If you’ve been reading the news lately, there has been a lot of noise about the rising inflation, especially in the US. In May 2021, the US CPI rose by about 5%. The Fed (Federal Reserve System) currently doesn’t seem fazed by the rising inflation, as they believe that this period of inflation is only occurring due to transitory factors. However, it seems that consumer’s see things differently, as can be seen with recent consumer survey results showing that median inflation expectations for the next 12 months is 4.8%. These survey results come from the New York Fed’s Survey of Consumer Expectations. It should be noted that 4.8% is considerably higher than the Fed’s prescribed healthy inflation rate of 2%. It should be noted that expectations for high unemployment a year from now have a reached a new low of 30.7%, which indicates that the chances of stagflation are low.
Before I discuss any further about the situation with
current rising inflation, let’s break down what inflation is, what causes it,
what are its consequences, and what individual investors can do to hedge
against it.
Inflation is the decrease of purchasing power of a
currency due to a general rise in prices of goods and services in an economy.
For inflation to occur, prices have to rise across a “basket” of goods and
services, the most common “basket” is the Consumer Price Index (CPI). When unsustainable
goods like food and oil rise in price, they can affect inflation immensely.
Thus, economists can take away food and oil in order to look at “core”
inflation, which is a less volatile measure. For example, the June 2021 CPI is expected
to have a 5% year-over-year gain, which has been the highest since August 2008,
while looking at core inflation (food & oil being taken out of the CPI
basket) the CPI is projected to rise at 4%, which would be the highest rate
since January 1992.
Inflation is caused by four major contributors. There is cost-push
inflation, demand-pull inflation, increase in the money supply & a decrease
in the demand for money. Cost-push inflation is the decrease in aggregate
supply of goods & services in the economy due to a general increase in the
cost of production. Aggregate supply is the total amount of good and services
produced an economy. Cost-push occurs when the factors of production (land,
labor, capital, entrepreneurship) increase in price, while companies are
already running at full-production capacity. Thus, companies can no longer
maintain the same profit margins and in order to compensate the higher costs
are passed down to the consumer, resulting in inflation. Demand-pull inflation
is when the aggregate demand increases as a resulting of spending from households,
businesses, governments, or foreign buyers. When demand exceeds what the
economy can supply, buyers will bid up prices in order to procure the insufficient
supply, thereby causing inflation. This phenomenon is known as “too much money
chasing too few goods”. An increase in money supply happens when central banks
purchase securities using newly printed money. This increases the money supply
and can have inflationary effects as consumers and businesses now have more
money to spends, thus driving up prices due to more money being spent. The current
inflation in the US could partially be the effect of the Fed’s quantitative easing
plan in March 2020 of over $700 billion. Then on June 2020 after a brief break,
the Fed promised to buy $80 billion in Treasuries and $40 billion in
mortgage-backed securities until further notice. Quantitative Easing is a form
of monetary policy where central banks buy securities in order to increase the
money supply.
Inflation isn’t necessarily good or bad, but it does need to be controlled. If not properly balanced on a fine line, the purchasing power or money will be significantly reduced. Also, it should be noted that if the rate of inflation is higher than the rate of wage increase, one will technically be making less money. This fact often goes under looked. Another side-effect of increasing inflation is that the tendency to spend and invest more occurs with it, thus further propelling inflation and causing a catastrophic feedback loop. This occurs because people and business will play “hot potato” with depreciating asset of money and eventually money supply will outweigh demand, thus causing a greater inflationary pressure. If this inflation is transitory as the Fed proclaims it to be, the best way for the public to combat it would to just not be alarmed. At the end of the day, no matter what anyone says money is only upheld by everyone’s belief in it, if people (consumers and companies) don’t act too frightened i.e. how they’re acting right now, then inflation has a good chance of just being transitory. However, what needs to be noted is when will the Fed end its monthly quantitative easing push? I bring this up because quantitative easing has caused interest rates to fall significantly making it that much easier for businesses to buy housing, thereby denying it from renters. As a result,affordable housing becomes more and more difficult to procure and more and more people won’t be able to afford rent costs.
The Fed has a very difficult task ahead of it, as the
emerging Delta variant of the Corona virus has hit the US and the full extent
of its effects are still unknown. It doesn’t help that the US has a far way to go before it reaches vaccination levels were herd immunity is possible, as only 56% of the total population has been vaccinated. It should be of note that children under 12 still have no vaccine authorization, these children make up an estimated 15% of the population. I bring this up because if Delta hits hard,the increasing demand occurring due to the economy reopening will dampen,possibly even decreasing prices. Do the Fed continue quantitative easing in
order to support a reopening economy? Do the Fed stop quantitative easing, but the
Delta variant happens to be the worst-case scenario, potentially causing significant
disinflation? The Fed is balancing on an incredibly thin tight rope, and nothing
seems clear as of yet.
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