Inflation, Inflation, Inflation. It’s all that people in finance seem to be discussing these days. Like watching a car accident caught on video, people can’t seem to look away from any headline telling us just hot inflation is running at the moment.

Please don’t take me for being unsympathetic. I realize the economic toll that inflation is having on many families across the country, and I’m feeling the effects in my own life as well. Inflation is a stealth tax that eats away at our wealth and steals our purchasing power.

Much of the inflationary wounds we have in the US are self-inflicted, as our government chose to stop flirting with Modern Monetary Theory and started going steady in 2020-2021. MMT is a school of thought that believes deficits “don’t matter” and our government can print an unlimited supply of dollars because it has a monopoly on its currency. Under the MMT plan, inflation would be controlled by taxes; but good luck raising taxes in the midst of a global pandemic, right?

During 2020, the Trump administration put together stimulus spending in the form of direct payments, PPP and EIDL loans, enhanced unemployment benefits, and a holiday on RMDs from qualified retirement accounts. Not to be outdone, the Biden Administration immediately passed more stimulus as soon as they took office in 2021, despite the warning signs that we could be overheating the money supply. The Biden Administration also extended rent moratoriums, student loan forgiveness, and (for too long) extended the enhanced unemployment benefits.

Along with the fiscal policy of Uncle Sam, the Federal Reserve did its fair share. You can read an extensive list of the monetary policy decisions enacted by the Fed at this link.​

Here’s a big piece that is only becoming clear in hindsight—- Look at the impact that this massive increase in money supply did to consumer saving:

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In the lower right corner, you’ll see a massive spike in disposable income. So— what do most people do when they have disposable income?

They spend it. As you can see from the graphic, some people used the extra funds to pay down consumer debt. However, let’s not forget what was also happening at this time–many people were forced to be at home with few things to do for entertainment and fewer places to go for recreation.

Thus, folks got busy buying goods. People bought new cars, upgraded appliances, and (with the help of low interest rates) new homes. If cash was an issue, you could refinance your home to free up liquidity.

All of this was happening at the same time that supply chains were contracting, energy prices were rising, and Vladimir Putin was beginning to plan his invasion into Ukraine. Looking back, it can feel like we should have known this was coming.

What’s Next?

I am seeing tons of predictions for the road ahead. The “R” word (recession) is being discussed on a daily basis, and the consensus seems to be that it’s inevitable. Recession is coming—but no one agrees on when it will arrive.

Recessions are inevitable. They are part of the economic cycle, so for good measure, you should know that the textbook definition of a recession is 2 consecutive quarters of decline in economic output. Therefore, it does stand to reason that we may see a decline in some areas of the economy simply because we pulled forward so much demand in 2020 and 2021.

Even if our economy still grows, it likely won’t grow at the same pace it did as we came out of lockdowns. However, there are other parts of the economy that were devastated–like services and tourism–that are now poised for a solid recovery. Folks that haven’t traveled, attended a concert, or visited a massage therapist in two years are likely going to make up for lost time.

Since energy runs the economy, I suspect that the higher energy costs will continue to push upward pressure on prices. As we all have learned, inflation is a lagging indicator, which means that it will be cooling off well before it feels like they are cooling off. To me, one canary in the coal mine to watch will be consumer behavior.

As you can see from the grapic below, consumers drive the US economy. This is one of the main reasons that our government worked so diligently to get money into the hands of consumers. They needed to prop up demand—and they succeeded.

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How long will inflation last? Will we enter a recession this year? It’s really hard to say. The Fed is fully focused on reigning in inflation, and there will be no shortage of political pressure for the Fed to get it under control (even if they attempt to blame it on Russia).

(Side bar: When did we begin blaming Russia for everything?)

The main area that I continue to watch is consumer behavior. Sometimes the cure for high prices is in fact high prices. I expect some folks to curb spending on items that seem overpriced (like new and used vehicles).

However, if people continue to go about their daily lives, making substitutions for certain goods or activities due to price, yet otherwise contiuning normal economic activity, we should be ok. As long as people feel confident that they can maintain their lifestyle and current spending levels, we should be able to get through this rough patch. This doesn’t mean we won’t feel some turbulence along the way.

So, What About Cash and Savings?

Note: I’m NOT referring to investments in the traditional sense. I’m a firm believer that traditional investment portfolios should be invested according to a personalized financial plan. If your long-term goals haven’t changed, then you won’t hear me calling for an overhaul of your asset allocation.

What I am going to discuss is cash, money markets, and CDs…. and some alternatives. If you’ve made it this far—congratulations! I suspect that many readers wish I would have started with this section. Here are two quick ideas for a place to stash some excess cash and earn a decent yield:

I-Bonds

Since we continue to run hot inflation numbers, this little idea has become like The Little Engine That Could. Countless bloggers, journalists, and media outlets are running stories on I-bonds. So, it’s important to know the basics before making a decision.

My friend, Jeff Levine, wrote a lengthly article explaining how they work, so I encourage you to check it out.​

It’s important to note that these bonds require funds to be there for 1 year. There is no liquidity. So– DO NOT invest your emergency fund. Only consider using cash that you can part with for at least 12 months.

In my opinion, I-bonds could make sense for those who have some excess cash, and they have no desire to enter equity markets (ever). I say this because I believe corrections and market volatility can provide opportunities to put dollars to work in capital markets.

You are also limited to 10k per person, so there is a cap on the benefits available to households with larger balance sheets. Still, they are an interesting tool that can make sense in some situations. Please be mindful of how the interest can be taxed.

Multi-Year Guaranteed Annuity (MYGA)

These contracts are like CDs in that they have a stated interest rate and a set term. Interest is guaranteed by the claims paying ability of the insurance company, so it’s important to understand that these products aren’t FDIC insured like banks. Instead, MYGAs are backed by the insurance company’s reserves and claims paying ability.

MYGA contracts may also have some limitations on liquidity. For instance, a common theme is for you to be able to only remove interest or 10% of the account value during the contract term. Thus, it’s important to know the terms of the contract and to make sure you are only using funds that can be allocated for the specific contract period.

The taxes on the interest paid by these contracts is tax deferred. However, when you liquidate the policy, the taxes are due in that year unless you exchange it for another contract. The exchange allows you to continue deferring taxes. Our team can offer guidance on tax efficient ways to unwind these contracts when the time comes.

MYGA contract rates change frequently as they are interest rate sensitive. They have 2 year and 3 year options that can be a reasonable alternative to CDs at the bank.

In summary, inflation is here and likely going to remain for a little while. Even if we see some slowdown in the rate of inflation, I feel like the step up in prices we’ve seen could persist. The future is definitely uncertain, and that can be scary. The main thing to focus on is your financial plan.

If you feel that your plan needs to be updated OR if you believe that inflation has changed your investment goals, please don’t hesitate to reach out to our team. We will gladly sit with you and review your plan and help you consider any adjustments that need to be made.