What is Inflation and Why Should you Care?
(From June’s newsletter based on May’s inflation data, the June inflation numbers were published this morning, 9.1%!)
Inflation is the general rise in prices of goods and services within an economy. There are two basic aspects to inflation, price increases, and the lower purchasing power of a given currency. These are different sides of the same coin. When the supply of a good or service exceeds the demand, the price goes. When the supply of money exceeds the supply of goods and services prices rise. The last couple of years have produced an unprecedented set of circumstances.
With the 2020 COVID-19 lockdowns thousands of businesses went bankrupt, supply chains were disrupted, and labor markets went into turmoil. This created fewer goods and services. The government provided trillions of dollars of economic stimulus to mitigate the economic impacts. Personal savings rates increased and pent-up demand sent an oversupply of dollars chasing limited goods and services. The result is record inflation. The most recent rate is 8.6% year over year. Of course, that is just the average. Individual energy and commodity prices are much higher:
Fuel Oil 107% Ground beef 13.6%
Gasoline 48% New autos 12.6%
Airfare 37.8% Electricity 12%
Eggs 32.2% Groceries 11.9%
Chicken 17.4%
Inflation is now running at 41-year highs. Many Americans have never experienced this level of inflation. Below is a video by legendary economist, Milton Friedman, explaining inflation.
(817) Milton Friedman - Understanding Inflation - YouTube
Why Should You Care?
Because as everything becomes more expensive you basically become poorer. Your dollar buys less. This can be equated to a pay cut. Imagine if your employer had to cut your annual pay by 8.6% or more! Everyone has their own “individual inflation rate.” Yours may very well be higher than 8.6% based on your lifestyle and circumstances. As prices rise and your money buys less you become poorer. As you become poorer, your disposable income shrinks. This leads to reduced savings and retirement funding in order to meet monthly expenses. The cycle becomes a downward spiral towards future poverty.
What can you do about it?
Only the government controls the money supply. However, there are a number of steps you can take to during times of rising inflation to minimize the impacts on your life. The most impactful step is utilizing comprehensive financial planning. You have limited resources, so coordinating those resources to produce the best outcome is vital to surviving or even winning against inflation. Developing an optimal cash flow plan where every dollar is assigned a mission with little to no waste is vital. Reducing your debt allows you to flow cash to other areas of your financial life such as food, utilities, a savings account and funding your retirement. This effectively builds you a financial “shock absorber” or a safety net that also allows you to combat future inflation. Effective financial management of your resources places you in a better position than those that don’t follow a deliberate financial plan. The effects of inflation are multiplied for those saddled with debt and inefficient allocation of their resources.
Making sound investment choices that are effective hedges to inflation helps preserve the value of your investment and retirement accounts. Use of Treasury Inflation Protected Securities (TIPS) and I-Bonds in a portfolio of equities and alternative investments creates the best opportunity for success. Energy, commodities, and precious metals have out-performed other asset classes to date. As the market and equity prices continues to fall, dollar-cost-averaging will allow you to pick-up bargains at discounted prices and position your portfolio for better than average returns when the economy recovers.
Some Good News
There are some positive systemic impacts of inflation. Some government programs that are tied to the CPI are examples. Social Security, military pay, VA benefits, and other programs adjust upward to keep pace with inflation. Having one or more of these as current or retirement income streams limits your exposure to the eroding effects of inflation.
Conclusion
The Federal Reserve board and other economists are like meteorologists. They are wrong at least 50% of the time. Both the “Fed” and many economists reported at the early states of inflation that it was only transitory. We now know that they were wrong. The same experts have opined that we can avoid a recession. I believe that we are in the early stages of a recession. Now is the time to get your financial house in order. Good financial planning and sound investment choices combined with dollar-cost-averaging will position you to weather this storm better than most Americans.
Next month’s newsletter will answer the question: What is Financial Planning?
