Inflation and Money Under the Mattress
Let’s say I have $100 saved in my bank account and it earns 0.07%. On paper, that $100 is going to be $100 as long as I don’t withdraw from my bank account. That’s the beauty of having a FDIC insured account because if I want my money, I’m going to be able to access it. But if I wanted to spend that $100 in 2021, it unfortunately won’t go as far as it did than when the year started. Broadly, inflation has been up significantly because almost everything has gotten more expensive. You may have heard the term “meatflation” because meat prices are higher or “gasflation” because gas prices are higher. Though my money was “safe”, I was able to buy substantially less with it. If that $100 was tucked away safely under your mattress, you would need to add nearly $7 to it to break even for 2021.
These terms are designed to invoke fear. Yes, eroding purchasing power is a real danger to your savings and investments. Our objective is to help you sift through what is noise and what is potentially concerning. Let’s start by looking at what’s causing increased demand for goods and constricting supply chains.
Starting with demand, the stimulus payments injected cash directly into the hands of consumers. This had several effects where the US economy recovered very quickly, and people started improving their personal balance sheets. Compared to the Great Recession, where the banks were bailed out, it took several years for our economy to recover. Which would you prefer? A painfully slow recovery where you have no inflation, or a quick recovery, like the one we’re experiencing now? Of course, there were many differences between the Great Recession and the COVID-induced recession, but this is just meant to highlight the differences is Fed response.
The Federal Reserve targets 2% average inflation as one of its barometers of a healthy economy. It is important to view long term inflation as a result of a growing GDP. The other test for the Fed is unemployment which stands at 4.6% as of the date of this writing. The biggest concern of whether higher inflation potentially more sticky is wage growth.
Workers are currently seeing wage growth at 5.1% which is higher than the 4% average we’ve experienced since the mid 80’s (JP Morgan Guide to the Markets November, 30th 2021). To throw in another media generated term, the “Great Resignation” is occurring in most industries. The pandemic caused many people to assess their current work environments. Take the trucking industry as an example where turnover was nearly 90% pre-pandemic. Many older drivers decided to retire early, a decision made easier by low pay and poor working conditions. The industry has responded by increasing pay by an average of 30% and offering signing bonuses. The job has become more attractive to young drivers as driving schools are at capacity. It also should be noted that a significant number of truck drivers quit their trucking jobs to create their own trucking businesses.
Companies beyond the trucking industry are jostling to attract needed labor, offering incentives that go beyond pay. Demand for various goods and services is outpacing the ability to supply those goods and services. Anyone who needs to book a hotel room, rent a car, or get an Uber has experienced high prices and limited availability. All these services ground to a halt during the pandemic. Hotel workers were suddenly out of work, rental car lots were full, and Uber had limited ride fares. These businesses responded by reducing their labor hours, shed car inventory, and reduced fare rates. As the economy reopened, demand was and is much quicker to recover than supply. Hotels are operating at a historically normal 60% capacity but are maxed out due to labor shortages. Uber rates have spiked by 79% in certain areas because of the shortage of drivers.
If inflation runs above 2%, the Fed will likely raise rates to slow down an overheating economy. If they raise rates too soon, we risk short circuiting the recovery and fall into recession again. If they wait too long, we could see a bubble in asset prices or other non-publicly traded metrics. As of early December 2021, the Omicron variant has now been detected in over 20 countries. There are a lot of unknowns, but governments have instituted travel restrictions which will reduce economic activity. This possible slowdown in activity may give the Fed reason to keep accommodative policies in place.
With both inflation and unemployment targets met, the market is pricing in three rate hikes in 2022, starting in the summer. Believe it or not, the Fed has struggled to get inflation up to 2% in the past 20 years. This risk would be an additional rate hike would be needed to keep inflation tame.
Another factor to look at is velocity of money or the movement of money. This is the measure of how fast money is moving or being spent. Based on headlines and prices, we would think this measurement would be historically high. See chart below. (St Louis Fed)
The data is lagged so we could see a spike but it would take a massive increase in spending to match pre-pandemic levels. If the Fed raises rates, spending will slow, which is the intent to get a handle on inflation.
What about the other cause for rising prices, the supply chain?
Everything is more expensive because there is less of everything. Supply chains were disrupted globally as countries instituted lockdowns of varying degrees. There isn’t necessarily a shortage of raw goods, there’s a shortage of our ability to transform these raw materials into finished goods. Sprinkle in a truck driver shortage and we have a complicated supply chain mess. Labor is most likely the biggest contributor to the current bottlenecks but some industries will recover faster than others.
The supply/demand imbalance can shift relatively quickly. Lumber peaked at $1,600 in May 2021 as lumber mills were still reopening. It took only a few weeks for lumber prices to crash as supply very quickly caught up to waning demand. People finished remodeling and were gearing up for the summer with fewer restrictions. Lumber is relatively easy to process compared to electronics or appliances. Suddenly we had a lumber glut. See chart below.
More complex goods have been slower to recover from the supply constraints. Every product that requires a computer chip has been painfully slow to ramp up due to the global chip shortage. This has impacted everything from computers to alarm clocks to cars. The good news is these goods are typically not recurring purchases like gas. This should self-correct in time as manufacturing (the supply) catches back up with the backlog of orders (demand). Notwithstanding, of course, the additional demand of the holiday season for pretty much everything.
Spoiler alert, Apple reported supply chain issues in their most recent earnings release resulting in a few billion dollars of additional costs, and we think they continue to see increased costs in the short term, reporting higher costs of building their already very profitable iPhones. Just in time for the holiday season, which is historically Apple’s largest quarter when everyone looks to upgrade to the latest iPhone for the holidays. Spoiler to the spoiler, Apple has told suppliers that iPhone demand has significantly slowed for the holiday season. In the amount of time it has taken us to write this, we’ve seen two different stories come from the same company.
Some expenses essentially hit consumer’s budgets less. Those who are lucky enough to work from home or have a hybrid work schedule save on gas and the stress of a daily commute. Ordering holiday gifts or groceries online saves time from waiting in long lines or fighting for parking. Though the trucker shortage has impacted prices we pay online, hopefully temporarily. We can “see” our families through video chat without long road trips with multiple stops and screaming kids. More and more drivers are switching to electric vehicles as well. CPI measures a predetermined basket of goods, that may not necessarily be your basket of goods. Some people will experience inflation more than others by their spending habits.
Inflation data is very noisy because we’re measuring the prices of a variety of goods. Issues with computer chips probably won’t impact bacon prices but as washing machine prices goes up, CPI suddenly says everything is more expensive. We buy groceries regularly but not washing machines. We do believe our food prices will stabilize if not start to come down.
Wages seem to be the most permanent aspect of this environment. As workers earn more, they will be able to spend more but also, they’ll be able to hopefully save more. There are benefits to higher wages. We’ve argued that the majority of high prices will eventually come down as the supply chain heals itself. The displaced workforce, whether voluntary or involuntary, will eventually come back to their old industries or new industries. Longer term trends will require further discussion such as population growth, immigration, and technology advances (which is inherently deflationary).
Skilled workers reminded us that their services are valuable to society as a whole. In addition to truck drivers, appreciate what plumbers, electricians, and contractors do. If prices for these professionals stay high, it can only attract new tradesmen and tradeswomen into their respective jobs. What we’re saying is prices aren’t permanent and that includes predictions on where prices will go.
Disclosures
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
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