Personal Finance: Inflation 101 | Chattanooga Times Free Press

Americans get a refresher course in inflation with every filling or trip to Walmart, but entire generations have come of age without ever remembering or experiencing long periods of rapidly rising prices. And not having to deal with this phenomenon, thinking about its causes and how to lick it, may also not have been at the top of their list of priorities until last year. Today we will take a deeper look at the causes of hyperinflation and the extraordinary confluence of events that got us to this point.

The written definition of inflation is a sustained increase in the general level of prices over a period of time. A more general and intuitive definition is the loss of purchasing power because the dollar is not reaching the extent it once was. It is known that it is difficult to predict accurately, as evidenced by the escalation of the epidemic, but it is necessary to attack it aggressively once it is diagnosed.

Inflation can result from more money in the system than economic activity. The Fed is tasked with calibrating the money supply to support the demand for dollars, measured by the speed or number of times the dollar trades through the economy during the year. When the economy expands rapidly, the dollar is changed frequently, requiring the Federal Reserve to add more dollars to the system (increasing the money supply). Too many dollars in relation to the speed or demand for dollars can lead to inflation.

It should be noted that controlling the money supply was the Fed’s primary tool in the 1970s and 1980s, but it has been largely replaced by the interest rate targeting that we hear about so much today. With the explosion in electronic and virtual transactions, managing and even defining the “money supply” has become a challenge, but the concept of super easy money as a cause of inflation still applies.

Another potential source of price instability is called “demand-pull” inflation, in which the economy expands rapidly and increased demand for goods and services outstrips production capacity, causing prices to rise. Demand-pull inflation can often be seen in home prices during booms in real estate sales. As the number of buyers expands faster than the pool of sellers, housing prices rise, sometimes quickly. Real estate is the leader in the broader economy, making up a large proportion of price indicators such as the CPI. The housing market and auto manufacturing are particularly close because they generate a lot of secondary economic activity in construction, sales, insurance, parts manufacturing, and lending activity.

The third major accidental cause of price increases is “cost-push” inflation, which is a shock to the supply side of the supply and demand equation in which demand remains relatively stable but the supply of goods or services is constrained or hampered. Cost-push inflation often occurs in response to a natural disaster that damages production facilities or to induced scarcity due to geopolitical forces. For readers of a certain age, the Arab oil embargo of 1973 is the classic example during which oil-producing countries in the Middle East formed a cartel called OPEC and conspired to limit crude oil supplies to the West, tripling oil prices and forcing drivers to queue. . at gas stations.

We can easily point to historical examples of bouts of inflation arising from each of these conditions. What is remarkable about the current price instability is that it traces its origin to all three of these conditions arising from external factors as well as political reactions to the crisis.

In response to the pandemic emergency, the Fed quickly inflated the money supply by a third in an effort to revive the collapsing economy as the pace slowed. The unexpectedly rapid recovery from the coronavirus lockdown has resulted in too many dollars chasing too few commodities, which is one of the traditional causes of inflation. Hindsight provides clarity, of course, but the reaction at the time was derived from the possibility of a prolonged slump in economic activity caused by a once-in-a-century health emergency.

In the middle of 2020, the prospect of a severe and prolonged recession was the base case as the world waited for an effective vaccine, and lockdowns and social distancing were the only measures available to stem the growing death toll. In this case, many workers have been able to keep their jobs remotely, just as Congress and its two presidents have pumped more than $5 trillion in direct stimulus spending into the economic bloodstream. And with money pouring in and staying home, families have increased their spending on everything from homes to cars to iPads. Hello Demand Pulls Inflation: The sudden and unexpected rise in consumer demand added fuel to the flames of inflation.

Meanwhile, off the coast of California: 109 huge container ships waiting to unload their cargo last January, bear witness to the unprecedented collapse of supply chains that justifiably shriveled in anticipation of a prolonged recession. This contraction in supply was a case study in cost-push inflation that is only now beginning to subside. Watch the triple whammy of inflationary effects that will serve as a case study for future generations of graduate students.

The good news is that we know how to beat inflation thanks to the lessons of the 1980s. The bad news is that the drug tastes bitter and will necessitate calming the inflamed labor and housing market, but in time the patient will recover.

Christopher A. Hopkins, Chartered Financial Analyst and Co-Founder of Apogee Wealth Advisors.

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