Are we headed to runaway inflation? That question seems to be top of mind these days. Inflation is already here. No duh, right? Many companies are reporting strong demand for goods and services following the 2020 pandemic lockdown. Everywhere we look, everything we see and hear says prices are rising substantially. Are the price increases we are currently experiencing a signal for a coming wave of broad and persistent inflation? (Baby boomers may be having flashbacks to the 1970s and 80s). Or is this just a temporary adjustment following the unusually sharp economic downturn in 2020 and a major disruption to the supply chain?
So, what is really driving inflation?
Is it Federal Spending or the money supply? Is it too few goods? Or is it something else? If you listen to the pundits and media prognosticators, you’d believe the answer to the questions are yes. That’s not true. I read a book called “Free Money: Plan for Prosperity” back in 2013 that examined multiple facets of our monetary system. One topic covered in depth was inflation. The author, Rodger Malcolm Mitchell, analyzed the relationship between Federal government spending, the money supply, and a variety of factors that many people believe lead to increasing inflation. Mitchell provided charts, graphs, and sources that showed there was no relationship between federal deficits — even large federal deficits — and inflation. The chart below shows that the peaks and valleys of deficit growth (blue line) do not match the peaks and valleys of inflation growth (red line): Mitchell did similar analyses for other factors looking for potential drivers of inflation. He found no immediate relationship between money supply (i.e., too much or too little money in the system) and inflation. Nor did he find a relationship between too few goods and inflation. Nor increasing labor costs and inflation. Time after time, analysis after analysis, he found no relationship among the things we hear in the “news” and from the pundits that drive inflation higher. None.
Mitchell found a relationship between changes in energy prices—driven by oil prices—and inflation. Oil has worldwide usage and affects the prices of most other products and many services. The graph below compares overall inflation (red line) with changes in energy prices (blue line) over the last 51 years from 1970 through the end of 2021. Do you see what I see? More specifically, when oil prices rise, inflation also rises. When oil prices fall, inflation also falls. I’m going to make an obvious and not so bold statement: When production costs increase, manufacturers pass along those costs to consumers. No duh, right? If this is true, then we should see skyrocketing energy costs in the current inflationary environment to support this claim. The graph below shows the percentage increase of prices in the Consumer Price Index from December 2020 to December 2021. The overall year-over-year price increase for all items was 7.0 percent. Now look closely. Did you notice that nearly everything above that 7 percent line are energy and transportation-related costs? If you drive a gasoline powered vehicle, does it now cost you almost twice as much or more to fill up your car as it did in late 2020 and maybe early 2021? Just sayin’. When we look toward the future of the markets, remember that inflation is just one of many factors that investors consider. Given the markets general response to changing conditions, the potential consequences of inflationary pressures and similar issues are already reflected in current market prices. The current view of inflation points to a moderate pickup in consumer prices in the coming years. Treasury Secretary Powell’s view and that of many economists hold, however, that the recent spike in inflation will be brief. And, we are resolving many supply chain issues. Investors don’t need to outguess markets or undermine their portfolio objectives to outpace or hedge against inflation. If you already have a well-crafted personalized financial plan and investment plan, maintain your discipline. Let your plan work for you. Markets go up and markets go down. When you stick to your plan and exercise patience as an investor, a well-diversified, global portfolio has historically delivered positive results. No need to overreact to short-term fluctuations in consumer prices.