Misc. Mental Musings
Inflation Calculation
S. G. Lacey
In . . . Case you missed it.
Does it feel like your weekly grocery bills are a little higher these days? Is it costing you more to fill up the SUV’s gas tank? Is your babysitter raising their daily rates again? If so, you may be experiencing the effects of rising inflation.
What does inflation really mean? How is it measured? What are the impacts of this economic phenomenon?
Generally, inflation occurs when the relative value of a currency declines, making goods and services more expensive in that unit of exchange. Inflation is usually beneficial for individuals who own hard assets like real estate and commodities, but damaging to people who hold lots of cash, as they are losing purchasing power over time. Sometimes very rapidly.
Governments try to walk a fine line between having enough inflation to encourage spending, while maintaining stable market prices. It’s generally accepted that if money supply grows faster than the economy, then the seeds for inflation have been sown.
The United States hasn’t seen persistent, rampant, inflation since the 1970’s. However, with the rapid expansion of the federal balance sheet as a result of COVD-19 support, many economists are starting to clamor about inflation concerns once again. [REF]
Hopefully by looking at actual facts and data, we can determine where inflation stands currently, and where it may be headed.
In . . . CPI & Chapwood
Let’s start with the inflation metric which most American’s are impacted by, even if they aren’t aware of it. The Consumer Price Index (CPI), which is tracked and reported by the U.S. Bureau of Labor Statistics (BLS). Government acronyms at their finest.
This value, calculated on a monthly basis, compiles price changes for a broad basket of goods commonly purchased by citizens, as summarized in the diagram below. Each month, researchers document cost fluctuations on over 80k items, across multiple regions and municipalities of the country. [REF]
This composite measurement is used to adjust key government payouts like Social Security cost-of-living-adjustment (COLA), salary increases for workers in the public sector, and food stamp allocation to low-income families.
The CPI values are perpetually attacked by all manner of critics, but it is a consistent means of measuring inflation, which dates back to 1913. There are certainly shortcomings to the metric, most notably that it fails to capture valuation changes in investment assets.
Recent months have been telling with regards to the CPI calculations. Monthly increases of 0.6% in March 2021, and 0.8% in April 2021, have resulted in a trailing 12-month total of 4.2%. This is the highest reading since the fall of 2008. [REF]
For reference, the Federal Reserve targets a 2% annual inflation rate, one of their core mandates for keeping the economy humming. This goal is debatable, since, if achieved, it means the U.S. dollar’s value will be cut in half every 35 years.
Regardless of your feelings about the accuracy of this official inflation tracking technique, the next few months of CPI measurements will be interesting to monitor.
If the national government doesn’t do a good job of tracking actual inflation measures, then who does? There are numerous independent compilers in this space, but the most commonly known in is the Chapwood Index.
This frequently updated compilation uses a wide variety of consumer goods; relying on online pricing data to come up with inflation figures. The numbers determined via this method are impressively high, and impressively divergent, from the official CPI, as shown below. For reference, M3 is a broad measure of U.S. dollar money supply which, while not official reported by the U.S government, can be extrapolated from other published metrics. [REF]
While the methodology used is likely sound, it’s difficult to believe actual inflation has caused the average consumer’s goods expenditures to double in the past 7 years. Sure, toothpaste and shampoo in bathrooms may be smaller and pricier, but the TVs and cell phones in living rooms are undoubtably getting larger, and costing less per unit of technology. [REF]
It’s important to note that everyone’s perception of, and impact from, inflation is different, shaped by daily activities and life stage. A retiree collecting a pension while living in a downtown nursing facility has a different set of expenses than a young couple with a newborn who’s trying to buy their first home in the suburbs.
Maybe by looking at price changes in specific elements which dictate the overall economy, we can get a better sense for the current overall inflation trends.
In . . . Currency & Countries
Inflation is relative, requiring both a numerator and denominator. The currency which the good or service is measured in is critical for assessing how its value is changing over time.
There are two ways that spikes in inflation occurs, per basic economics. A lapse in supply, typically caused by rising raw material prices, known as cost-push, or an impulse in need, usually as a result of too much money in the hands of consumers, known as demand-pull. There’s also a perpetual, built-in, pressure on a country’s currency; as workers see good’s prices rise, they require higher salaries to maintain their desired standard of living. [REF]
Interestingly, in the real-world, inflation is driven as much by perception as reality. When citizens see their purchasing power degrading daily, they are more likely to spend now, stock up, and acquire to excess.
If you’re skeptical of this phenomenon, just think back to the toilet paper hording episode of April 2020. A year later, some people are still working through their amassed closet inventory, which was superfluously purchased in a time of fear.
Inflation in the United States has ebbed and flowed over time, various tweaks to the government policy influencing the purchasing behavior of its citizens. The bar graph below breaks down the measured CPI inflation by decade. As shown, after the very high inflation of the 1970’s and 1980’s, subsequent decades have come in below the long-term average. Will the 2020’s see a shift back above trend? [REF]
If you think predicting inflation is easy, take a gander at the overstimulating eye chart below. In addition to graphing the erratic U.S. inflation values of the past 3 decades, a variety of geopolitical shocks, government policy changes, and macroeconomic factors are identified. Inflation is clearly a complex and fickle beast. [REF]
U.S. citizens currently have the benefit of their dollar being the global reserve currency. The ongoing 75 plus year run since the Bretton Woods agreement after World War II is comparable to other reign of various European monetary offerings during their eras of worldwide trade dominance. [REF]
While this desirable reserve status never lasts forever, an imminent U.S. dollar collapse, and associated aggressive inflationary pressures, would require another global medium of exchange to come to the forefront. Still bullish sentiment for a currency, and thus it’s role as a reliable store of wealth, can change quickly.
When considering currency devaluation, and the associated inflation potential, it helps to examine history. You don’t have to look too hard.
There’s no shortage of inflation induced fiat currency meltdowns over time which can be referenced. The linked info graph video shows just how local currency inflation around the world has changed over the past 4 decades. Some of the inflation rates experienced, and the breath of nations where this phenomenon has occurred, is staggering. [REF]
In . . . Commodities & Crypto
Traditional commodities are the primary metric typically cited by economists to demonstrate inflation. Unfortunately, lean hog futures, and soy bean oil contracts, don’t resonate with the average citizen.
However, McDonald’s sausage breakfast sandwich and fried hash brown prices certainly do.
Commodities are traded daily at various exchanges around the world, with physical settlement of goods, so represent a live proxy for global supply and demand. While individual factors like rainy weather in the Midwestern U.S., or ramped up geopolitical tensions in the Middle East, can influence specific good prices, the broad commodity complex tends to move together, following major economic cycles.
The century long chart below demonstrates how these raw material price trends move in waves. This model from a few years ago, predicted the current phase still had some time to run on the downside, suggesting an inflationary spike was unlikely in the near term. As expected, broad commodity prices continued to languished through 2020. [REF]
Now, all manner of commodity futures have exploded over the past year. The Bloomberg Commodity Index, a basket combining the major raw material groups into a single value, has risen 70% off its March 2020 low, as shown in the graph to follow. [REF]
Despite the rapidly increasing price trajectory, commodities as a whole are still well off both their 21st century, and historic, all-time highs, especially on a currency adjusted basis. Is this the start of a new long-term inflation trend, or just an artifact of the pandemic fueled collapse in demand for goods? For now, this indicator clearly points upward.
There’s a fine line between inflation, speculation, and exaggeration. The fields of cryptocurrency, blockchain technology, and decentralized finance satisfy all three adjectives.
The beginning of 2021 has seen a boom in all things collectable: from cardboard baseball cards, to in-game basketball clips. Most of the new digital assets are being exchanged through non-fungible tokens, or NFTs, which guarantee the purchaser uniqueness of electronic data like artwork, music, and videos, which could be ubiquitously copied and shared in the past.
The incredible growth and adoption in the NFT space can be summed up by the colorful plot below. [REF]
Make sure to take note of the scale on the x-axis of the graph; this is not a decade long progression, but just a multi-month snapshot. A nearly 20X increase in the NFT industry’s market cap is pretty respectable, for the first quarter of the year.
One interesting debate, made primarily by the Bitcoin community, is that currency inflation is much more evident, if one prices other financial assets in terms of cryptocurrencies. This theory is hard to argue in the short term. However, when your reference point increases by 5X a year, it’s going to look like every item measured against it is inflating.
However, relative value determinations are tricky, especially when every country in the world uses a different medium of exchange. Only time will tell if the blockchain space is in a bubble, or if the legacy financial system is being inflated into oblivion.
Even most individuals trading NBA Top Shots moments, CryptoPunks digital collectables, and Dogecoin cryptocurrency, will admit that they are planning to sell their units at a higher price. Not in the next decade, but in the next month. [REF]
In . . . Categories & Counterpoint
Since the CPI represents a curated basket of products, its recent muted rise can mask more significant shifts in inflation and deflation for specific goods. It’s intuitive that the pricing pressures for various items are different, shaped by consumer preferences, technology trends, and input materials.
The graph below captures pricing trends for a broad variety of products in a single graphic. [REF]
It’s telling how large of a range is observed over just the past 20 years, with the bills for health and education services tripling, while electronics prices have been cut in half. Why is there such a bifurcation, and what factors can actual causes product prices to decrease over time?
One of the most subtle, yet most pervasive, factors driving the cost of consumer goods has been globalization. Back in the 1980’s, China stormed onto the worldwide manufacturing scene, using their prolific amount of cheap labor to undercut wages in other countries. The developed world happily obliged, anxious to get a wide range of products on the cheap. [REF]
In subsequent decades, low-cost manufacturing of consumer staples has transitioned around Asia, but the trends have remained the same. Cheaper products, and higher trade deficits, especially for the United States.
Apple i-phones. Nike shoes. Lego building blocks. Giant bicycles. Many products made overseas have increased in quality, while simultaneously decreasing in cost. This phenomenon is deflationary to the core.
However, recent developments around fair labor practices, intellectual property disputes, and the resulting escalating trade wars, are all conspiring to reverse this trend. Locally made may mean faster lead times, but likely at higher costs. If the push towards deglobalization continues, another key segment of the American consumer’s common purchases may be headed towards inflation soon.
Technology is another significant contributor to deflation. Semiconductor processing power has advanced exponentially, with manufacturing costs remaining essentially constant. This capability results in all manner of electronic devices having drastically improved performance, at constant, or even diminishing, prices. Sounds like a boon for computer game consoles and home entertainment systems everywhere.
While economist often talk about sudden global supply chain shocks, with can cause inflation to spike, most of these events are fairly short lived. In contrast, in the corporate world, there’s a relentless push to innovate, and optimize capabilities. These industrial process improvements can play out over decades, as opposed to days.
The CPI graph below is overlayed with a variety of key commercial occurrences, many of which are deflationary. Since these highlighted items represent productivity improvements, and resulting input cost reductions, they are arguably more valuable considerations, when examining the long-term interplay between inflation and deflation. Technology, like life itself, will find a way. [REF]
In . . . Construction & Consumer Goods
Are you shopping for a house? Welcome to the crowd. There’s no way this current approach of bidding well over asking, waiving inspections, and purchasing homes sight unseen, makes sense, or is sustainable at this current, frenzied pace.
Historically low mortgage rates, thanks to the Federal Reserve, conspiring with people realizing they need more space in this new era of work from home, have upset the delicate balance between supply and demand.
Since the U.S. housing bust of 2008, homebuilders have been hesitant to construct more single-family houses. As a result, supply has continued to be reduced, at the same time more millennials are starting families, and entering the residential real estate market. All signs pointed towards an inflationary impulse, even before the relocation fuel applied by the pandemic.
The market obliged, as shown in the graph below. From a sharp V-bottom in March 2020, which almost touched 0% annualized, less than a year later, the price appreciation is approaching levels not seen since 2013. It took only a few months to recover the initial price declines; now the chart seems to be accelerating upwards. [REF]
There’s no doubt first home standards have become more demanding over the years.
In the 1950’s, newly formed American families were just happy to find a generic structure, which would put a sturdy roof over their head; the white picket fence, and associated grassy lawn, was a bonus. These massive, rapidly build, suburban communities, using industrial manufacturing methods optimized during World War II, were affectionately dubbed, “a womb with a view”. [REF]
Today, millennial entrants to the residential real estate market draw inspiration from the large houses of their boomer parents, while also seeking modern technological amenities. Apparently, 750 square feet, decorated with bulbous white appliances, beige linoleum floors, and faux-wood paneling, is no longer in vogue.
If prefab homes are expensive, why not just buy a plot of land and build one? Oh wait, lumber is twice its historical high, and has gone up 4X over the past year, as shown in the vertical chart below. For historical reference, in past U.S. housing booms, lumber prices tapped out around $500, with the long-term average under $300. We’re getting into rarified territory. [REF]
This commodity exemplifies the core driver of inflation in recent months; an imbalance of supply and demand. Have your tried to buy a 2 x 4 at your local hardware store lately?
With everyone redoing their porch deck, or turning their spare bedroom into a home office, there’s no shortage of need for lumber. Add in the lack of planting over the past decade, and bottlenecks at the sawmills, and this meteoric rise in wood-based product prices was inevitable.
How long will this last? That’s anyone’s guess. Considering this commodity relies on natural growth, taking around 50 years for viable tree to mature enough for harvest, this shortage could be with us for a while. Somebody in Canada better get planting.
Everyone in the United States remembers the irrational rush for hand sanitizer in the spring of 2020. Then, all manner of PPE in June, as COVID cases ramped up; hospitals battling civilians for the limited supply of masks, gloves, and other medical products. How about the lack of bicycles, be they stationary, motorized, or traditional? At least the local animal shelters were emptied, with people paying top dollar for any available tiny companion they could still find. Now, people are putting gasoline in plastic bags. It’s a crazy world we live in these days.
If this isn’t a testament to supply and demand imbalances, then what is? Regardless of the price trends, Keynes and his colleagues would be intrigued by these modern-day events.
Fortunately, there’s a variety of real-world metrics which are much more focused, and likely much more relatable, to the average consumer, than the U.S. government’s CPI value. Everyone has to eat, so looking at shifts in food cost is a valuable starting point.
The Big Mac index. [REF] An ongoing brown bag sandwich survey. [REF] The cost of a typical Thanksgiving feast. [REF] There’s no shortage of obscure metrics which attempt to capture the rise in caloric intake expenses that the average American is experiencing.
Let’s look at a product which has been a staple of generic family consumption since the invention of pasteurization. A gallon of whole milk. This is an interesting item, since in recent years, there have certainly been changes in household consumption habits, fueled by a combination of health consciousness, environmental awareness, and alternative options.
It will be interesting to observe how the price of milk tracks in coming years. It seems the FDA has finally concluded that a large bowl of soggy Lucky Charms isn’t considered a balanced breakfast.
Shrinkflation. Supply chain delays. Job sign-up bonuses. These obscure terms are now part of the national vernacular. What started as a few shortages of previously neglected products and services, has now spread into a full-fledged economic fiasco.
In . . . Cars & Cargo
From an inflation standpoint, if you think housing prices are expensive, maybe buying an RV, and traveling the country, makes more sense. Until you start looking at “for sale” postings online.
Over the past year, the only way for many Americans to escape the cooped-up lockdown of their own house, was to pile into an even smaller, less accommodative, enclosure. Many citizens willingly obliged. As a result, there’s one segment of motor vehicles which has seen explosive demand. Motor homes.
Even if you consider the generally red-hot, used vehicle, sales market to be a transitory occurrence, there’s the potential that the desired for luxury coaches, as opposed to 4-cylinder coupes, may be permanent. The last year has shown consumers the value, and freedom, of being mobile, while engaging with nature. Plus, the lead time for building brand new RVs is substantially longer than posting your appreciated lemon on Craigslist. [REF]
As with any product cost, when evaluating the potential for cost increase, there are nuances. In the case of used cars, ancillary considerations are even more important than a pure commodity, like steel or platinum, from which they are constructed.
Are individuals buying used cars because they can’t afford new ones, due to their drop in income from work hours being cut during the pandemic. Or, are these vehicles supplemental purchases, fueled by stimulus money, and the desire to have a safe, versatility, mode of transport, when ridesharing used to be the norm? The multitude of parameters dictating consumer activity, especially for large purchases like automobiles, is almost unfathomable to assess. And that’s just the demand side of the market.
In terms of supply, there is one shortage which has trumped all others, and brought motor vehicle production to a near standstill. Semiconductor chips. Not surprisingly, the performance standards are higher, and the margins are better, for phone, computer, and TV applications. As a result, the automotive industry is last in line for semiconductor procurement. [REF]
The rental car industry, a surprisingly influential player in the used vehicle market, is another ancillary consideration. Unsurprisingly, rental car demand crashed during the COVID-19 pandemic. No travel, for business or pleasure, means no bookings. As these major carriers saw their budgets diminish, they were forced to sell vehicles to amass cash, offloading any 4-wheeled craft with marginal wear and tear, and the increasingly infrequent auctions. Another complex, nuanced element of the used car market. [REF]
Combining all these various factors together paints a pretty clear picture on the direction for used automobile prices in the near term. Upwards, at the tune of nearly 10% in the last month alone. Just as the annual rate of change was starting to stabilize, and potentially return to normalcy, as highlighted below, another surge of demand materialized. [REF]
However, there are a few undeniable facts, based on the typical array of use cases for automobiles, which ensures this shortage can’t persist indefinitely. Most notably, a person can only drive one car at a time.
Sure, it’s nice to have an extra 4WD jeep at the vacation home on the beach, or a sportscar for those sunny Sunday drives, but augmented consumption only goes so far.
Speaking of stagnant vessels, the story of the massive Ever Given container ship getting stuck in the Suez Canal earlier this spring was an interesting anecdote. For those who missed it, just summon up your most memorable reference to a clogged waterway, be it an antifreeze line, garden hose, roof gutter, or guest bathroom toilet. Then apply 1000X multiplication, in terms of both size and impact.
This event represents a microcosm of the broader logistics challenges in the shipping industry, which will inevitably influence pricing and lead time for the wide variety of goods carried in these 20-foot-long containers, sometimes over 20k units at a time.
It’s estimated that 80% of global trade, which influences nearly every consumer in the United States, travels on these maritime channels. Each nation’s ratio of imports to exports is critical the delicate balance of international trade. These levels have shifted drastically in the past year, resulting in a shortage of empty containers in manufacturing hubs, with heavy loads stagnantly sitting on the water. [REF]
Another challenge is with unloading at major ports. The ocean is vast, able to accommodate a seemingly infinite number of large, seafaring, vessels. In contrast, major ports are limited, thus representing a key pinch point between the water and land.
In fact, many companies are paying extra to secure spots on ships, or taking the much more expensive approach of using airplane transport. This rampant increase in shipping rates is certainly a global phenomenon, as shown on the jagged plot below. If you think a lot of these graphs are starting to look similar, with massive spikes on the far-right side of the chart, then you’re starting to catch on. [REF]
Typically, public companies don’t incur extra costs out of the goodness of their heart. It seems likely that these higher transportation costs will be passed on, thus spurring further product inflation to the end consumer.
In terms of water-based transport, the current shortage doesn’t just apply to quarter-mile-long cargo ships, but also standard recreational fishing trawlers. Tommy Boy wants his dingy back.
As a result, the main takeaway is, if you have a wood side-panel station wagon with bald tires, or a sailboat which hasn’t seen the water in 3 summers, now may be the time to sell, and free up some extra space along the side of the garage.
In . . . Colleges & Care
There is one individual expense where inflation has been recognized and accepted for years. It’s also one of the few areas where COVID-19 effects may be reducing, as opposed to aggravating, inflation. University tuition.
The rising cost of college has been acting like the summer growth in your lawn. Steady, bountiful, and relentless. Whether you have turf grass or thriving bamboo, the result is the same. If the invasion doesn’t get trimmed back, it will continue to expand at an unmanageable rate.
For confirmation, just look at the steady rise in the graph below, averaging out around 4% annually since 1980, and exceeding the CPI by nearly 1000% over this period. Inflation in university tuition rates is not a new phenomenon. [REF]
Where is all this money going?
It turns out, a bulk of the increased revenue has been put towards more administrative personnel, expanded campus facilities, and higher pay of leadership, as opposed to increasing or improving the teaching resources which actual drive the continued learning. This seems like a raw deal for the students, who are running up larger and larger tabs for education each semester. [REF]
However, the winds of change are starting to blow. Significant secular challenges are facing the secondary education industry.
Online content has become ubiquitous, allowing humans to learn to their hearts content, on essentially any topic, nearly for free, and without leaving their homes. Major corporations are offering their own specific skills training programs; guaranteeing job placement after less than a year of focused study. Lastly, the diminished emphasis on collegiate extracurricular activities, especially in this recent pandemic era, has resulted in an essential elimination of the dorm room socialization experience.
Another element to consider is that the high debt burden of millennials, who are just entering their maximum earning years, may actually serve as a deflationary force, in both the housing and consumer goods markets.
Debt incurred by American individuals for secondary education, which now exceeds $1.7 trillion, is becoming a topic of political relevance. Not surprising, since the federal government owns over 90% of this debt. As a result, it’s possible we may be nearing the tipping point, where these perennial tuition hikes may level off, or even come down. [REF]
These headwinds are also well known and acknowledged by university overseers. With huge endowment budgets, and powerful lobbyists throughout Washington DC, the likelihood that the top 100 colleges in the country will be disrupted, or change their pricing drastically, is unlikely. There’s just too much demand tied to the allure of that Ivy League experience, that NCAA football national championship, or that top-tier MBA degree.
While rising college costs are adversely affecting the youngest cohort of adults, the individuals at the elder end of the spectrum face their own similar challenges. The sector of the economy which old folks spend most of their money throughout the U.S. has also seen rampant inflation for several decades. Healthcare.
When you think about an essential part of your budget, spending on treatments to stay alive is probably pretty high on the list.
There’s another critical element of inflation which comes into play here. Demographics. The United States populous, like most around the developed world, is steadily aging. Old people, aged wisdom aside, tend to contribute less, and consume less, than their young, thriving, offspring. With a captive, unhealthy, expanding, elderly customer base, many of whom have significant retirement assets to burn through, it’s no surprise big pharma companies are raising prices.
The drivers for cost increase in this sector are numerous, and pervasive. Between drug monopolies, hospital overhead, a pay-for-service model, malpractice lawsuits, and governmental subsidies, it’s no surprise healthcare billing inflation is rampant. [REF]
There is one factor that separates America from its affluent counterparts. A completely different healthcare structure, where businesses are required to pay for their employee’s protection.
This system creates a perverse incentive, with obligation pushed from the public to private sector. As employees are not incentivized to shop around, or even understand what they are paying, the traditional competitive pricing forces of capitalism are distorted.
The bar chart below shows the striking discrepancy in health care expenditures for the United States, when compared to our developed nation counterparts. This cost breakdown highlights some of the key challenges of our system, which encourages physicians to often perform unnecessary tests and procedures, for which they are well compensated. [REF]
At least if we’re spending more, we must be getting better treatment, and improved life expectancy. Not quite. Despite spending over twice as much per year on healthcare services, the United States has the lowest life expectancy of the bunch, 2 years below the comparable country average.
Unfortunately, American’s lifespan isn’t inflating at the same rate as their medical expenses.
In . . . Companies & CEO’s
Interestingly, moderate, and even explosive levels of inflation, can be good for the stock market. To a point, that is.
Since each country’s equity exchange is denominated in their local currency, initially it can appear that stocks are rising, as the monetary reference point inflates, and citizens seek a relative safe haven. However, when company’s shares are inevitably sold, and converted back to a stable medium exchange like the global reserve currency, or gold, these impressive equity gains disappear.
In 2016, Venezuela’s stock market led the world with annualized returns over 100%. However, less than 2 years later, hyperinflation of the bolivar peaked beyond 100,000%, an order of magnitude higher than the accrued investment returns. The Venezuelan economy continues to be mired in devastating economic troubles to this day. [REF]
Inflation is clearly in the eye of the equity holder. Where does the U.S. stock market stand in this regard?
One approach is to see if the Wilshire 5000, a cumulative measure of the largest publicly traded national companies, is inflating, by looking at changes in valuations over time. Comparing the summed price of stocks, to the gross domestic product, a measure of economic output created by these companies, provides some historical reference.
As shown in the graph below, this ratio recently surpassed the lofty value observed at both the posthumous 2000 and 2007 stock market tops. [REF]
While it’s fair to argue that GDP is not a perfect measure of productive business output, especially in this age of technology, while working off a COVID-19 depressed base, there is clearly a rising trend. Traditional inflation metrics, like CPI, don’t capture increases in investment assets, so this is one area where inflation, at least in terms of household wealth, may be understated.
Unfortunately, only slightly more than half of Americans participate in the stock market. In addition, this engaged cohort skews decidedly more affluent, favoring the formally educated, higher earners, in society. In fact, the top 10% of annual incomes own 70% of the total assets; this data exacerbates underlying race and gender gaps which already exist. If domestic equities are considered to be inflating, it’s certainly not impacting all citizens evenly. [REF]
Discussions of wealth inequality abound these days.
One of the key elements of sustained inflation are rises in salaries. While the median wage has stayed fairly stagnant over the past decade, there’s been one segment of workers who have seen their salaries grow rapidly. These happen to be the individuals with the large, corner, offices. The C-Suite corporate executives.
Below is a graph of CEO compensation over the past half century. Granted, this trajectory somewhat mimics the rise of the stock market, since equity-based options has become an increasingly large portion of executive pay. Still, top leaders of these companies have seen their compensation rate increase tenfold over this period, with much of the rise occurring in the past 3 decades. [REF]
This increase is an interesting counterfactual for the traditional theory that wage rises are a predecessor to inflation. Granted, currently this growing salary trend applies to a very small segment of the general public.
It will be interesting how the various wage inequities are resolved in coming years. If the average worker starts to see more money in their paycheck, this could be a harbinger for rising consumer price inflation, due to an increased propensity to spend of good and services.
In . . . Commentary & COVID
Back in 2008, when the Federal Reserve initiated their first round of quantitative easing, or QE, all manner of economists clamored about inflation fears. By the time QE2 was rolled out in 2010, a petition, signed by some of the most well-known academics, investors, and strategists in the world, urged the American government to change their policy, at risk of imminent financial peril.
Over a decade later, the previously discussed CPI metric has yet to breach 2% year over year target. Not only were these key market stakeholders completely wrong, but many of them quickly became ecstatic with the prospect of permanent government monetary intervention, thus completely changing their tune.
As was the case a decade ago, there are no shortage of economists weighing in on inflation these days. In fact, these discussions have been occurring for years. For those who don’t spend their weekends researching macroeconomic theory, here’s how the key players are positioned.
Predictably, there are extremists at both ends of the spectrum.
The gold and bitcoin camp, while clearly divided on some topics, are both predicting an imminent crash of the U.S. dollar, causing massive inflation in all manner of hard assets, as measured in their stable monetary vehicle of choice, at one end of the spectrum.
Alternatively, generational deflationists, who have not changed their tune since the early 1980’s, when the 10-year U.S. Treasury bull market began, continue to point towards pegged low bond yields, a stagnant economy, and the relentless pull of technology, to increase productivity. [REF]
However, most economic analysts are comfortable with a conservative prediction, generally maintaining the status quo, as show in the composite survey data below. In politics, and investing, it’s much safer to be conformist than contrarian. [REF]
QE, and other Federal Reserve fiscal manipulation policies, work well in recessionary times, when the future is uncertain, which causes banks to horde cash, and limit loan growth. However, if the U.S. government finds a way to infuse money directly into needy consumer’s hands, as they have done with the recent rounds of pandemic stimulus checks, then whole a new fiscal regime may be approaching.
Like the financial crisis, and the initial implementation of QE, the COVID-19 pandemic, and the subsequent relief packages, are unprecedented events, requiring unprecedented reaction.
There’s no doubt consumer purchasing preferences have changed in the short term, as a result of mandated lock-downs, fear about the future, and significant shifts in daily routine. The real question is how long these new consumption habits will last, and how quickly manufacturing supply chains will react.
As shown on the infographic below, the health of entire sectors of the economy relies on a return to normalcy. Meanwhile, other industries are hoping the current unique consumer landscape becomes the new status quo. [REF]
Exogenous shocks have a tendency to cause unforeseen consequences downstream. Only time will tell what ancillary ripples will develop from the global economic tidal wave emanating from the COVID-19 pandemic.
These days, it’s nearly impossible to turn on financial media without becoming inundated with debates of inflation vs. deflation, permanent vs. transitory, and hawkish vs. bearish. But there’s one scenario which most rational analysts align on as the worst-case result.
Stagflation, a phenomenon not seen since the 1970’s in the United States, combines weak economic growth, with rising consumer inflation, and high unemployment.
This seemingly impossible scenario is thought to be initiated by a major supply shock, oil in the case the 1970’s, which causes rising prices, and simultaneously slowing growth. These problems can be exacerbated by the government growing the money supply too quickly, while also implementing policies which limit to ability to put newly created funds to productive economic use. [REF]
This doomsday scenario presents a conundrum for government policymakers; fighting inflation, and unemployment, simultaneously, is challenging. Thus, stagflation can be difficult to escape from. While this outcoming is certainly not the consensus view, it’s something for our administration to keep in mind, and take all necessary steps to avoid, moving forward.
This article has just begun to scratch the surface on the multitude of factors which influence inflation. In addition, it has a decidedly America focused tilt. However, global commerce is more interconnected than it has ever been in the past. A rise in a currency, necessitates a fall in another nation’s medium of exchange. One country’s trade deficit, is counteracted by a trade surplus of the land adjacent, or far afield.
Various regions of the globe are growing at different rates, but the general trend of improved quality of life, and the associated consumer demand, is decidedly upward. On a fixed based of raw material, technological advancements will need to continue occurring, to offset the scarcity of physical inputs required for the products 21st century humans will require in increasing quantity.
Whether you’re simply trying to top off your fuel tank in your lawnmower, or trading millions in oil futures to hedge costs for a global airline fleet, inflation calculations will be on your radar this summer.
In . . . Case you think it matters.
There are a variety of investment classes which have historically performed well in periods of inflation. Combining an inflation expectation with an outlook on economic growth, creates a 4-quadrant grid, which has been utilized by savvy investors for decades, as summarized below. [REF]
Per the dart points on the board, hard assets like commodities, as well as most real estate, tend to perform well in any type of inflationary environment. Equities usually at least keep up with inflation in currency terms, and can provide additional upside when economic growth is occurring. Interestingly, in the past, gold has offered protection in both inflationary and deflationary backdrops, provided other macro variables are constructive.
If you’re in the deflation camp, bonds are the way to go, especially long-dated U.S. Treasuries, though they don’t have much opportunity for further appreciation from the current low yield levels. Stocks can also perform well amid deflation, as long as the underlying companies are able to experience profit growth, and increased earnings.
Regardless of your economic view and timeline, there are lots of low-cost ETF options for investors these days. Just make sure to do appropriate due diligence.
That being said, making such market predictions has been historically difficult. Just consider all the various elements of inflation previously discussed, which are a small slice of the innumerable factors and metrics which contribute to the overall economic landscape.
One thing is for sure. If you simply stuff cash under your mattress, and come back half a century later, you likely won’t be happy with what you can buy using those green dyed pieces of paper. As shown in the graph below, the purchasing power of the U.S. dollar has decreased every decade since the 1950’s, even with the very low observed inflation rates of recent decades. [REF]
Considering the FED’s continued adherence to the 2% inflation target, to maintain purchasing power in the future, any investment you make should at least keep up with this bogey. Unfortunately, even high yield savings accounts have been suppressed to levels well below that menial value.
It’s a difficult environment for the conservative investor, who just wants to maintain their purchasing power over time. Gone are the days of earning 5% on a one-year CD. Mediocre interesting times indeed.
In . . . Chat form for podcast enthusiasts.
The Sherman Show – March 23rd: Larry McDonald offers wide ranging commentary on politics, finance, and inflation. [REF]
The Rebel Capitalist – April 12th: Lyn Alden explains how U.S. government activities will dictate the path towards either inflation, or deflation. [REF]
Odd Lots – April 14th: Zach Carter discusses the drivers of hyperinflation in Weimar Germany during the early 1920’s. [REF]
What Goes Up – May 14th: Zachary Griffiths summarizes the most recent high CPI readings, and how this information might influence future Federal Reserve policy. [REF]
Marco Voices – May 20th: David Rosenberg justifies why the current observed price increases are transitory, with deflation being the inevitable long-term result. [REF]