The Inflation Debate

Nobody should be surprised that prices are increasing everywhere from the grocery store to the car dealership. Demand is soaring as the pandemic recedes while supply constraints linger, especially in labor and transportation. (1)

The Federal Reserve has maintained its outlook that current inflation figures are “transitory”, implying long-term stability is not too far off the horizon. Nonetheless, as short-term prices spike, the Fed remains confident that they have the tools to control prices if they start to spiral out of control. As the economy reopens, money that was previously saved and largely out of circulation is now being spent across different industries. For example, prices in the “food away from home category” rose 0.6% M/M, the fastest pace since September. (2) Lumber prices are down approximately 30% from their year highs, while at the same time, copper prices are down nearly 6%.

Nonetheless, it’s important to look at some root causes of inflation:

Excessive Monetary Easing

As the fed prints money at a faster rate than the economy grows, consumer demand also increases at a faster pace than supply can keep up with. The result is higher prices to cover the higher demand.

The money supply has increased 31% since the end of 2019, and federal spending is 50% higher. Record low mortgage interest rates have enabled homeowners to lower their monthly payments to burn more cash on other things. (3)

Supply Chain Disruptions

The global microchip shortage has affected nearly every industry. As a result, shortages from automobiles, televisions, appliances, computers, and phones are distorting prices as demand for these products continues to increase. The automakers seem to be hit the hardest. Rental car companies, like Hertz, are resorting to buying new cars at auction. Automakers such as Ford Motor and General Motors expect massive earnings cuts this year due to the chip shortage. Ford said the situation will lower its earnings by about $2.5 billion in 2021. GM expects the chip shortage will cut its earnings by $1.5 billion to $2 billion. (4)

Severe Labor Market Shortages

Congress’s $300 unemployment bonus and other welfare payments for not working have contributed to an enormous worker shortage, which is magnifying supply shortages (5)

The U.S. economy added 559,000 people to payrolls in May. The jobs figure was below economists’ estimate of 671,000. At that pace, it would take more than a year to regain all the jobs lost since February 2020. (6)

Although it’s too early to tell whether current inflation numbers will lead to a longer-term shift, you can expect higher prices for some time as the economy reopens. With interest rates near zero, the Fed has plenty of room of make any necessary adjustments to monetary policy.

1, 3, 5) The Wall Street Journal, June 10, 2021

2) U.S Bureau of Economy Analysis, 2021

4) CNBC, May 14, 2021

6) CNBC, June 7, 2021