Inflation Shouldn’t Be Scary

| By Richard M. Birch III

There is no doubt inflation is high. Currently, we are at a 5.4% year-over-year inflation rate, which is all the more jarring since we have been at historically low inflation rates for over a decade often not breaking 2%. 

For context, over the past 100 years, inflation has averaged 3.24%. High inflation itself is neither good nor bad, its what’s occurring within the economy along with inflation that really matters. 

If the rise in income for workers increases, and the economy chugs along with inflation, then purchasing power increases. In this case the average person is just as well off, if not better. On the flip side, if wages remain stagnant, but inflation increases, then purchasing power decreases, which is both concerning and detrimental to the economy as a whole. 

Inflation Affects Consumer Confidence

Either way, the reports of higher inflation are beginning to affect consumer confidence, especially since some of the areas most affected are the ones that are unavoidable by consumers, such as food, transportation, clothing, and housing. 

Currently, the questions for investors and non-investors regarding the level of inflation are: 

(1) How high will it go and how long will it last? 

(2) Is it strictly being driven by COVID-related labor shortages and supply chain bottlenecks or does it go even beyond that?

The Federal Reserve, who actually has a decent track record of predicting inflation rates, claims higher than average inflation is temporary, with “transitory” being their preferred term on the matter. Not only are they predicting it to be temporary, but also that we will be back under a 2% inflation rate in 2022. That is according to minutes of last month’s Federal Open Market Committee meeting released October 13, 2021. 

“The boost to consumer prices caused by supply issues was expected to partly reverse, and import prices were expected to decelerate sharply,” the minutes read. Clearly, the Federal Reserve is in the camp that prices are primarily COVID related. 

Other economists, however, will tell you that while COVID is exasperating inflation, the real issue with its rise is no different than any other inflationary period, which boils down to excess in the supply of money. American Economist Milton Friedman would agree, as he touted that all inflation issues result from monetary policy. 

What it May Boil Down To

This camp of economists has a lot to point to:

(1) The various relief bills have injected a lot of money into the economy and into people’s bank accounts with possibly trillions more to come. 

(2) Lending rates continue to be at historic lows in spite of increasing inflation, and 

(3) In addition to this COVID-related spending, the Fed has been purchasing government securities for some time now, currently to the tune of $120 billion a month in Treasury bonds and further increasing money entering the economy. 

To this point, Fed officials broadly agreed at their meeting last month, they should start reducing emergency pandemic support for the economy in mid-November or mid-December, and have further stated intent to begin tapering its Treasury bond purchases before the end of the year as well.

If you fall into the latter camp, believing that high inflation is here to stay, it’s important to remember that sustained periods of elevated inflation are extremely rare in U.S. history. Sure, people will often point to the ultra-high inflation of the 1970s and early 1980s, but in hindsight, it’s clear those were unique periods with circumstances very different from today. If anything, deflation is much more historically difficult to control should that ever become a future issue; students of the Great Depression can certainly attest to that fact.

Perhaps It Is Not All Bad

Some inflation can be a good thing for investors. Even during times of historically higher inflation, both stocks and bonds have generally provided solid returns. On the other side, when inflation has gone negative, stocks and bonds have generally suffered more losses. 

Historically, higher prices that inflation brings have boosted commodities, as well as sectors that benefitted from higher interest rates (such as banks) and companies in must-have categories like semiconductors and popular consumer staples.

So, if you’re sitting there thinking about our original questions, you might think that none of this answers whether higher inflation will be temporary, or whether wages have or will increase to offset any negative inflation implications should it prove not to be as temporary as the Fed is predicting, and you would be correct. No one really knows at this point and anyone telling you they know is certainly not telling you the truth. 

In addition, without a lot of further data – it takes time to gather, compile, and report – the word “inflation” itself shouldn’t be scary even though many TV pundits will insist otherwise.

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