A Look at Significant Differences Between Historical and Contemporary Inflation
For most of us, the term “inflation” doesn’t stir a positive reaction. It means a higher price tag for goods or services and brings to mind all sorts of other associations, such as higher interest rates and lower real returns on savings.
For better or worse, inflation is part of the U.S. economy’s natural rhythm. Historically, the U.S. has endured high inflation rates in wartime eras, such as World War I, World War II, and the Vietnam War. As it has been widely reported in the last year, we are also in a period of inflationary pressure today, for reasons that go beyond the current conflict between Russia and Ukraine.
Although there are some conditional similarities between today’s inflation and that of the past, there are some notable discrepancies that should alleviate investor concern.
How We Got Here
Inflation is measured by the Consumer Price Index (CPI), which is used to monitor overall price pressure in the U.S. economy. It is one number that reflects a diversified basket of goods and services. Inflation is caused by a number of factors, such as increased government spending, excess demand, supply shortages, and wage pressure.
Today’s high inflation is mainly a reaction to the extreme shutdown that happened in 2020. During this time, consumers received stimulus checks, government spending skyrocketed, interest rates plummeted, and people saved significantly more than they would have otherwise.
After vaccine rollouts, the economy experienced a quick reopening. The demand for goods exceeded the supply,
which caused the supply chain disruptions that we’ve experienced. On top of that, labor shortages resulted in corporations having to pay higher wages to their employees. The combination of these factors, among others, effectively produced the inflationary pressure we feel today.
The current crisis in Ukraine has continued to increase energy prices and put upward pressure on CPI, further prolonging a higher-than average inflationary period. Only time will tell how this conflict will shape our history. However, as we see it now, we are not expecting runaway style of inflation, like we did in the 1970s. Today’s workforce is less unionized and has less bargaining power than in the past. Also, baby boomers created massive demand in the 70’s, while today’s demographics of consumers in prime spending years is much lower relative to the population — largely due to Baby Boomers reaching retirement age. This means the surge in demand is likely to subside over time as supply shortages ease.
Additionally, in past periods of high inflation, the Federal Reserve may have received executive pressure to keep interest rates low, despite high inflation. The Federal Reserve raised interest rates once already this year and expects to raise the Fed Funds rate six more times in 2022 (as of the March Fed meeting), and an additional four times in 2023, with a focus on quickly mitigating a significant portion of the price pressure we’re seeing. The Federal Reserve has also indicated they may act quicker if necessary to keep current levels of inflation from becoming entrenched.
Inflation Projection
At Trust Point, we have proactively structured investment accounts to take advantage of today’s high inflation in both the equity and fixed income portion of our portfolios.
Equities perform well during inflationary periods and are the ultimate hedge against rising inflation rates. We have allocated to real assets, such as commodities and real estate, which tend to do well when inflation is rising. On the fixed income side, we’ve had dedicated exposure to inflation hedges. Additionally, we have had less exposure to interest rate risk as interest rates typically rise with higher inflation expectations. As such, our portfolios haven’t been as negatively affected as the overall market from higher interest rates.
