Over the past several months, inflation concerns have come to the forefront for many investors. Recent increases in the prices of certain goods have sparked fears of 1970’s-style inflation. Prices for things like airline tickets, used cars, houses, and gasoline have jumped dramatically compared to last year.
Some commentators point at all of the credit created by the Federal Reserve last year as the reason for inflation. The Federal Reserve creating money isn’t enough by itself to create inflation. Inflation is driven by two factors – how much money exists in the financial system, and how quickly that money is changing hands. Every dollar you spend is a dollar someone else makes. Simply put, the velocity of money is how quickly the next person in line will turn around and spend that dollar.
Prices for some things have jumped dramatically since last year. Increases in the prices of many things like gasoline and airline tickets are simply a reflection of economic recovery and consumers returning to pre-pandemic spending patterns. Over 30% of the recently reported inflation numbers have been the result of dramatic increases in the prices of used cars. While this is bad news for anyone shopping for a used car, no one expects used car prices to continue going up over a long period. Studying history can give us a good idea of what it would take to cause prices to continue rising substantially.
It’s not the 1970s all over again.
From the mid-1960s to the late 1970s, the Baby Boom generation was coming of age and entering the workforce. Like most of us when we entered the workforce, these new workers had to spend almost all of their income just to make ends meet. This demographic wave increased the turnover of money in the economy and was a significant contributor to the structural inflation which followed. In America today, an opposite trend exists. The boomers are now headed toward retirement and are leaving the workforce. It is unlikely that inflation will be driven by retirees spending more. Surveys show that making savings last a lifetime is a top concern of retirees. If anything, the boomers will try to spend less in retirement.
Interest rates remain low and the Dollar is holding steady
Despite all of the talk about inflation, the capital markets show few signs that significant inflation is imminent. US government bonds have historically low interest rates. Recently ten-year US government bonds have yielded as little as 1.2% interest, while 30-year US government debt offered returns as low as 2%. The average US investment-grade company now pays less to borrow money than the US government did from 2010-2020. The US dollar remains stronger than it did for most of the past two decades. All of these are powerful signs that the market views recent inflation as transitory.
Even low levels of inflation can be harmful to your wealth, so planning is essential.
This doesn’t mean it’s safe to ignore inflation. A low level of persistent inflation will erode the purchasing power of your savings over time. Even if you expect inflation to be low, having too much cash will cause your real wealth to shrink rather than grow. Academic research proves that high-quality, dividend-paying stocks build wealth for investors no matter what course inflation takes in the future.
Matthew A Treskovich | CFA, CPA/PFS, CITP, CMA, CFP®, AEP®, MBA, CLU, ChFC
Chief Investment Officer