Will Inflation Ever Go Away?

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Will Inflation Ever Go Away?

Inflation is one of those things you hear a lot about, but you might not understand how it happens in the first place. In an episode about a year and a half ago I used Chick-Fil-A points to help describe what inflation does to erode your buying power. Today, I’m going to use a swimming pool. This swimming pool analogy is not original. Brian Wesbury with First Trust Advisors recently used it in one of his blog posts, and I thought it was a good picture to help us understand what does and what doesn’t cause inflation. I’m going to take the liberty to adjust his analogy just a bit, but one of the reasons I’m dedicating an episode to inflation is that I think we will continue to see it in 2025.

Alright, so let’s think of the total money supply in the U.S. Economy as a big saltwater swimming pool. If you are wondering, salt water pools can help make chlorine, so that’s why lots of people are buying salt water pools these days. So, let’s assume that the private sector’s money as well as the government’s money is the water in the pool. And let’s say that the private sector’s money is in the shallow end, and the government’s is in the deep end. When you pay taxes, we are going to be scooping water/money out of the shallow end. But does that water/money disappear? No, it simply moves to the government’s balance sheet. So we’re just going to pour it back into the deep end of the pool. The total supply of money has not changed – its location has just been relocated. And the concentration of salt in the pool has not changed. There is the same amount of water and the same amount of saltiness in the pool. Got it? Good. So that means that taxes, in and of themselves do not change the supply of money, and thus, do not create inflation in and of themselves.

But let’s consider what the government did back during Covid. It backed up a massive water truck and flooded the pool with water in the form of newly created money. Not only does this cause the pool to overflow, but it dilutes the saltiness of the pool. It reduces its potency, because there is so much water. Let’s think of the salt content as our purchasing power. When the government adds money to the system (or water to the pool in this analogy) it dilutes the purchasing power of the money. Whereas you could once build a house for $100/foot in Jackson TN, it will probably cost you $200 per foot? Why, because more dollars in the system back in 2020 gave more people dollars to spend. Those dollars went to buy more stuff, which caused the prices of the stuff to go up. More money creates more demand. More demand, coupled with less supply (which is what we experienced due to Covid) leads to higher prices on everything. Higher prices dilute the potency, or saltiness of our dollar. You’ve got this now, right?

The shortest and easiest definition of inflation is too much money chasing too few goods. We had both of those things happening during Covid, and to some extent, we still have it.

So…how do we cure inflation? We have two choices, drain the pool, or expand its size. Draining the money supply can be painful and often leads to recession. Higher interest rates are an indirect way to reduce the supply of money. The second option is to allow supply and productivity to catch up – to grow the pool. Although this does not increase the saltiness of the pool, it does give you more areas to swim in the pool – or more businesses with which to do business. In other words, a larger pool = a larger economy = more competition for goods and services. More businesses in more places may not make prices go down, but competition in the marketplace can keep prices from going up. This is the option new administration is counting on. Their thesis is that less government regulation will stimulate growth in the number of businesses – thereby growing the size of the pool. If this works, it could help inflation to level off.

My personal opinion is that it will be hard to grow the pool. Not impossible. But difficult. One of the primary reasons for this is a demographic one – there is a shortage of labor. There are not enough people to do all the things we want to do in the economy. Ask any business owner, and they are likely to say that there is unrealized opportunity in their business because there aren’t enough people to help develop it. Appropriately skilled labor will be harder and harder to come by, so I think that will be a primary contributor to inflation remaining with us for some time. Not the 9% inflation we saw a few years ago. But a 3%ish inflation that never seems to get down to the Fed’s target of 2% – at least not for an extended period. If this happens, the new normal will be 6%ish mortgage rates and 7%ish Prime Rate (which is the rate that many business loans are priced from). If rates settle into this range, the Era of low cost government spending will be over.  Did you know right now that interest payments on government debt are greater than the total cost in the budget for defense spending? This is what is causing this government, and those around the world, to take a hard look at what they are spending. The smart ones will look for ways to grow the pool. The unwise ones will keep pouring water into the pool, and more inflation will be the result.

One last important takeaway is our need to adjust to the new normal of prices. It is shocking what some things cost now. But unless we have a major recession (and that is still certainly possible), those costs are here to stay. But the good news is that the rate of their increase has slowed dramatically from the last few years, and it likely to remain modest. But I don’t think inflation becomes a thing of the past – but something we just get used to living with in the present and future.

I mentioned mortgages rates earlier. We’ve got some great ones. But one of the unique features about our home loans is that we have a program that keeps them with our bank. You’ve probably had your mortgage sold a dozen times. And if you’ve ever had to call your mortgage servicer, you know how painful that can be. If you or someone you know are going to buy a house in the near future, you should really check us out. Start your financial conversation with us at foundationbank.org. We also hope you’ll subscribe this podcast to it in your favorite podcast app and share it on social media. Until our next episode, God bless you.

-President Chad P. Wilson, CFP

Today’s episode of “Money Matters” was written and recorded by President Chad P. Wilson of Foundation Bank/McKenzie Banking Company on January 28, 2025. This episode does not constitute financial advice. Please consult a financial professional to discuss your specific needs. Any rates mentioned are subject to change and are accurate as of the recording date. Foundation Bank/MBC is an Equal Housing Lender, Member FDIC.