Headline: What is responsible for the current inflation levels?
Date: 1/1/2022
Body: Pick up any personal finance or business magazine today, and likely, just under the COVID headline on the cover, there will be an article about inflation. Normally, the Federal Reserve takes great pride in being able to shepherd the economy along with 2-3% inflation each year. This has become our bottom line expectation over several decades. But, the critics appear to be correct. There IS terrible inflation. In fact, A LOT of inflation! We now have an inflation rate of 6.8%, the highest rate since 1982. The core inflation rate (excluding the most volatile energy and food is 4.5% and this is easily double what it was last year. What caused this inflation?
Some Sympathy for the Devil, uh, I mean the Federal Reserve?
Before any blame games start, it should be noted that The Fed is charged to take on 2 tasks, and since they can suggest opposite treatments, one might be excused for having a bit of sympathy for the Herculean job that they do. At one time, they have 2 charges:
To get the economy as close to full employment as possible.
To manage the inflation rate and keep it to 2-3% per year.
These goals are often in conflict with one another, and each tweak to the economy must be pre-thought-out as to short, intermediate and long
First, has there been a significant increase in the inflation rate?
The consumer-price index, a key reading of inflation, is up 6.2% from a year ago, according to the Labor Department’s report for October. Economists often drill down into this number and report the “core inflation” rate. This rate eliminates food and fuel from the computation based on the observation that they are significantly more volatile in pricing compared to other goods and services. (I have always wondered about the wisdom of drawing this distinction because I couldn’t make a decision to forgo food and fuel. Could you?) But, even eliminating these from the computation, the CPI is inflating at a rate of 4.6%, a rate more than doubling the target, for the Fed. (For perspective, we haven’t seen an increase in inflation like this since 1990.)
In an effort to stabilize prices for oil and gasoline, the U.S. Government has auctioned off about 9% of its petroleum reserves. It remains to be seen if and when the availability of oil will translate to a lower price for gasoline.
Second, is it indeed “Transitory?”
For months now, the Fed Chief has said that this strong inflation will be a very short-lived event. Reading some tea leaves (a little bit) we can see the term of this transitory increase in inflation changing from “immediate future” to “intermediate future.” The Fed seems to currently think that inflation will return to 2-3% in 2023, but other economists suggest that 2023 is the year that inflation will begin to return to its long-term state. What cannot be controverted is that this inflation is placing the pinch on all consumers, especially in the increase in gas and fuel prices. (I don’t even drive, and I can see a slight uptick in Uber and Lyft prices, I suspect due to this increase in gas prices.) The same appears to be true with respect to airline tickets and the purchase of any building supplies. There appear to be 2 main causes of this rapid price fluctuation: supply chain issues and Labor issues.
Supply chain issues continue to mess with prices. The prices of new cars is much higher now than before the pandemic. Per a few mechanics I know, this is largely due to a worldwide shortage of computer chips used in modern vehicles. During the pandemic, the plants that produce these chips were forced to close and re-starting them is not like flipping a light switch. People must be re-trained, some new employees might be required, and the raw commodities might also be limited in supply. OK, you say, so buy a used car. Yeah, well, people have already crossed that synapse, and used cars (that are worth anything) are very expensive as people try desperately to get just a few more months or a year out of their old car.
Labor issues are another source of concern. This one is perplexing, but there is a real effect out there. I belong to a social club, and many people there are entrepreneurs and small business owners. To a person, they all complain about the difficulty in finding people, and when they do, these people often do not last for very long within the enterprise: they voluntarily leave. (I have even heard of many interviews being set up and the applicant just doesn’t show up.) This is especially vexing because there has been a 1.7% decrease in the labor-force participation rate since the pandemic, according to some studies. Are people retiring early? Are they going back to school to pursue a new line of work, using the pandemic as a prod to go and do what they like? The reason for the labor shortages remains elusive, but the effect is VERY real.
Officials of the Federal Reserve have said that they will slow down the buying of bonds. This will slow down the adding of liquidity of the market. But, given the drop in labor participation rates, they appear leery of increasing interest rates too much too soon.
Others see the increase in inflation as a Supply & Demand problem.
Ok, demand for goods is up, but this isn’t the whole picture. In the depths of the pandemic, many people stayed at home, and consequently demand for goods and services dropped dramatically. (Think about it. If not going to a workplace, there is less need for daycare of young ones. If not going out, demand for restaurants plummets. You get the idea.) Now, after 2 years of privations and then the government starts opening up the regulations, one can easily understand the immediate impulse to begin to BUY, BUY, BUY. But, the supplies are not there, so the prices increase, hence we have inflation. Supply is the other side of this coin, and that supply chain is tangled worse than any string of Christmas lights you have ever had to contend with. The goods often start in Asia, where they are produced. Labor has largely not returned to the factories, so output is substantially down. Further, there is a shortage of truck drivers to drive these goods to the ports. Then, the goods are shipped to (let’s say) California. I have seen reports that 170 ships with more than 200,000 containers sit waiting off the California Coast. After some research, I have reason to believe that this logjam in the supply chain is decreasing significantly. But, we still have 2 problems:
There is a perception that there are a lot of ships waiting to dock in California ports. Doubtless this is true to some extent. But, the extent is rather immaterial because the perception of the backlog is so engrained in minds of business people. The perception is that supply is down, so prices MUST rise.
There IS a huge shortage of truck drivers at the California ports. What is this due to? The reasons appear to be manifold. But, many of the truck drivers are older, and deciding to retire, and the younger people are deciding that being away from their families for days and weeks at a time is unacceptable. At the same time, federal requirements are beefing up. Up to now, truck drivers receive a CDL (commercial Driver’s License) from the state they live in. Because they are involved in interstate transit most of the time, the federal government is now requiring the schools that train these drivers to meet certain requirements, regardless of state. Further, there is a federal database being maintained, and if a driver receives an alcohol-related charge, their CDL is at risk. All of these pressures make drivers far less common than before.
How does inflation affect the stock market?
Surprise, surprise, this is actually a 2-part question because short-term and long-term effects might be very different. In the short term, inflation might help the stock markets as profit margins will inflate, and this will make the stock appear more valuable. Valuations will then increase. But, if the inflation lasts long-term, the Fed will have to increase interest rates. This will make borrowing more expensive, and the stock prices will probably reflect that by trending down.
The Verdict
It would appear that we might have to get used to higher inflation than we are used to, for at least the next year or so. Nothing we can really do about this, but realize that any money we have sitting around (under a mattress, perhaps) might keep its value a lot longer if invested in some asset that will appreciate or throw off income.
REFERENCES
https://www.forbes.com/advisor/investing/why-is-inflation-rising-right-now/
https://www.wsj.com/articles/what-is-inflation-cause-stock-market-11637623703
Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice. Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.