Living With Inflation: How Did We Get Here? (Part 1 of 3)
It’s a topic on virtually everyone’s mind. The classic definition of inflation is “too many dollars chasing too few goods.” If we think about our purchases as taking place in an auction, that description makes sense. As of this April, the inflation rate in the US was reported to be 8.3% as a year over year increase, well above the stated target level of 2% from the Federal Reserve. Since inflation is such an important topic, we have decided to present a 3-part series on Living with Inflation. We hope that you find our insights to be helpful to you and your family.
How did we get here? We can break it down into 6 main causes.
1. COVID-19 and Subsequent Government Policies
In a reaction to the COVID virus, governments around the world participated in a remarkable experiment by shutting down broad sections of the economy, and then replacing earned income with government programs that disbursed money to workers. We had our share of these programs in the US with PPP loans and generous unemployment compensation programs. Depending on the state and city, some went back to work in 2020, while others were not allowed to return until the 3rd Quarter of 2021. When people are not allowed to produce goods and services, we create future shortages of those goods. Cash in households was strong because of the unprecedented level of supplemental government payments, and being confined to the home.
2. Supply Chain Shocks
As the last states opened for business, all of us were anxious to buy those things that we had been denied (new and used autos, travel, dining out, consumer goods). The impact of so many people hitting the markets to buy unleashed a torrent of spending. We might describe it as the dam breaking. Retailers and manufacturers had historically embraced a technique of minimizing their inventory referred to as “just in time delivery.” That approach works, as long as our economy is in balance. When the dam broke, purchases overwhelmed retailers and emptied their inventories. That worked its way through the supply chain so that at every level of distribution, inventories were depleted and the rate of replacement was inadequate to maintain supply.
Further exacerbating shortages were continued variants of COVID-19 that caused persistent disruption to production both in US, Europe and in Asia. Shortages of critical components and microchips created bottlenecks in the supply chain raising prices significantly, especially in automobiles.
3. Tight Labor Market
As people resumed their jobs from the pandemic, it became apparent that there were not enough workers in the US to fill the amount of job openings. Currently the unemployment rate is 3.6% and considered to be “beyond full employment.” There are 2 open jobs for every 1 unemployed person. Competition for workers raises cost of labor. As wages rise, labor costs are passed along to the consumer which helps raise inflation. Shortages of labor in areas of manufacturing and distribution cause further disruption to the supply chain.
4. Rising Energy Prices
As the world came back from the pandemic, the demand for energy, specifically gasoline and diesel, outpaced the supply. Since oil is very sensitive to supply shortages, the price has gone up significantly and is currently $110 per barrel. Average gasoline prices are now nationally above $4, and diesel fuel is over $5.50 per gallon. Higher energy prices drive inflation as energy cost is embedded in almost every product and service. Increasing the supply of oil would help meet demand in the future, but we believe that in the interim period, prices will remain elevated. In the US specifically, there has been political pressure to limit the consumption and production of petroleum products to address the climate change issue. While this may help accomplish intended policy goals, it also causes prices to rise further by constricting supply.
5. Loose Monetary Policy from the Federal Reserve
The money supply is affected by several factors, but is largely driven by government spending, interest rates, and bond purchases from the Federal Reserve. During the pandemic, the government ran enormous budget deficits (about 5-6 years’ worth of spending into 2) to help prop up the economy during the shutdown periods. Essentially, the Federal Reserve absorbed this excess spending by purchasing approximately $5 Trillion worth of Treasury bonds and Mortgage-Backed Securities. Taking their balance sheet from $4 Trillion to $9 Trillion in under 3 years is astounding. As a result, more money is in the system. Furthermore, the Fed was slow to raise interest rates in the fall and spring as it believed the rising inflation was merely transitory. Whether inflation will remain transitory is unclear, but the Fed has since shifted its stance to indicate a tightening cycle for the remainder of 2022.
6. Russian Invasion of Ukraine
Russia made the decision to invade Ukraine in February of 2022. This is the first time since World War II that we have seen this level of military conflict with a nuclear power. Ukraine is a large producer of minerals and grain, and as a result of the invasion they have been unable to maintain their normal level of exports. This creates shortages in the food market and will add to inflation as long as the conflict continues. As a result of the Russian aggression, many countries throughout the world have refused to accept Russian exports of goods, oil and natural gas. Russia is the world’s largest exporter of oil to global markets. Disruptions of supply due to sanctions can have the result of further restricting supply and driving prices up.
In our next blog, we address Living With Inflation, Part 2: What is Being Done About It. If we can be of service to you and your family, please don’t hesitate to reach out to us.
The commentary is informational in nature and not intended to imply a specific strategy or course of action. Investment advice and recommendations are only provided according to each individual’s personal circumstances. Chancellor Wealth Management is an investment advisor firm registered pursuant to the laws of the state of Georgia. The firm is also registered to conduct business in the states of South Carolina and Texas. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright © 2022 Chancellor Wealth Management, All rights reserved.