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:
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.
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.