How Inflation Can Destroy Our Economy…… Explained in 5 Minutes.

So here we are 10 months into the Democratic Biden Presidency and inflation has gone from 1.4% to 5.4%…..unbelievable. We all hear about the “rate of inflation”, the “cost of living index” and “consumer price index”. Let’s learn what inflation REALLY means to all of us in understandable terms. The who, what, where why and how.

So what IS inflation? Simply put Inflation is the decline of purchasing power of a given currency over time. How much of a product you get for your dollar. Deflation is just the opposite. A steady INCREASE of purchasing power of a currency over time. According to Investopedia.com the most commonly used inflation indexes are the Consumer Price Index (CPI) and the Producer Price Index (PPI). Inflation may be viewed negatively as in the case of the price of food and energy draining your wallet or positively if you have assets such as property or inventory that increases in value. How do we MEASURE inflation? Statistical agencies start by collecting the prices of a very large number of goods and services. A “basket” of goods and services specifically used by households and what their prices are in total give us the CPI or Consumer Price Index. First they calculate how much the basket would cost at today’s prices (multiplying each item’s quantity by its price today and summing up).  They then compare that value to a “base period” value and arrive at the Consumer Price Index (CPI). The CPI does NOT provide a measure of inflation, it provides a measure of the general price level compared with a base year. To calculate the RATE of inflation, the statistical agencies compare the value of the index over some period in time to the value of the index at another time, such as month to month, which gives a monthly rate of inflation; quarter to quarter, which gives a quarterly rate; or year to year, which gives an annual rate. The PPI measures price changes from the perspective of the seller such as the cost of raw materials and energy to produce a product. That differs from the CPI which measures price changes from the perspective of the buyer.

So what is causing the huge increase in inflation we’re seeing? Well, economists tell us that sustained inflation occurs when a nation’s money supply growth outpaces economic growth. As a currency loses value, prices rise and it buys fewer goods and services. Ultimately this leads to a decrease in economic growth. The government has been printing wads of money during Covid and spreading it everywhere! Next add in the scarcity of goods due to decreased production, supply chain delays and you end up with $4 gas and skyrocketing costs of everything from groceries to new and used cars. Some countries have experienced such high inflation rates that their money became worthless. They go to the store with boxes full of money and still aren’t able to buy anything with it because prices have gotten so high! The country with the WORST inflation right now is the Socialist country of Venezuela with an inflation rate of 9,986%!!!! This is lower than Venezuela’s previous inflation rate of 10 MILLION % in 2019 ! Potential causes of Venezuela’s hyperinflation include heavy money printing and deficit spending. At such high inflation rates, the economy tends to break down.

How does the government try and control inflation? Well the Federal Reserve tries to control inflation by influencing interest rates. The Federal Reserve sees a rate of inflation of 2% / year, as measured by a particular price index, called the price index for personal consumption expenditures as the “right” amount of inflation. When inflation is too high, the Fed typically raises interest rates to slow the economy and bring inflation down. When inflation is too low, the Fed typically lowers interest rates to stimulate the economy and move inflation higher.

So where does America stand currently on inflation? The annual inflation rate in the US edged up to a 13-year high of 5.4% in September, 2021! Some of the individual increases in cost were housing up 3.2%, food up 4.6%, the highest since December of 2011, new vehicles up 8.7%, energy (gas, etc.) up a whopping 24.8%, used vehicles up 24.6%. How about a graph of where inflation has gone since Biden took office?

So what happens next? Nancy Davis, founder of Quadratic Capital Management has this to say: “the Fed’s low interest rates and bond purchases, so-called “easy money” meant to encourage economic activity, likely aren’t going anywhere for the time being and businesses (and their stocks) may continue to grow.” The article goes on to say: ” the Fed announced last August that it would tolerate higher inflation than its target rate for a modest period of time since inflation has been too low for the last 10 to 15 years. That said, the Fed doesn’t expect higher inflation to stick around once more people are back at work.” What’s this mean to you and me? Inflation will be here for quite awhile longer so you might as well get used to paying MORE FOR EVERYTHING. Kiplinger.com the well known financial advice site known as the Kiplinger Letter says the following:

• A hot housing market, component shortages and supply chain disruptions are some of the reasons inflation is likely to stay elevated. The strong rise in housing prices will eventually cause rents to rise more than usual.
• Prices of new cars, trucks, appliances and computers continued their upward march because of a shortage of needed semiconductors. This shortage will likely last well into 2022.
• Rising wages for workers amid a labor shortage are likely behind the steady increase in restaurant menu prices.
• Shipping capacity constraints will also find their way into price increases as businesses pass on cost increases to consumers. 
• The current 12-month inflation rate is 5.4%. Expect it to rise to 6.1% by the end of the year. This will be the highest rate of inflation since 1990.
• Higher inflation could get the Federal Reserve to start raising short-term interest rates in late 2022, instead of waiting to 2023, as originally planned.

So there you have it. Inflation 101. Good luck out there and remember…….It’s later than you think!