Understanding how to preserve the Value of Money

Prices of goods usually rise every month all over the world. This phenomenon is called inflation.

For example, let us assume that prices doubled in a given year, i.e.,increased by 100%. If the price of a pair of pants was $30 at the beginning of the year, then by the end of the year it had become $60.

Assume that Eddie asked his friend for a $30 loan to buy a pair of pants at the beginning of the year. It was agreed that Eddie would repay the money to his friend at the end of the year and without interest.

Eddie paid his friend $30 at the end of the year, but afterward felt that he had been unfair. His friend had done him a favor by loaning him $30 at the beginning of the year, which at the time was enough to buy a pair of pants.

At the end of the year, however, the money he repaid was enough to buy only half a pair of pants.

Eddie therefore decided to pay his friend $60, which is enough to buy a pair of pants, instead of the $30 that he was obliged to pay him. In this case, Eddie is said to have linked the loan to the price of the pants.