Those of us over a certain age may have a foggy memory of times when the prices of goods and services rose at a rapid and destabilizing pace. Inflation has ceased to be much of an issue for almost 40 years. The Federal Reserve Board, which sets the all-important Federal Funds rate on which most other interest rates are based, pushed that rate up to nearly 20 percent in 1980 to slow down the economy, ending the out-of-control inflation of the 1970s.

Federal Fund Rate – 62 Year Historical Chart

It is unlikely then that anyone under the age of 60 would have much of a recollection of the economic impact of rising prices. People coming of age over the last four decades have not “officially” experienced any significant inflation. (Government statistics are biased toward minimizing inflation so while certain areas such as tuition and house prices have increased you would not know it from official figures.)

Now we seem to be at a critical juncture where several forces have coalesced to make inflation much more likely than it has been in decades.

Inflation Rate – May 2020 – April 2021

During the recent Strategic Investment Conference featuring many of the country’s top economic and investment minds, a compelling case was made by many speakers that the possibility of inflation has increased dramatically over the past year. Here are some of the key factors cited:

    • Supply chains for many products have tightened due to tariff policies over the last few years as well as additional impacts from the pandemic. The result is limited supply of many products causing substantial price increases.
    • Consumers have extra money to spend due to government stimulus checks and money saved up during lockdown periods. As the economy continues to reopen it is likely to result in increased consumer spending.
    • Commodity prices have increased markedly for many in-demand items such as lumber, copper, steel, oil, and grains.
    • Due to historically low interest rates which make home mortgages cheaper, an inadequate supply of housing, and soaring lumber costs, home prices have risen at the fastest rate in several years. A significant percentage of home sales are now above the asking price.
    • Labor markets are tight which could result in increased wages leading to increased prices for goods and services.
    • Federal government debt has exploded due to the pandemic. In the past this has put pressure on interest rates to rise which can contribute to inflation.

The conference also had several speakers who contended that inflation should stay under control because:

    • During the pandemic, economic activity has been heavily influenced by government intervention that will likely end soon. The economy is still on heavy duty “medication” and is not as strong as it seems.
    • Although consumer demand is increasing while supply of many items is still constrained, demand could decrease as stimulus spending wanes and supply could improve as companies are able to adapt.
    • Unemployment is still extremely high (2 million more people are unemployed now than even at the height of the Financial Crisis in 2008). Until employment improves consumer spending will face head winds.
    • Demographics. The population is aging, and older people spend less money. Also, there is less growth in the workforce which reduces economic growth.
    • Debt. Government and corporate debt have exploded in recent years and are likely to be a drag on the economy due to increasing debt payments (especially if interest rates rise). More money will go to debt payments and less toward productive economic activity.

Most economists believe that we will have higher inflation over the next several months. Given increasing consumer demand, restricted supply of many goods and services, and the comparison of current prices to last year’s artificially low prices, some short-term inflation appears very reasonable and even desirable.

The question is what happens after that. Predicting inflation is extremely complicated and there are cogent arguments on either side of the debate. It is clear, though, that we are closer to inflation and the investment risks it presents than we have been in many years. Journey Tree will be monitoring the situation and making adjustments as needed.