loses value overtime even under normal circumstances and stable economic conditions, inflation is inevitable. It’s due to this fact that you lose a small portion of your money every time it’s kept (saved) rather than put to use, it’s why money in a future time is less valuable than the same amount right now and vice versa: shs. 100,000 a year from now is less valuable than shs. 100,000 right now. This reduction isn’t immediately visible, but reflected through the loss of purchasing power: your shs. 100,000 won’t lose any zeroes however, that same money that could get you five bags of cement a couple of years back might now only get you three. We’ve all been told to invest rather than save, but why is this so, what makes money lose value overtime?
There are a number of factors that can be discussed that contribute to the loss of value of money like: opportunity cost (loss due to the earning potential of money), value of money at hand compared to uncertain money in the future, inflation among others. However, there’s one particular trait intrinsic in money that makes its loss of value inevitable.
To understand why it loses value, we need to shift our perspective and look at money as a measure of value rather than an item of value itself. Under the fiat money system, we use in Uganda, a shs.1000 note isn’t really valuable in itself, it’s a piece of paper not any different from a shs. 2,000 or shs. 50,000 note. Their value comes from a mutual agreement in which we all concede to the fact that a particular piece of paper represents shs.20,000 of value in an arm’s length transaction. It’s also backed by the governments confidence of the same, making it legal tender. Its value is theoretical.
At any one point in time, the amount of money in circulation is fixed. However, every single day, someone somewhere produces something of value: Mugerwa the carpenter crafts a few pieces of timber and assembles a chair, the value of the chair is roughly shs. 50,000, reduced of production costs it will still be at least shs. 20,000. This results into a miss match between the value being created and the money supposed to measure its worth (the total money in circulation). How does the government cater for that extra shs. 20,000 and restore balance? It’s for this reason that the central bank (Bank Of Uganda) prints more money to try and match the new value created hence print more pieces of paper and declares their value (remember that notes themselves are not valuable).
So now there is new money in circulation. How exactly does it affect your savings? Before that, let me explain the concept of demand and supply and why it affects an item of value (please bear with me). I could say aside from utility of an item, its level of scarcity also determines its value: That’s partly why gold is more valuable than aluminum, it’s scarcer. Imagine for a second if everyone woke up in the morning with heaps of gold in their backyard, its value could plummet to zero. Money also behaves like an item of value and follows market forces of demand and supply: that means the more money in circulation, the less its value. Using the same analogy, if everyone woke up in the morning with heaps of money, its value could also drop to zero. That’s why the more money in circulation, the less its value. That is why usually after elections, the economy usually experiences some shocks of inflation from the large amounts of money injected into the economy. That’s why inflation is inevitable and perpetual, new value is always being created and yet the value of the money itself isn’t increasing, in fact money’s value is merely theoretical. That means the money which you are hoarding is losing value over time.
How to not lose your money to inflation
You’ve probably heard this a million times now but I’ll reiterate, the best way to keep money is to invest it in an asset, but not just any asset, pick one that will store its value, preferably one that will appreciate in value like: Real-estate, business, securities among others. These are assets with real value, if the value of money drops, their purchase price goes up hence inflation is hedged. A piece of land right now will go for a higher price in the future.
Real-estate particularly is unique and I could say reverses the behavior of money: the amount of land in circulation will never increase (maybe when we finally become an interplanetary species but not any time soon). Rather it’s only the demand of land that increases over time because the overall population of the world is increasing hence a more need for land. It’s for this reason that the value of land increases perpetually.
Investment is the best way to keep your money. However, if you feel you must save, at least save your money in a fixed deposit account, such money is usually paid back with an interest, however you have to leave it in the account for a specific period of time without withdrawal, otherwise you are penalized.
Joseph Oloya is a third year valuation surveying student