Let’s Get Real About Money

Throughout the world, people suffer from a serious perception error that has inhibited them from taking concrete steps to protect themselves from inflation or deflation. The error is called the “money illusion ” – the belief that a nominal unit of currency is the best measure of value, even though its real value is unstable.

Historically, failure to protect against inflation or deflation has helped spur calamitous outcomes. When spectacular inflation hit Germany in 1923, it wiped out the real value of the (unhedged and unindexed) life savings and social-security benefits of millions of people, whose anger contributed to the rise of Nazism.

Similarly, spectacular deflation in many countries around the world in the early 1930’s magnified the real value of (unhedged and unindexed) debts, leading to millions of defaults and widespread bank failures. Deflation also magnified the real value of wages and salaries, thereby fueling layoffs and unemployment. Failure to hedge or index brought us the Great Depression. Much of Japan’s economic malaise in recent years also reflects (unhedged and unindexed) debts magnified by deflation since 1999.

In 2003, an IMF study raised the specter of Japan-like problems around the world, and listed thirteen countries, including, China, Germany, Singapore, and Poland, with a moderate to high risk of deflation. Yet, in the face of overwhelming evidence of the importance of inflation or deflation risk, most people – even in countries that have been warned – generally still have not taken steps to protect themselves.