If you own a car and commute to work or drive to the store once a week, you are painfully aware of the price of gasoline in your city. At my home in Washington, a gallon of regular gas has increased 58.1% this year. The cost of meat products in grocery stores is up13.3%, and produce has jumped 4.1%. Unless you avert your eyes when paying for goods today, only then would you think inflation is not a problem.
So, let us have an honest conversation about the escalation of prices of goods and services in America.
What is inflation? Milton Friedman said it most succinctly, “it is when too much money is chasing too few of goods.” Still, it needs more context to understand such a crucial macroeconomic concept.
Inflation is a trend where prices for goods and services increase over a period of time, the length varies, but it is usually more than six months. While there are different indexes used to track inflation, the most reliable indicator is the Consumer Price Index.
When the issue is a significant increase in demand, as we are experiencing today, it causes an imbalance, and we call that demand-pull inflation. Inflation also occurs when commodities like copper or wood begin to rise and impact pricing at manufacturing, we call that type of increase cost-push inflation.
According to the BLS, the CPI rose 6.8% year over year in November, which is the most significant increase since the early 1980s. Also, the Producer Price Index jumped 9.6% from last year; this makes it the largest increase on record.
What is going on in America to create such disruptions in our economy?
First, we are in what I am calling “the spend like crazy economy.” After being stuck in our homes for 18 months, not taking vacations, or dining out, Americans have been buying stuff, all kinds of stuff. This year alone, imports are up over 30%, retail sales are through the roof, and if you are lucky enough to be in the electronics, appliance, or furniture business, you know Americans are spending in ways we have never seen before. This craziness has been fueled by stimulus money, business loans, and other types of relief to help Americans during the pandemic.
The dynamic increase in demand is not necessarily the cause of inflation. Still, if you add in what is going on in the ports across this county and the disruptions to the supply chains, now you have the classic move to higher prices due to issues in supply and demand. In addition, you have employers offering all kinds of rewards to retain and hire workers; as a result, wages were up 4.8% last month. Those in the job market are exuberant over the good fortune, but businesses will pass this added cost to the marketplace.
Next, we need to determine if this price rise is a disaster for our nascent economic boom. The Federal Reserve has been trying to get inflation up to 2% for the past ten years under the theory that some rise in pricing is good for our economy. The opposite problem, deflation, is generally a much bigger issue and can lead to corporations cutting back on capital investments due to shrinking profits, which could then cause an increase in unemployment.
However, with inflation now headed to 10%, we have a severe problem. For consumers on a fixed income, seniors on social security, and Americans with low wages, a rapid increase in prices makes it difficult to stay above the poverty level. A recent Census Bureau survey found that “9% of adults said that they did not have enough food for their families.” So, inflation has wide-ranging implications for America.
There is one more scenario we must consider when discussing price escalation. If inflation is not transitory, as Fed Chairman Powell called it, and it goes on for months, it can lead to hyperinflation. This is what happened during the early 1980s in America when consumers expected prices to rise month over month, and every dollar you held on to lost value every payday. The psychology that fuels this narrative is when consumers say, I need to buy today because prices will be higher tomorrow.
Historically, we have witnessed many third-world countries like Venezuela whose currency collapsed due to hyperinflation. The United States economy has never suffered from hyperinflation; there were periods after the Revolutionary War and the Civil War where we got close, but; we are nowhere near collapse today. As I discussed in my last article, America’s leading economic indicators are more vital than ever, from unemployment to consumer confidence to consumer spending; we are in record territory, but we must be vigilant.
The Fed announced today, December 15th, that they will step in and raise interest rates three times in 2022. With these moves, Powell’s forecast for 2022 is that inflation would drop to 2.6% next year, and the unemployment rate would drop to 3.5%. Powell concluded his policy statement and eliminated “transitory” from the document. He was embarrassed by the rise in prices and his failure to act promptly.
The Fed needs to move more rapidly in hiking interest rates. Powell should be concerned that prices may not slow down. If inflation remains at its current pace, it could impact our economic expansion. The U.S. unemployment rate is 4.2%, this is nearly full employment, but a rate increase could derail the robust growth of jobs. The housing market would be a concern, but even if mortgage rates rose to 4%, that would still be low by historical standards.
We must address the problems at the ports, all the related supply chain issues, and the severity of the lack of workers in many industries. This has added to the shortages, and inflation will not subside without improving response times. With the personal savings rate shrinking and stimulus money mostly gone, the “crazy spending economy” will return to a more normal pace in 2022. Even Lowes predicted that their same-store sales would shrink by 3% because American consumers could not keep pace with the home improvement spending over the past two years.
We need to give the Fed time to act and get this under control, 2022 will be difficult, but our economy’s strength and resilience are unequaled globally.
Copyright 2021 Joe Higgins All rights reserved.