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Inflation, Inflation, Inflation

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Inflation, Inflation, Inflation

Inflation, Inflation, Inflation. You are probably hearing that word more and more often. It has become such a hot topic, that the President discussed it today in a speech that included an announcement that the US will be releasing 50 million barrels of oil from its Strategic Petroleum Reserve to address it. The 6.2% annual gain in the Consumer Price Index is the latest catalyst prompting the President to specifically address inflation in a dedicated speech. In today’s podcast we’re going to answer a few questions regarding inflation that might be on your mind including what causes inflation, will inflation be transitory and temporary, and will interest rates go up because of inflation?

What causes inflation?

Simply put, inflation is caused by too much money chasing too few goods. Starting with the first part of that equation, do we have too much money? Absolutely. According to Brian Wesbury with First Trust, the money supply has grown by 40% since before the pandemic. Bank balance sheets reflect this. In our own bank, we’ve seen deposits grow dramatically. People simply have more money. Some of this is attributable to the $1400 stimulus checks that went out which were partially saved and partially spent. Some of it is from PPP loans that went out to small businesses across the country. Some of this increase is also from moratoriums or delays on expenses paid, like rent and student loan payments. In short, the government has borrowed money and then placed that money into circulation in some shape or form. Are you struggling to see how the money supply has grown? Then ask yourself this question – do you or your business have more money in checking and savings than you did prior to the pandemic? Or you could ask it this way, do you have less debt than you did before the pandemic. If either of these is true, then you’ve seen the increase in money supply directly affect you. Now, if there is more money in the system, then this creates more fuel for buying goods and services. We can buy more if we have the money to do so. This is creating more demand than we have seen in many, many years. So that’s the demand side of inflation confirming that we indeed have too much money in the system looking to be put to work in a purchase of some form.

An increase of this scale to the money supply alone might be enough to cause inflation, but when you couple with it the restraints today on the supply side, it’s almost a certainty. So let’s shift and talk about the supply side. Covid-19 created a supply-side shock unlike anything we have experienced in recent memory. Never in the history of the world has there been a simultaneous shutdown of production on a world-wide basis. Even in the world wars of the 20th century, production shifted from consumer production to military production – but it didn’t disappear. Covid caused the global supply chain to come as close as it has ever been to shutting down. The global supply chain isn’t something you can just start back up. It takes time to rebuild. When 22 million people in the US alone are laid off which we saw at the beginning of the pandemic, it takes a while for them to come back to work, to retrain, and to start producing. Even a year and a half later there are still 7.4 million who are still unemployed. And yet, if you ask any small business owner what their biggest challenge is, they will tell you it is finding enough good help. There are 7.4 million people available to work that aren’t, and yet you see help wanted signs everywhere you look. Not having enough people on the payrolls then leads to too few goods. This was the other side of the inflation equation we shared. We have tons of demand, and not enough supply to meet it which leads to an increase in prices.

Will inflation be transitory?

If you ask the Federal Reserve, they say yes, but they admit that inflation has been more persistent than they thought. I have personally also operated under the assumption that inflation was real, but transitory. My assumption has been that once more people went back to work, the supply issue would gradually be relieved and we would see inflation start to wane and eventually level off. I still believe this, but I think it will be happen more slowly than I originally thought. However, there have been a few trends that emerged that could be inflationary in nature causing inflation to persist longer.

The first of these trends is additional government stimulus. Government stimulus creates additional, and often temporary, demand. If new government subsidies put money into the hands of consumers, this decreases the incentive to work. If this creates a disincentive to work, then the labor force will remain tight and unemployment will be stubbornly high. This could be inflationary in nature, particularly if the Build Back Better Bill is approved by the Senate. After its recent approval in the House.

The second trend that could be causing inflation to persist longer than anticipated is the continued lack of available labor. Two demographics that have yet to come back to work in large numbers are retirees and young mothers. It has been speculated by certain economists that retirees have not come back yet because of Covid Concerns, which makes sense. Young mothers, in the meantime, appear to be struggling to find child care, so many have yet to go back to work. Every age demographic is needed in today’s workforce, so the pace at which these two come back will have some effect on the number of goods and services that are available, and thus the level of inflation.

A third trend that could emerge is green energy initiatives. Although certain initiatives may prove better for the environment some of them may be more costly. Building out new infrastructure and ensuring that infrastructure can meet demand will be a long and expensive process. Even if you believe that Green initiatives are a good pursuit, it will likely come at a cost.

Will interest rates go up?

The answer is yes, but maybe not as much as we’ve seen in previous cycles. It’s possible that we see inflation tamed or at least moderated by the Fed ceasing it’s bond purchase program and then letting those bonds roll off their balance sheet, as well as a modest increase in the Fed Funds rate, (or short-term rates). Let’s say we are 1% higher than we are now over a 2 year period. That is not that dramatic. The Fed is reluctant to raise rates, because over the last 30 years, aggressive tightening by The Fed has led to the taking the wind out of the sails of the economy, in some instances leading to recession. In addition to that, the Federal Reserve has a vested interest in keeping interest rates low because the US government is continuing to add to its deficit. An increase of borrowing costs could be disastrous not just for the Federal Reserve but for every government in the world that is continuing to finance its growth through debt. The reality is that the Fed cannot avoid recessions. It can delay or accelerate them, but the business cycle will always be cyclical. So will they be able to walk the tightrope of raising rates gradually and carefully so this expansion is not derailed? Only time will tell. This task is so delicate, that it is no wonder that President Biden reappointed Fed Chair Jerome Powell to guide the Fed in this precarious process. Could interest rates increase dramatically from current levels? Anything is possible, but it appears very unlikely in the short-term. Inflation that persists longer than the Fed would like is probably a more realistic scenario over the next two years than seeing mortgages rates back at 6% (which is what they were back in 2008).

Speaking of mortgages, did you know it is possible to do your home loan locally and keep it local? At MBC/Foundation Bank, our Home Sweet Home Loan program allows you to do your mortgage with us, and then when you have questions about your escrows, need to modify your payment, or have an insurance claim, you call us instead of a 1-800 number. Do your loan locally and keep it local by starting your mortgage conversation today. If you’ve found this podcast helpful we do hope that you will share it with your friends and family and share it on your favorite podcast app. Until next time… God Bless. – President Chad P. Wilson, CFP


Today’s episode of “Money Matters” was written and recorded by President Chad P. Wilson of McKenzie Banking Company / Foundation Bank on November 23, 2021. This episode does not constitute financial advice. Please consult a financial professional to discuss your specific needs. MBC/Foundation Bank is an Equal Housing Lender, Member FDIC.