Transitory Inflation & COVID: History repeated?
This isn’t the inflation you’re looking for… But it’s exactly what you should have expected.
We Knew This Was Coming, But We’re Still Freaking Out?
This week saw the release of the April inflation data, and boy was it a big number – 4.2% inflation over this time a year ago! That is the highest #inflation figure in the U.S. in over 12 years, and in the context of our economic situation, that’s scary! But really, this was inevitable; it doesn’t take a Ph.D. in Economics to connect the dots to understand this figure.
This inflation figure is, in a word, Transitory. Simply interpreted, “transitory” means that what we’re seeing now are the base effects resulting from lower prices and suppressed spending last year. Think about it – last April, where were you spending money? Going out to eat? Taking vacations? Buying concert tickets? Able to find toilet paper?? Since everything was shut down, we couldn’t enjoy any of those things… On top of that, there were $Trillions in stimulus dollars released (many of which went directly to consumers) to keep us afloat and encourage spending (but again, in April of 2020, we didn’t have as many available options as to what we could spend money on). So, thanks to an influx of stimulus and suppressed demand, the household savings rate skyrocketed (relatively) last year, and we created a sort of “pinched hose” effect on our spending. Now, not surprisingly, the hose is getting released.
Consumers should have seen this coming, and in fact, many of them did! It seems that many people have been waiting anxiously in anticipation for this inflation. But this data isn’t scary… It’s just transitory inflation – think of it as “temporary.” That does not mean your inflation fears are unbased! Just that you should know to recognize April’s inflation data as something different than potentially damaging inflation. That said, let’s discuss what we’re really afraid of.
What We’re Really Afraid of: Sustained Inflation
I am lucky enough to have not experienced our most recent period of sustained inflation (“The Great Inflation,” 1965 – 1982. It’s hard for many people to disassociate the term “inflation” from what happened over those 17 years, and I believe there are some good learning opportunities that help us put today’s events in context. Inflation in that period can be largely attributed to policies that allowed for excessive growth in the supply of money – Federal Reserve policies – right in the midst of major supply chain complications (i.e., an embargo… ). Before we look at those policies that caused The Great Inflation, it’s worth noting that the Federal Reserve admits it has learned from decades of past mistakes, and there is evidence to support that it has a much better handle on its policies now.
The origin point was many years before 1965 with the release of The Employment Act of 1946. An act that created what we now recognize as the Fed’s Dual Mandate to “maintain long run growth of the monetary and credit aggregates…so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” In other words, from that point on, #TheFed would be tasked with maintaining price stability and maximum employment. But – spoiler alert – they goofed. In practice, The Fed believed that inflation could “buy” maximum employment, which we now know does not work. All that said, the policies in place at the time were designed intentionally to pump additional money into the system to produce a level of spending beyond its ordinary productive capacity. We call this “Demand-Pull inflation.
Coincidentally, amid these early-stage demand-pull inflationary policies, the Bretton Woods Agreement collapsed. This agreement, which was created to facilitate smooth exchange systems, linked all the currencies among the 44 participating nations to gold. With its collapse, the dollar no longer had a hard benchmark (gold) backing. The value of the dollar was simply floating! This floating effect compounded the demand-pull inflation, as you can imagine.
But that’s not all! These policy decisions all occurred in the middle of major supply chain complications (i.e., an embargo on oil that led to oil prices quadrupling that is until the Iranian revolution led to another tripling)! This is what we call “Cost-Push” inflation.
Using proper terminology, let’s recapture what happened: The Great Inflation resulted from demand-pull inflation (macroeconomic policies pumped enough money into the system that produced a level of spending above its ordinary productive capacity) AND cost-push inflation (supply disruptions pushing production of goods into higher retail prices). Put simply, Americans saw inflation being “pulled” from central policies and being “pushed” by supply disruptions. That’s scary and potentially very harmful.
Doesn’t that sound familiar though? In this past year, we have seen some economic policies that have pumped a lot of money into the economy (“demand-pull”?) all the while noticing massive supply-chain constraints that are resulting in huge price-increases, particularly in commodities but also in other components like microchips, semiconductors, and even used cars (“cost-push”?). Many people are wondering if this is the beginning of “demand-pull” AND “cost-push” inflation again.
But. That’s not what’s happening today. At least this is not the cause of April’s inflation report.
What This Actually Is, And Why It’s Not Concerning
To begin, April’s inflation data is not demand-pull, and a good argument could be made that it’s not even cost-push inflation (though I’m not going to make that argument yet…). April’s inflation data is, again, transitory - a result of reflationary policies, which is exactly what it sounds like. It’s transitional. Temporary. Let’s not call it an anomaly, but let’s do recognize it for what it is – a measure of aggregate spending in April of 2021 in comparison to April of 2020 (let’s hope April of 2020 was a once-in-a-lifetime event).
In other words, one year ago saw a huge pullback. Today’s “inflation” number measured from that point might simply be a “return to normalcy.” Think about it – a year ago, oil was being sold for negative prices (have you been able to wrap your head around that yet?)! We expected oil prices to return to normal, so that alone accounts for a huge increase in total spending.
Beyond that, we were all just not spending money last April. Savings rates skyrocketed in 2020, but now that states, counties, and businesses are reopening, data suggest we’ve all been chomping at the bit to get back out there and spend our money. Really, a lot of this April inflation data can be blamed on the return of aggregate demand.
“Demand,” therefore, is understandably transitory, but what about the other side of the story – supply? It’s going to be hard to confidently identify what’s happening with supply right now until we’re well past it, but the simplest translation is that COVID has caused a massive tightening in the supply chain (oh, and remember how the Suez Canal was blocked for so long?). For the sake of time, we’ll leave it at this: if COVID and its restrictions diminish, we’ll look back on this supply-chain constriction (and resulting “cost-push”) and be able to identify it as transitory!
So, This Is Transitory… But That Doesn’t Mean Our Sustained-Inflation Fears Won’t Materialize!
Having learned our lessons from The Great Inflation, our skepticism today is that all the $trillions in government stimulus could create demand-pull inflation while COVID supply chain constrictions could compound that with cost-push inflation. The good news about the demand-pull side of the inflation equation is that we have a government and Federal Reserve who has learned from their mistakes and is making their position clear about inflation – they don’t want it to get out of hand. The bad news more so applies to the cost-push side, and if the bad news materializes, then it might make it difficult to manage demand-pull.
The concern about Cost-Push inflation right now is that our current supply chain constraints may extend beyond (i.e. “longer than”) current expectations. There are reasons to be hopeful, but all you need to do is look at the situation in India to recognize we might need to continue exercising caution. Consider this – a thought stemming from the mind of a financial planner, not a qualified public health official – supply chain constrictions might be loosening going forward as we see COVID restrictions lifting. Most of the lifting of the COVID restrictions is stemming from reduced cases, which is at least correlated to promising vaccine distribution. Roughly half the US population has received at least part of the vaccine! But that half of the population is the half that wanted the vaccine… In my opinion, how the next half of the population accepts the vaccine will be critical to our supply chains. If they don’t, will we see cases rise again? If that happens, will that force businesses and governments back into workforce restrictions? As of today, we simply don’t know, but this issue (vaccine distribution into the next 50% of the population) may be a good metric to watch moving forward.
So. Get your vaccine. It might help keep inflation away😊