Rising Inflation – A Fad or a Trend?

December 6th, 2021 by Jim Allen

When it comes to the recent surge in inflation, you don’t need to read about it in the news or hear about it on the TV. You are feeling the pain in your pocketbook every time you fill up your car or buy groceries. Just about everything has had rapid and dramatic price increases over the past several months.

While we are all aware that inflation is on the rise, the big question is “how long will this last?”. Is the inflation spike the start of an upward trend, or is it simply a short-term anomaly brought on by the COVID pandemic? The answer is a little bit of both.

A large portion of the inflation spike can be attributed to the “supply chain” issues that the global economy is experiencing now. When COVID hit, the world economy had to shut down for almost a year. The especially hard-hit sectors were energy, manufacturing, and leisure. This created shortages of everything from lumber, to microchips and beef. It also slowed energy production as no one was traveling during the shutdown.

Once the economy started to spring back to life, demand for goods, services and travel started to increase and demand is exceeding supply for virtually every type of good or service. Manufacturers started producing goods again, but this activity all at once has created the infamous supply chain crisis. You have boats full of goods all arriving at the ports at the same time creating a bottleneck there. Then these goods all need to be unloaded and transported across the country, which is now also a part of the bottleneck. So, until these goods get distributed to the public, shortages occur, which drives up prices.
The fact that the supply chain problem is the main cause of this spike can be shown in the difference between the growth of Core Goods prices and Core Service prices. When COVID hit in early 2020, the Core Good price index was a negative 1.5% (meaning the cost of products was declining), while Core Services was hovering around +2.25%. As of this month, Core Goods has increased to over 8% while Core Services (still higher) is only around 3%.

This would indicate that the bulk of the spike is simply due to the current supply / demand imbalance. However, this isn’t the only reason there is higher inflation on the horizon. It is also a result of the economic policies of the Federal Reserve and the government.

During the COVID crisis, the government pumped money into the economy in the form of stimulus checks, loans and other spending measures. While these helped the economy stay afloat, it has led to an increase in inflation. When the government has budget deficits (like the US typically does) one way to minimize the debt burden is through inflation. The Federal Reserve has wanted to stimulate some mild inflation growth, but with limited results.

In order to stimulate the economy, the Federal Reserve used a program called quantitative easing or QE (the practice of purchasing government bonds with the goal of lowering long-term interest rates). The Federal Reserve has signaled that they may start to “taper” their QE program as a way to slow inflation growth. The change to tapering QE could lead to increased rates and slightly higher inflation going forward, but the trend would be more manageable and not lead to spikes like we are seeing with the supply chain issue.

In general, we see the current spike in inflation as largely related to the supply chain crisis which is a result of the COVID pandemic. Inflation has been at historic lows for a number of years, and the trend can only be an upward one. However, once the supply chain crisis starts to clear up, we should see supply and demand start to stabilize and prices should levelized or decline.
Our investment team is constantly monitoring interest rates, inflation and the economy for longer term trends. We are currently still bullish on the economy for the near future while at the same time looking to minimize the impact of the inflation spike on your portfolios.
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Jim Allen, CFP, ChFC, EA, CDFA is President, Sr. Advisor and a Principal at Anchor Bay Capital. In addition to his 30+ years of financial planning experience and his professional credentials, he holds a Master’s Degree in Financial Planning and is a former instructor in the CFP program at the University of California Irvine. He is also the co-author of the book “The Tools & Techniques of Charitable Planning.” Jim can be reached at [email protected]