When I was a child, I remember asking my father why “they” didn’t just print enough money so that everyone could be rich.
It seemed so obvious! It turned out the answer was just as obvious: if they printed that much money, then the money wouldn’t be worth anything. It’s a shame that so many of our policy makers have yet to grasp the lesson I learned at the age of ten.
Inflation, at its simplest, occurs when too many dollars chase too few goods. That seems very straightforward, but the effects and implications are more complicated and far-reaching. The Fed tells us they are willing to accept higher inflation in order to support a more “equitable recovery.”
In the last year the government has spent more than $5 Trillion on Covid-related programs, stimulus, tax breaks, etc. In a normal year the amount of money in circulation increases by about 6%. Last year that figure jumped to 27%. Consequently, many businesses have reported record earnings. What you aren’t seeing, though, is that these businesses are not also reporting record production. In fact, supply chains are still stretched incredibly thin as factories struggle to ramp up production.
The government-induced labor shortage isn’t helping the problem, as generous unemployment benefits keep many would-be workers at home. People are being paid to purchase good they aren’t producing. As inventories dwindle, the cost of the remaining supply should continue to spike and the cost of labor continues to rise. Consequently, the local Burger King is posting jobs starting at $15.25, and teen employment is the highest it’s been in more than two decades.
The Fed tells us they believe the current jump in inflation to be temporary, but supply chains cannot be turned on like a light. Already running at twice the Fed’s target rate, if inflation increases and becomes persistent, the Fed will need to take action, which can be risky and damaging in the long run.
Since interest rates are essentially the price of money, when inflation runs too hot, the Fed will typically make it more expensive to access that money by increasing interest rates. This can lead to larger systemic issues, especially if they hit the brakes too hard.
The 1970s were characterized by persistent inflation hovering around 7% per year. In order to counter this, the Fed raised rates in the 1980s. By 1981 the average rate for a 30-year mortgage was more than 18%, and rates for new cars were up to 15%.
Think about what happens to the market for homes, or any other goods, when interest rates are that high. People are less willing to move across the country for a better job, if it means selling a home with a 4% mortgage to buy a home at 18%. Renters will be priced out of the market, and home construction decreases. People are going to drive their cars longer, rather than replacing them. Businesses who produce these goods, as well as the factories in which they are made, and the tools with which to make them, not to mention the raw materials they are comprised of, become less profitable and have to lay-off workers.
As you can imagine, the first three years of the 80s were spent in recession, and double-digit mortgage rates continued through the remainder of the decade.
Many of the policies put in place to get us through Covid were intended to help the most vulnerable in our communities which, of course, is a laudable goal. The reality, though, is that markets are efficient, not equitable. There are always unintended consequences of any policy decision. Rampant inflation and higher interest rates would be the most damaging to the exact communities these policies are purported to help, and would only exacerbate inequalities that already exist.
You should continue working closely with your Certified Financial Planner® to monitor the situation. If inflation continues to rise, and the Fed is moved to act, you may need to make changes to your portfolio in order to avoid losses and increase income to match rising costs. Many of your bond positions could be especially sensitive to rises in interest rates, meaning those investments you think of as being “safe” may lose substantial value. If you still haven’t considered refinancing your mortgage, that opportunity may be slipping by. If you are currently unemployed, jumping into the labor pool before benefits end could garner you a higher pay rate than if you wait to seek work along with the other 10 million unemployed workers.
Yes, the Fed could be right, and inflation could subside if production ramps up quickly enough. Half of states have eliminated additional unemployment assistance, which could help that process. The remaining benefits are slated to run out in September.
Time will tell…
Stephen Kyne, CFP® is a Partner at Sterling Manor Financial in Saratoga Springs and Rhinebeck.
Securities offered through Cadaret, Grant & Co., Inc. Member FINRA/SIPC. Advisory services offered through Sterling Manor Financial, LLC, an SEC registered investment advisor or Cadaret Grant & Co., Inc. Sterling Manor Financial and Cadaret, Grant are separate entities.
