Tag Archives: Inflation

Simple Truths about Inflation

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Five simple truths embody most of what we know about inflation, according to Milton Friedman, Ph.D, American economist and a Nobel Prize in Economic recipient:

  1. Inflation is a monetary phenomenon arising from a more rapid increase in the quantity of money than in output (though, of course, the reasons for the increase in money may be various).
  2. In today’s world government determines – or can determine – the quantity of money.
  3. There is only one cure for inflation: a slower rate of increase in the quantity of money.
  4. It takes time – measured in years, not months – for inflation to develop; it takes time for inflation to be cured.
  5. Unpleasant side effects of the cure are unavoidable. 

 

The money supply

The money supply is the stock of money in the economy. It is determined by the roles and uses to which certain physical and financial assets are put.

Money performs a number of roles in our economy. Money functions

  1. as a medium of exchange;
  2. as a unit of account;
  3. as a store of value; and
  4. as a means of making payments inter-temporarily, i.e., over time. Its most obvious role, the one everyone is familiar with, is as a medium of exchange

The Money Aggregates (M1, M2 and M3) are money supply measures are that are meant to reflect differing roles of money;

Money Stock M1 — M1 is made up of notes and coin and several other financial instruments that the general public may not consider to be money. However, the Federal Reserve includes them because they are used as a medium of exchange and thus, on that account, perform a monetary function. Consequently, M1 is composed of currency in the hands of the public, checking accounts at commercial banks, deposit accounts against which checks can be written, and traveler’s checks issued by institutions that are not banks.

Money Stock M2 — M2 is a broader measure of the money supply than M1. It counts as money not only those financial instruments that generally act as a medium of exchange but also act as a store of value, another important function of money. Therefore, M2 includes M1 plus three other types of financial assets. These are (i) savings deposits, including money market deposit accounts; (ii) fixed deposits less than $100,000; and (iii) and retail money market mutual funds.

Money Stock M3 — M3 consisted of time deposits $100,000 and over, repurchase agreements (RPs) larger than $100,000 and longer than one day (called term RPs), and institutional money market mutual fund accounts.

Sometimes, M0 is used to denote central bank money, which consists of coin and currency in circulation, cash in bank vaults, and balances held in reserve accounts at the central bank by commercial banks and other depository institutions. In the U.S., M0 is called the “monetary base (MB).”

MI measures money used as medium of exchange, while M2 measures money used as store of value.

References:

  1. https://corporatefinanceinstitute.com/resources/knowledge/economics/milton-friedman/
  2. https://businessterms.org/money-supply/

Inflation and Political Silly Season

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40-year record high inflation of 9.1% is driving up the price of everything from gas to groceries, according to a recent Bureau of Labor Statistics report.

The consumer price index was unchanged in July, the first month without an increase since May 2020. But, this does not suggest that the inflation problem has gone away, despite political wishful thinking, states Brian Wesbury, Chief Economist, First Trust.

Energy prices surged 7.5% in June and then dropped 4.6% in July. That’s what you really need to know about inflation in the past two months. As a result, overall consumer prices soared 1.3% in June and then were unchanged in July. But a new inflation trend this doesn’t make. Looking at both June and July, combined, consumer prices rose at an annualized 8.1% rate. That is no different at all than the 8.1% annualized increase in April and May, before the extra surge in energy prices in June then the drop in July.

Some 96% of global economists said they expect the U.S. to face “high” or “very high” levels of inflation for the rest of the calendar year, according to a World Economic Forum (WEF) report. Inflation refers to when prices for consumers increase, thus driving down the purchasing power of consumers’ money.

If you look at the unchanged CPI in July and think the Federal Reserve is nearly done, you’re in for a big surprise, says Wesbury. The Fed isn’t close to done. Yes, the inflation rate likely peaked at 9.1% in June. But getting from 9.1% down to the 5 – 6% range by sometime next year is the relatively easy part. Getting from there back down near the Fed’s 2.0% target is the hard part. Rents have been increasing rapidly around the country and we don’t see that ending anytime soon, which will make it very tough for the Fed to reach its stated goal.

And, it’s delusional to think that the officially-called “Inflation Reduction Act” is actually going to reduce inflation. Inflation is a monetary phenomenon; the bill passed by the Democrat controlled Congress isn’t going to have any noticeable short-term impact on inflation.

Bottomline, regardless of political affiliations, the economy continues to grow and inflation remains a very serious problem. “Investors need to set aside their personal political preferences and follow economic reports as they are, not as they want them to be,” writes Wesbury.

  1. https://www.ftportfolios.com/Commentary/EconomicResearch/2022/8/15/silly-season

Inflationary Energy and ESG

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The Environmental, Social, and Governance (ESG) movement has shaken up the oil and gas industry over the past 10 to 15 years.

Rising energy prices points ti the reality that the global demand for oil and natural gas exceeds its current supply.

Investments in oil and gas companies and the development of new projects are increasingly under scrutiny due to ESG, which, according to analysts at Deutsche Bank, could increase inflation in the long run. And higher inflation is already one of the biggest worries people have.

ESG stands for environment, social and governance. It is characterized as a responsible or sustainable investment.

According to ESG philosophy, a portfolio manager may not invest in a company if, for example, he or she considers the risk due to climate change to be too severe. Another scenario is that investors may only invest provided the company works to reduce the environmental risks such as climate change.

“If you systematically underinvest in oil and gas production for years, then that necessarily increases your reliance on foreign dictatorships abroad that don’t care about the green energy transition,” says Vivek Ramaswamy. “This is not by accident, this is by design.”

References:

  1. https://nationworldnews.com/what-esg-investment-can-mean-for-oil-prices-and-inflation/

Consumers Falling Behind on Monthly Payments

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AT&T announced that “more of its customers are starting to fall behind on their bills, a sign that rising costs are pinching many households even for services most Americans consider essential,” writes Drew Fitzgerald in The Wall Street Journal.

The company executives reported that subscribers were paying their monthly phone and internet bills on average two days later than a year ago.

Rising interest rates and higher prices on everything from groceries to gasoline this year due to decades high inflation have pressured consumer sentiment. “When you have 9% inflation, it tends to hit those in the low end of the market really, really hard,” said John Stankey, AT&T Chairman and CEO.

Dividend payout ratio matters

The dividend payout ratio is the amount of dividends paid to shareholders in relation to the total amount of free cash flow the company generates. In other words, the dividend payout ratio measures the percentage of free cash flow that is distributed to shareholders in the form of dividends.

AT&T’s current dividend commitment is for around $8 billion annually, or $2 billion a quarter. The company generated $1.4 billion in free cash flow in the second quarter, far short of the $4.7 billion that analysts were expecting. It means that AT&T’s free cash flow for the quarter didn’t cover its dividend commitment in the period.

References:

  1. Drew Fitzgerald, AT&T Says Customers Fall Behind, The Wall Street Journal, July 22, 2022, pp. B1-B2.
  2. https://www.barrons.com/articles/att-stock-dividend-yield-earnings-51658426833

The War on Fossil Fuels

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“Solar and wind power aren’t reliable sources of energy, simply because there are nights, clouds and windless days.” Bjorn Lomborg

“The developed world’s response to the global energy crisis has put its hypocritical attitude toward fossil fuels on display,” writes Bjorn Lomborg. Wealthy countries continue to admonish developing ones to cut their fossil fuels consumption and increase their use renewable energy, he states.

Last month the Group of Seven went so far as to announce they would no longer fund fossil-fuel development abroad.

Meanwhile, in response to the current energy supply constraints, Europe and the U.S. are begging Arab nations, specifically Saudi Arabia, to expand crude oil production. Germany is reopening coal power plants, and Spain and Italy are spending big on African gas production.

Over the past century, the developed world became economically wealthy through the pervasive use fossil fuels, which still overwhelmingly powers most of their economies. Fossil fuels still provide three fourths of wealthy countries’ energy consumption, while solar and wind provide less than 3% combined.

The reality is that solar and wind power aren’t reliable sources of energy, simply because there are nights, clouds and windless days. And, improving battery storage won’t help much: There are currently enough battery storage in the world today only to power global average electricity consumption for 75 seconds. By 2040, the battery storage capacity would cover less than 11 minutes of average global consumption.

The assault on fossil fuels has shrunk U.S. refining capacity and the refinery shortage is driving up fuel prices. Basic economics should inform politicians that “prices rise when supply doesn’t meet demand”.

With oil and gas prices on the New York Mercantile Exchange are at five-year highs, you would expect that it would be in oil and natural-gas companies interest to ramp up production, given the current high prices,.

But, oil and gas companies expect that as soon as the current energy turmoil subsides, the Biden administration will shift back to hostile rhetoric, anti-energy legislative proposals, and oppositional regulatory policies.

By forcing up the price of fossil fuels, policymakers have put the proverbial cart in front of the horse. Instead of driving up fossil fuel prices higher, policymakers need to make green energy much cheaper and more effective.

Humanity has relied on innovation and technological breakthroughs to solve other big challenges. We didn’t solve air pollution by forcing everyone to stop driving but by inventing the catalytic converter that drastically lowers pollution.

References:

  1. https://www.wsj.com/amp/articles/the-rich-worlds-climate-hypocrisy-energy-fossil-fuel-wind-solar-panel-india-poverty-power-battery-storage-11655654331
  2. https://www.wsj.com/amp/articles/is-6-a-gallon-gasoline-next-gas-prices-refining-shortage-fossil-fuels-11654806637
  3. https://www.wsj.com/amp/articles/why-energy-companies-wont-produce-oil-natural-gas-biden-administration-fossil-fuel-inflation-prices-11654720932
  4. https://nypost.com/2022/06/19/fossil-fuel-price-spikes-are-causing-pain-but-little-climate-payoff/

Recession and the U.S. Economy

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There is always a recession in the future. The reality is that the U.S. economy could be in a recession now.

Inflation is too high and interest rate adjustments are required, says Esther George, Kansas City Federal Reserve President. She sees consumers taking actions to combat inflation and those actions, such as not buying appetizers while dining out, are apparent to the Federal Reserve. Thus, the economic data shows that there are already signs of a pullback in consumer spending…just look at Walmart, Target and Dollar Tree sales and earnings.

There is always a chance of a recession in the future, no matter what the current economic data look like or current consumer spending is doing. The question of whether the economy slips into a recession is basically a “not if, but when“ proposition.

It’s become obvious that a recession will come to the United States economy in the future, but the essential question is when. It is important to keep in mind that recessions are a normal and unavoidable part of the economic business cycle.

A recession is a significant decline in economic activity that lasts for months or even years, according to Forbes. Experts declare a recession when a nation’s economy experiences negative gross domestic product (GDP), rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time.

The National Bureau of Economic Research (NBER) generally defines the starting and ending dates of U.S. economic recessions. NBER’s definition of a recession is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

The reality is that the U.S. economy could be in a recession now.

The definition of a recession is two consecutive quarters of negative gross domestic product growth. First-quarter GDP decreased at an annual rate of 1.4%. Should that happen in the second quarter, that would technically place the economy in recession.

Recessions usually come from demand weakness, but supply problems can also trigger a downturn.

Consumer demand for goods and services continues to be strong, according to the Federal Reserve. Consumers have plenty of money, thanks to past earnings, fiscal stimulus payments and extra unemployment insurance. They have paid down their credit card balances. Even though they also increased their car loans outstanding as they upgraded their rides, their general condition is good. Employment will increase thanks to the spending, reinforcing the income gains that enable expenditures. Supply restraints are fueling current accelerating inflation.

The economy reacts with a time lag of about one year, plus or minus.

The greatest recession risk in the near term is that the Federal Reserve realizes that much of the recent decades high inflation is long-lasting rather than transitory. They will then ‘hit the brakes’ to control inflation by raising interest rates. Because of the time lag, the Fed may decide to raise interest rates faster, triggering a recession.

“Inflation is worst than a recession, and inflation will take us into a recession,” states Liz Young, SoFi Head of Investment Strategy.

References:

  1. https://www.forbes.com/sites/billconerly/2021/11/02/no-recession-in-2022-but-watch-out-in-2023/https://www.forbes.com/sites/billconerly/2021/11/02/no-recession-in-2022-but-watch-out-in-2023/
  2. https://247wallst.com/investing/2022/05/19/goldman-sachs-has-6-strong-buy-dividend-stocks-that-can-weather-a-certain-coming-recession/
  3. https://www.forbes.com/advisor/investing/what-is-a-recession/

Inflation and Time Value of Money

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As time passes, the value of money declines.

Consumer-price inflation rose to 8.6% in May, its highest in forty years. This tax on households and businesses threatens the overall health of the U.S. economy. Deficit fiscal spending and supply shocks and Russian invasion are the primary causes of the current historic inflation.

Inflation is defined as the decline of purchasing power of the U.S. Dollar over a certain period of time. Inflation is usually expressed as the change in prices over a one-year period.

Purchasing power means how much your money can buy—its “buying power.” You lose purchasing power when prices go up (inflation) and gain purchasing power when prices go down (deflation). Inflation changes the value of a currency over time.

Inflation, risk and opportunity cost together reduce the value of the dollar as time passes. And, when inflation increases, the purchasing power of the U.S. Dollar decreases.

Inflation is rampant, the Federal Reserve seems poised to raise interest rates even higher than previously expected, financial markets are free falling, and there are fears of recession in the air. All this signals economic pain ahead for Americans.

A recession is my no means certain, with a strong jobs market and consumers still flush from pandemic fiscal government handouts. But inflation is sapping consumer and business confidence.

A tax increase would reduce investment and further restrict supply, which would arguably increase inflation.

Inflation is a cost spread over every American. Unemployment, a byproduct of a recession, lands especially hard on specific Americans and American families. Thus, it natural for economists to accept a little more inflation to protect employment and strive for a soft landing.

Blossoming federal role in directly supporting the consumption of a vast number of Americans is a primary driver of fiscal deficits and persistent inflation.

  • 75 million receive a combination of Medicare, Medicaid and Social Security
  • 98 million receive veteran and retired federal government benefits, college aid, rental assistance, Obamacare, food stamps, etc.

These transfers are financed by chronic fiscal deficits. To remedy the problem, politicians would face the career ending choice of benefit cuts, tax hikes or increase borrowing regardless of the worsening effect in inflation.

If prompt and effective actions are not pursued by the Federal Reserve and Administration, the nation may revisit the Stagflation of the 1970s which persisted more than a decade with great consequences to society and the economy.

References:

  1. https://debtinflation.com/how-does-inflation-impact-purchasing-power/
  2. https://www.acorns.com/money-basics/the-economy/what-is-purchasing-power-and-how-does-inflation-affect-it-/

Protect Yourself Against Inflation

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“Rising costs can erode your purchasing power if you aren’t careful.” Fidelity Investments

Adding certain asset classes, such as commodities or real estate, to a well-diversified portfolio of stocks and bonds can help buffer against inflation, according to Fidelity Investments.

The last 12 months have seen the highest increases in the consumer price index (CPI) and producer prices (PPI) in decades, and many investors are concerned about the impact that inflation might have on their ability to reach their financial goals.

A trip to the supermarket or your local restaurant brings home the reality of inflation.

The consumer price index (CPI) has risen 8.5% over the last 12 months. Meanwhile, producer prices (PPI) have jumped by 11.2%. Those are the highest rates since the 1970s. And the forces driving prices up such as war, the pandemic, supply chain disruptions, and surging demand from consumers and businesses don’t look to be going away anytime soon.

While it may not be possible to avoid or eliminate the effects of inflation completely, there are actions you may be able to do to reduce its sting.

Add inflation-resistant assets

Though the rise in inflation may be troubling, investors who already have a well-diversified portfolio of traditional stocks and bonds may already have some degree of protection, as portfolios such as these have historically tended to grow even in periods of high inflation. “We still believe that a mix of stocks and bonds can help investors experience growth while managing risk,” says Naveen Malwal, an institutional portfolio manager with Strategic Advisers, LLC.

Source: Bloomberg Finance, L.P.

Malwal recommend specific steps to help provide additional inflation protection. They emphasize that certain investments that have historically done well in inflationary environments. This has included adding diversified commodities, such as energy, industrial metals, precious metals, and agricultural products, as well as real estate stocks and international stocks.

In the bond market, Malwal notes a greater emphasis on high-yield bonds. “While these carry more risk than investment-grade debt, the higher yield may allow them to more easily withstand any increases in interest rates that might occur in response to rising inflation.” He also highlighted a greater exposure to Treasury Inflation-Protected Securities (TIPS), which are designed to help protect investors from the impact of inflation.

Lastly, short-term bonds have typically experienced less volatility during periods of higher inflation. “We generally have more exposure to short-term bonds than to intermediate-term bonds in client accounts,” says Malwal, “But we also have more exposure to long-term bonds, as they have historically provided stability within well-diversified portfolios during periods of stock market volatility.”

References:

  1. https://www.fidelity.com/learning-center/wealth-management-insights/6-ways-to-help-protect-against-inflationhttps://www.fidelity.com/learning-center/wealth-management-insights/6-ways-to-help-protect-against-inflation
  2. https://www.fidelity.com/learning-center/trading-investing/markets-sectors/peak-inflation

Recession Causes

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Recessions occur typically when the demand for goods and services starts declining rapidly and steadily.

A recession is a significant decline in economic activity that lasts for months or even years. Experts declare a recession when a nation’s economy experiences negative gross domestic product (GDP), rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time.

The National Bureau of Economic Research (NBER) is generally defines the starting and ending dates of U.S. recessions. NBER’s definition of a recession is when “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Unemployment rate. NBER-dated recessions in gray. (Cart below)

Source: Bureau of Labor Statistics via the Federal Reserve Bank of St. Louis.

There is more than one cause for a recession to get started, from a sudden economic shock to fallout from uncontrolled inflation. According to Forbes Advisors, some of the main drivers of a recession are:

  • A sudden economic shock: An economic shock is a surprise problem that creates serious financial damage. In the 1970s, OPEC cut off the supply of oil to the U.S. without warning, causing a recession. The coronavirus outbreak, which shut down economies worldwide, is a more recent example of a sudden economic shock.
  • Excessive debt: When individuals or businesses take on too much debt, the cost of servicing the debt can grow to the point where they can’t pay their bills. Growing debt defaults and bankruptcies then capsize the economy. The housing bubble in 2007-8 that led to the Great Recession is a prime example of excessive debt causing a recession.
  • Asset bubbles: When investing decisions are driven by emotion, bad economic outcomes aren’t far behind. Investors can become too optimistic during a strong economy. Former Fed Chair Alan Greenspan famously referred to this tendency as “irrational exuberance”. Irrational exuberance inflates stock market or real estate bubbles—and when the bubbles pop, panic selling can crash the market, causing a recession.
  • Too much inflation: Inflation is the steady, upward trend in prices over time. Inflation isn’t a bad thing per se, but excessive inflation is a dangerous phenomenon. Central banks, such as the Federal Reserve, control inflation by raising interest rates, and higher interest rates depress economic activity. Out-of-control inflation was an ongoing problem in the U.S. in the 1970s. To break the cycle, the Federal Reserve rapidly raised interest rates, which caused a recession.
  • Too much deflation: While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and business stop spending, which undermines the economy. Central banks and economists have few tools to fix the underlying problems that cause deflation.
  • Technological change: New inventions increase productivity and help the economy over the long term, but there can be short-term periods of adjustment to technological breakthroughs. In the 19th century, there were waves of labor-saving technological improvements. The Industrial Revolution made entire professions obsolete, sparking recessions and hard times.

According to NBER data, from 1945 to 2009, the average recession lasted 11 months. Over the past 22 years, the U.S. has gone through three recessions:

  • The Covid-19 Recession. The most recent recession began in February 2020 and lasted only two months, making it the shortest U.S. recession in history.
  • The Great Recession (December 2007 to June 2009). The Great Recession was caused in part by a bubble in the real estate market. It lasted 18 months, almost double the length of recent U.S. recessions.
  • The Dot Com Recession (March 2001 to November 2001). At the turn of the millennium, the U.S. was facing several major economic problems, including fallout from the tech bubble crash and accounting scandals at companies like Enron, capped off by the 9/11 terrorist attacks. Together these troubles drove a brief recession, from which the economy quickly bounced back.

If there’s a silver lining, it’s that recessions do not last forever.

References:

  1. https://www.forbes.com/advisor/investing/what-is-a-recession/
  2. https://corporatefinanceinstitute.com/resources/knowledge/economics/business-cycle/
  3. https://www.nber.org/research/business-cycle-dating

Federal Reserve Raises Interest Rates

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“Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.” FOMC Report

The Federal Reserve raised interest rates 50 basis points (1/2 percent) on Wednesday in an effort to tame inflation that’s soaring at a 40-year high. And, the Fed anticipates that ongoing increases in the target range will be appropriate.

The Federal Open Market Committee (FOMC) is highly attentive to inflation risks. The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run.

Short-term borrowing was nudged up a half a point, and consumers are going to feel the increase in their bank accounts.With a 50 basis-point interest rate hike, you can expect higher costs for:

  • Credit Cards – Your credit card’s interest rate will likely increase slightly within a couple of billing cycles. The size of that increase can vary based on your credit score and credit card provider. A 1% interest rate increase will likely only add a few dollars to your monthly interest payments on a few thousand dollars of outstanding debt. Current average interest rates are close to 16%, but they could be as high as 18.5% by the end of the year.
  • Mortgages – Mortgage interest rates are calculated based on multiple factors, like inflation and the housing supply — but they’re also affected indirectly by the federal funds rate, which influences how much banks pay to borrow money. When that rate increases, the interest on adjustable-rate mortgages tends to follow.
  • Other loans – The federal funds rate is used to calculate the lowest interest rate offered for loans, known as the prime rate. Any loan tied to the prime rate, known as adjustable-rate loans, will likely have a slight increase in interest rates.

If you currently have a fixed-rate loan, your payments won’t change. If you have an adjustable-rate loan, you should take some time to look at its terms, says Jacob Channel, a senior economic analyst at LendingTree: “The last thing you want is to think, ‘Oh, I have a few months before my rate goes up,’ and realize that the rate hike will kick in much sooner.”

References

  1. https://www.federalreserve.gov/newsevents/pressreleases/monetary20220504a.htm
  2. https://www.cnbc.com/2022/05/04/3-things-thatll-get-more-expensive-after-the-feds-historic-rate-hike.html