Should you be worrying right now?
Are we about to go back to the future where economic malaise brings a sorrowful stew of high inflation and rising interest rates?
Or is this just a temporary temporal anomaly caused by a fixable mix of bad luck and bad decision making?
You might have noticed inflation hitting the headlines of late. Yes, it appears to be registering its highest rate in some time.
It’s more important, however, that you dig deeper than those headlines. If you can identify the likely cause of this current bout of inflation, you’ll be in a better position to understand its roots and its potential impact on you.
“We are experiencing this sudden surge in inflation for two main reasons,” says Craig Kirsner, President of Stuart Estate Planning Wealth Advisors in Coconut Creek, Florida. “First, for the past year and a half due to Covid hardly anyone was spending money. Now that the economy is back open, people are spending and traveling and, as such, there is a bottleneck with very high demand. Our system isn’t set up for this high demand level, so that causes inflation in the short term. Second, with interest rates lowered to almost zero since March of 2020, these low interest rates have spurred demand in housing which is experiencing a large backlog as well as adding to inflation worries.”
What you’re seeing is a simultaneous confluence of one-time occurrences that have both exposed economic weaknesses and created a vicious inflationary cycle.
“It’s largely due to a perfect storm of supply chain disruption from Covid, government spending to fill the economic void and a synchronized global recovery driven by vaccine rollout and economies re-opening,” says John P. Micklitsch, Chief Investment Officer at Ancora in Cleveland. “The pandemic is probably just the event that exposed over a decade of underinvestment in the global commodity supply chain and the vulnerability of ‘just-in-time’ inventories to this sort of supply shock.”
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There is no evidence that, without Covid, we would be facing this “supply shock” induced inflation.
“The strained supply lines due to Covid paired with an increase in demand we are seeing now would be one of the main reasons for inflation at the moment,” says Derek S. Taddei, Relationship Manager, 401k Specialist at HoyleCohen, LLC in Phoenix. Using language familiar to anyone who has taken an ECON101 class, Taddei calls this “a combination of Demand Pull and Cost Push inflationary pressures.”
This, however, isn’t the only Covid-based reason for inflation. Another is a simple “Snapshot-in-Time” anomaly. It’s merely the coincidence of the reporting calendar.
“A large portion of what we are experiencing in inflation is due to the deflation which we saw in 2020 during the Covid shutdowns,” says Mike Windle, CEO at Custom Wealth Solutions in Plymouth, Michigan. “As prices work to normalize, it is causing inflationary pressure. Add to that the pent-up demand caused by the Covid lockdowns; we are seeing prices rise quickly.”
This reason gives many people pause to say the current level of inflation will be short-lived. If we look at the last twelve months, we’re seeing the pendulum swinging wildly between both extremes. The expectation is that it will quickly settle into its normal, less volatile, range.
“Much of the elevated inflation numbers are being attributed to the ‘base effect’ as inflation is commonly quoted on a year-over-year basis,” says Steven Saunders, a Director and Portfolio Advisor with Round Table Wealth Management in New York City. “One year ago, global economies were nearly fully shut down so the denominator in the calculation is arguably artificially depressed. As these depressed numbers from one year ago ‘roll off,’ inflation metrics will likely come down.”
How might you explain this to your children or to someone consumed by anxiety regarding the headline news on inflation?
“You have to look at the whole picture,” says Mike Cocco, Equitable EQH Advisor at Equitable in Nutley, New Jersey. “First, if you are looking at the 1-year changes in inflation, those numbers will be pretty jarring, with many metrics coming in at 5%+ over the previous 12 months. However, you must also keep in mind that 12 months ago, most of our economy was shut down, and people bought less things, traveled less, etc. It was like hitting a big time ‘pause’ button on the economy. That put us into a deflationary position, as many prices and wages decreased, because no one knew what the next week would bring. It was pure survival mode and many people hoarded cash (and toilet paper!). Now, 12 months later, our world couldn’t look more different. Restrictions are all but lifted across the country, people are traveling again, buying things… it was like all of us were freed from a year and a half grounding and now we are ready to re-introduce ourselves to the world. There is so much built-up demand, which can drive up prices as we’ve seen, as consumers compete for goods and services. Let’s couple that high level of demand with low levels of supply in many areas, such as building supplies and some groceries, due to the supply chains getting disrupted by the pandemic, and anyone who has taken an Economics 101 course knows that high demand and low supply leads to higher prices… and that is what inflation is.”
Lest you too quickly pin this whole inflation thing on Covid, realize other factors have contributed to higher prices. These factors did not need a pandemic to spur them.
“Prices are increasing simply due to a mismatch in the supply and demand of goods,” says Saunders. “Over the last 16 months or so, pandemic restrictions closed many factories and shipping routes around the globe, resulting in less availability of products. However, it’s not just pandemic-related supply issues as the Texas winter storm in February of 2021 shut down production of many petroleum-based products that play into multiple industries like foam for furniture or resin for PVC pipes in construction. Additionally, extreme droughts around the world also have the ability to impact the supply of agriculture products.”
But wait. There’s more.
“At the same time as the global supply chain was experiencing large scale disruptions, stimulus payments resulted in many individuals with excess disposable income,” says Saunders. “Since much of the economy was shut down during that time period, individuals shifted their spending away from services such as eating out or travel to buying physical goods like TVs or materials for home improvement. Since fewer products were available, people had to pay up for these products, resulting in increasing inflation.”
It’s clear the “Demand Pull” that Taddei referred to isn’t just coming from lack of spending last year. It’s also coming courtesy of Washington policy-making. Here, Taddei refers to “The three rounds of stimulus that have taken place, as well as a possible 4th round, and even more proposed spending which may or may not be paid for with funds already allocated to unemployment and Covid stimulus from local governments.”
If many point a finger at Covid causing inflation, many point a second finger at national leadership.
“Legislation from Washington has likely played a role in increasing demand for goods over the last year,” says Saunders. “The CARES Act distributed direct cash payments to individuals and also increased unemployment benefits. These had a direct impact on increasing incomes and savings rates of many individuals. Along with these transfer payments, the Act also allowed for those in need to defer payments on mortgages and student loans, ‘freeing up’ more cash for individuals to spend on goods and services.”
But it’s not just individuals going on this government-subsidized spending binge.
“In addition to the ‘free-spending’ behavior of consumers in this current environment, the US Government has not been afraid to take aggressive measures to provide aid to the economy as it was navigating a Covid-world, and they have kept on the path of providing additional assistance to families, businesses, and local state and municipal governments, to ensure a full recovery from this pandemic and the shutdowns,” says Cocco. “To be specific, to date, the Federal Government has approved and earmarked more than $5 Trillion towards Covid relief bills. The latest bill passed (as of 6/29/21) was the American Rescue Plan, which will provide almost $2Trillion of relief to many different areas, ranging from more direct payments to individuals and families, aid to state and local governments, tax incentives, etc. Additionally, Congress is very close and may have framework on a new infrastructure deal, which would be the largest infrastructure deal in our nation’s history, to build and repair roads, bridges, railways, internet broadband, water supplies, etc. Passage of this bill will pump more money into our economy which can certainly create additional inflationary spikes in the short-term.”
Some feel this government intrusion will only worsen the inflationary situation.
“Injecting large amounts of cash into an economy through stimulus and other spending programs like the proposed trillion+ dollar ‘infrastructure’ bill will ramp up economic growth, and will certainly not decrease inflationary pressures,” says Taddei. “It is a combination of issues, fiscal stimulus, the Federal Reserve’s loose monetary policy and the subsequent increase in money supply that creates more money chasing fewer goods and services.”
This is where the vicious cycle really starts building on itself.
“The U.S. economy is powered by the consumer and we are currently seeing consumers with a lot of extra cash,” says Windle. “This has led to a greater demand for goods and services without supply chains being able to fully recover from the shortages that were created due to shutdowns over the past year. Gasoline prices are still elevated from the shortages that were caused during the Colonial Pipeline shutdown and as businesses try to entice employees back into the workforce, we are finally seeing low-wage workers getting raises, signing bonuses and other benefits whose costs are being passed on to the consumer.”
Plenty of reasons exist for the sudden surge in inflation. Alone, they may have just caused an annoyance. Together, they can do some real damage if not contained.
Which begs the question: Are you prepared to live with longer than expected inflation?