Inflation: Why is Everything more Expensive?
The facts and stories to know regarding inflation.
"I continue to view the 2020s decade as likely being a significantly more inflationary decade overall than the 2010s decade, although it won’t be a straight line." -Lyn Alden, global macroeconomics expert
This edition of the FirstWatch Crypto newsletter is a little different than usual. We're doing a dive on inflation: how does it work, where does it come from, and what things might look like going forward. We are not experts, but hope to provide insights and resources that reveal underpinnings of the current macroeconomic landscape.
Inflation is the increase in the price of goods and services over time. When you hear the inflation rate, you can think, "how much more does it cost to do what I did last year?" Whether you experience it at the grocery store, at the gas station, or in rents and housing prices, everyone feels and experiences inflation. The US Bureau of Labors Statistics (BLS) publishes inflation rate data using the Consumer Price Index (CPI), which showed prices in October 2021 rising 6.2% from a year earlier, the fastest rise in 30 years. The Federal Reserve targets 2% inflation on average over time. We aren't here to debate the efficacy of the CPI, but the rise begs the question: why are we seeing these levels of inflation?
There are a few key factors, amongst many others:
Demand of Goods — flush with cash, consumer spending is 15% higher than it was pre-pandemic according to the US Bureau of Economic Analysis.
Labor Supply — combine the increase in demand with the changing nature of work in a post-pandemic world, and you have a dramatically restrained labor supply. A lack of workers will affect the ability of the economy to produce the supply of goods to match increased demand, causing prices to rise.
Material Costs & Supply Chain — in early 2021, the cost of lumber spiked 400% after concerns around the pandemic, a labor shortage (see above), and housing concerns. Inventories were down and demand jumped during the pandemic, causing supply chain shocks. When the cost of wages and materials rises, the consumer bears that through higher prices in goods and services.
Money Supply — The Federal Reserve sent pandemic stimulus money into millions of individuals' banks accounts. In 2020, the government used $6 trillion of stimulus to curtail one of the US' worst recessions. Americans had trillions in excess savings that have been put to work. An increase in the money supply of that magnitude produces creates more dollars, which devalues the currency in global markets and increases the price of goods.
Is Inflation Bad?
As stated, the Federal Reserve targets 2% inflation over the long run. This level of inflation is generally viewed positively — it creates a positive economic cycle for producers and consumers. But when inflation begins to escalate, the effects can be devastating, especially for those who have fixed income. It can cause a wage-price spiral or lead to higher interest rates and a recession.
'Transitory' has been the key for Federal Reserve chair Jerome Powell. With a goal of 2% average inflation, a transitory spike could balance out over the long term. Professor, Kenneth Rogoff of Harvard University recently said it is "knife's-edge," or 50-50 that this period of inflation is transitory. There is a very real chance this could be here for years. This week even Powell doubled back and ditched the term, saying it would be a good time to retire the word in the context of inflation.
Not everyone believes inflation is here to stay, either. Cathie Wood, the woman, the myth, the legend, thinks that inflation is a short-term phenomenon that's a result of the global pandemic. However, long term, she believes so much in the deflationary forces of innovative technology that she thinks these forces will bend the price curve back down.
Looking Ahead
Overall, we know we must take many factors into consideration when learning about inflation or making any conclusions. President Biden has said "reversing this trend is a top priority for me." So how do we reign it in?
The Fed will undoubtedly consider winding down stimulus measures, raising interest rates, and carefully reigning in consumer prices at the meeting in December 2021. Their job, according to US Treasury Secretary Janet Yellen, is to avoid a wage-price spiral. Certainly no small task.
With fears of rising prices and inflation that will be anything but transitory, digital assets are increasingly viewed as an inflation hedge. No more than 21 million Bitcoin will ever exist. Not everyone believes in the potential, the Motley Fool reminds us, but the inelastic supply offers an appealing alternative investment for anyone worried about creating or preserving wealth in the face of rising prices.
This is a shallow dive into the current inflation in the US. For more history, resources, and information see below.
Resources:
The Ultimate Guide to Inflation by Lyn Alden
BITCOIN NET ZERO by Castle Island Ventures on the history of inflation
WTF Happened In 1971?, a website (and Twitter account) showing some of the long-term effects of unpegging the dollar to gold.
Bretton Woods Agreement and System, on creating a foreign exchange system.
Inflation is always and everywhere a redistributional phenomenon – Capital As Power
Causes of Inflation from Business Insider
Moving away from Transitory Inflation with the Financial Times
➡️ About FirstWatch Crypto ⬅️
FirstWatch Crypto was started by Dan McGlinn (@DigitalDanMcG)and John "Blaize" Hrabrick (@blaizebitcoin) who have been investing in the space for a combined 8 years. FirstWatch Crypto is on a mission to simplify the crypto investment landscape.
Source of cover image.