Well, the federal reserve has done it. As I was in the store today I realized “holy cow, things cost a ton more than they did a year ago.” And they do. What on earth has happened?

Well, for years now Americans have been going to town buying things on credit, getting crazy loans and spending like its going out of style. Unfortunately, exuberance extracts a price. The housing bubble has bust, and there is a debt crisis. The fed keeps pumping cheap money into the economy but the thing is, consumers, already strapped for cash, aren’t spending as much.

At the same time, politics and violence in the Middle East, Venezuela, and Russia keep adding to the global uncertainty that is pushing up the price of oil and natural gas. Breakneck growth in the developing economies of Brazil, Russia, India, and China continues to put upward pressure on prices of other key input commodities as well.

To make matters worse, the U.S. dollar has weakened severely against other major currencies over the past year. The U.S. dollar just doesn’t buy as many Euros, Yen, and Pounds as it used to. So, Americans must use more dollars this year to buy the same imported goods from Europe and Japan that they bought last year.

Perhaps most damaging of all, our elected officials in Washington, D.C. keep spending hundreds of billions of our hard-earned tax dollars – from both this year and, through debt financing, many years to come – like drunken sailors on shore leave..

In short, we have a U.S. economy awash in cash, a U.S. dollar beaten down by foreign currencies, and global commodity prices near record highs. The specter of a dastardly economic demon – inflation – rears its ugly head.

So the fed has been cutting and cutting and cutting and we have a nasty bit of inflation.

What does this mean?

Over time, inflation degrades the purchasing power of a $1 bill. Decades ago, the price of a loaf of bread was a mere nickel. Back then, you could buy 20 loaves of bread for $1. Today, the price of a loaf of bread is at least $2.00. For a $1 bill today your baker will hand you back just half a loaf. The bread didn’t change; the value of the $1 bill declined.

The erosion of purchasing power caused by inflation is why investing for the future is an absolute requirement for a financially successful life. For your investments to maintain for the future the purchasing power you enjoy today, the average annual rate of return on your investments must exceed the average annual rate of inflation in the general economy. To get ahead financially over the long term, your investment returns must trounce the rate of inflation by a wide margin.

Lets hope we get this beast under control (no more rate cuts fed!) or else things could get really nasty….really quickly.

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