INFLATION AND STOCK PRICES

Logically, inflation should be a universal phenomenon. Therefore, the test of stocks' overall performance relative to inflation is one of capital values, without reinvestment of dividends, relative to the value of money. In fact, using the consumer price index as a benchmark for the value of money in real terms is far less satisfactory. It does not adequately reflect what people actually buy in order to live, or the rising standard of living. It is artificially lowered by productivity the improvement in manufacturing, as is readily evident from the way the real cost of computers has always declined precipitously. Investors cannot be complacent about inflation by any measure. If you get an after-tax return of 3 percent and inflation is 3 percent, the purchasing power of both the capital and the income is declining by 3 percent in real terms. Even with a relatively low inflation rate of 3 percent annually, the value of money declines by 50 percent every 24 years. Therefore, money managers for the likes of family trusts and pension funds face a challenge in order to maintain the real value of their portfolio. Using expanded credit to deal with a financial crisis or the deflation of a bubble merely leads to the inflation of further bubbles. The bailout of an individual company, the stock market, or the government of a bankrupt third world country seldom leads to well-founded prosperity and stability.