Should We Be Worried about Inflation?

Inflation is the buzzword of the day across many financial media channels and frankly, it has investors wondering if they should be worried. It might help our understanding of the current situation by examining it using historical context.

By comparing the current situation to the Spanish Flu of 1918 and the Great Financial Crisis of 2007-09, it enables us to better understand the economic ramifications of these events in the U.S., and how they are echoed in the current macro environment.

Drawing Comparisons

The Spanish Flu. As the U.S. economy shut down during the outbreak of Spanish Flu, industrial capacity was drastically reduced. With that, major gridlock in the production of raw materials was created, particularly within the natural resources sector of the economy. This bottleneck resulted in severe upward pricing pressure in consumer goods. What followed was an upsurge in labor-management conflicts due to the burden that workers experienced with the inflation of their daily expenses. A cry for higher wages followed and ultimately, 1 out of 5 people in the U.S. labor force engaged in a strike.

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Great Financial Crisis of 2007-09. Central Bankers are busy comparing today’s environment to the Great Financial Crisis of 2007-09 to explain away inflationary fears. One could, however, argue that the factors that prevented inflation following the Great Financial Crisis no longer exist. For example, Quantitative Easing has put money in the banks’ hands to distribute in the form of loans. This, of course, is different than receiving a check in your mailbox. Plus, the incentive to get out and work for a prior wage earned has decreased. Additionally, during the 2007-09 crisis, supply chains were not nearly as stressed. This time truly could be different.

What is Different Today?

Fast forward to today’s environment. Manufacturers cannot meet demand fast enough for a range of products. For example, we are seeing shortages in microchips used in automobiles and computers, as well as raw materials used to build new homes. There are other issues beyond supply and demand at play as well.

A Push for Increased Pay. Large restaurant chains, such as McDonald’s and Chipotle, are already experiencing pressure from employees to increase pay and provide improved working conditions. As a result, you may have seen the signs touting increased pay and benefits when you drive up to your local Starbucks. Many economists believe it is only a matter of time before similar conditions emerge in other parts of the economy.

Government Policies Contribute to Labor Shortage. Another factor is that government policies may be magnifying the labor shortage problem by discouraging some folks to return to the labor force. There are other factors at play as well, but as a CEO said in a recent earnings call, “Our human resources department reports that even at a starting pay for non-skilled-level workers of $14 per hour, we cannot fill our 20-plus open positions. People don’t want to go to work when they can stay home and collect $400 or more per week in unemployment.”

Pull of Demand. Another contributing factor is the estimated average U.S. household balance sheet. At its strongest point in two decades, April household savings peaked at over $6 trillion. The resulting demand-pull inflation is likely to continue as relaxed masking and social distancing guidelines draw Americans to get out and spend. The one-two punch of pent-up demand and a “ready to spend” situation will cause further strain on a supply chain that already has fewer workers available to operate it.

Monetary Debasement. An additional driver of inflation is the phenomena of monetary debasement. An “easy money” situation resulting from lower borrowing rates has caused balance sheet expansion for both consumers and corporations as they “borrow on the cheap.” This easy money has fueled speculation in all asset classes, including homes (have you seen your latest tax appraisal?!), collectibles, equities and commodities. Contributing to the situation is the Fed’s premise that any marginal increase in interest rates could be detrimental for financial assets already at near record valuations.

Over Stimulating. One could also argue that Jerome Powell and the Fed’s usual mandates of controlling inflation and maintaining full employment have taken a backseat to preventing rising rates to fund massive government stimulus spending. What’s more, we are not the only country guilty of over-stimulating as the Global Central Bank’s assets have ballooned to over $31 trillion. This activity means we are kicking the can down the road and hoping someone else will pick it up later.

Look for Those Silver Linings

None of these mechanisms should be viewed in a vacuum as a reason to expect a stock market decline or a recession. But if inflation does continue to worsen, having a playbook to defend against it is key. Look to reducing reliance on growth-oriented companies in favor of those with strong cash flow and balance sheets. Consider adding commodity exposure and replacing longer duration bond holdings. The focus in a period of inflation is to watch for more opportunities that will likely come as the new era unfolds.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.