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Why Is Inflation in the US High?

Phil Town
Phil Town

The increasingly steep food prices, gas prices, and commodity prices we’ve been seeing mean we’re living in a time where high inflation is significantly impacting the US economy.

We see its effects reflected in the price of goods, but what are the drivers that are responsible for high inflation? And why is inflation in the US at the highest level it's been in years?

The answers to these questions are multi-dimensional, encompassing both national and international events that include increases in the demand for specific items, supply chain shortages that occurred as a result of the pandemic, and a strong labor market. 

But, before we get into specifics, let’s define inflation and look at specific scenarios that have typically caused annual inflation in the US to spike.

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What is Inflation?

Inflation refers to the devaluing of a currency’s buying power which leads to an intentional increase in the price of goods and services. 

There are three different types of inflation that can be triggered in different ways. 

  1. Demand-pull inflation is characterized by an increase in the money supply which pushes the demand for goods and services beyond an economy’s production capabilities. When there’s extra money, consumer spending increases, which can lead to surplus purchasing which triggers shortages of items that used to be widely accessible. When these goods aren’t readily available, prices rise to match this limited availability.

  2. Cost-push inflation is the result of an increase in the price of wages and raw materials needed to produce certain goods. Consumers end up taking on more production expenses in order to obtain the items they desire. However, cost-push inflation is not characterized by a change in demand. Oil and natural gas prices are affected most by this type of inflation.

  3. Built-in inflation is calculated based on expert predictions for future inflation rates. It can occur when workers foresee their salaries increasing at a rate that matches the rising prices of goods and services. In other words, this equates to employees asking for more compensation so they can comfortably handle daily living expenses.

What Causes Inflation?

The event that causes inflation can vary, but inflation is always measured as an increase in the money supply along with a decrease in the currency’s purchasing power.

For example, this can occur when a government prints more money to give to individuals and legally devalues it in order to provide more money to those who need assistance.

At this point in time, inflation is being driven by three things—major events, labor, and housing.

Major events

The onset of a global event, such as a pandemic, can disrupt how consumers get access to imported goods. If the event impacts supply chains, traditionally, consumers will experience delays in shipments and pay a premium on food and other items. 

The same concept applies to oil and gas prices. Since the US sources natural gas from overseas, if they become more difficult to access because of an event that causes a disruption in supply chains, gasoline costs will spike.

The recent COVID-19 pandemic had large negative effects on economic activity. 

The first was the reduction in business activity. Many companies shut down during the pandemic and lost revenue they could’ve made if they had allowed buyers to continue to invest in their products and services. 

The second was the decision to send stimulus checks to Americans. 

As money is printed slowly, prices increase slowly. However, when the Fed approved and printed trillions of stimulus dollars for the public to use, this sent prices up rapidly. 

In fact, the Federal Reserve Bank of San Francisco estimates that by the end of March 2020, the government stimulus may have added three percent to the national inflation rate.

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Labor Markets Impacting Consumption

Labor Department data shows that unemployment is low and it’s an employee’s market! This is great news for job seekers looking to change career paths or ask for an increase in compensation. 

However, because wages are increasing—even though they aren’t increasing at the same rate as inflation—this is being used to justify higher prices on essential living expenses, such as food, gasoline, and more.

In addition, inflation affects retirement, which also causes many to panic. Even at just 3% inflation, if you were to retire with a salary of $50,000, you would end up paying around $67,000 a year to live that same basic lifestyle. 

Since inflation is currently so high, many people have chosen to delay retirement in an effort to save more money before leaving the workforce. 

Housing Shortages

The Federal Reserve has continued to raise interest rates in order to combat inflation. However, this rate increase affects the borrowing costs associated with everything from credit cards to car loans to mortgage rates. 

Due to these higher mortgage rates, competition for properties has become fierce. It also means that more people are looking at the same properties and many are being priced out of housing options that fall within their budget. 

Historical Data on Inflation

Inflation is not a new phenomenon. In fact, US inflation follows some general trends. 

The White House recently released a statement saying: 

“No single historical episode is a perfect template for current events. But when looking for historical parallels, it is useful to concentrate on inflationary episodes that contained supply chain disruptions and a spike in consumer demand after a period of temporary suppression.”

So, let’s go back in time to uncover some parallels.

Inflation Back in Time

Both World War II and the Korean War put the economy in a similar situation. Each of these conflicts led to price increases, massive supply issues, and lots of demand. Essentially, they were textbook examples of the way that demand-pull inflation can impact economic activity. 

With the booming economy and low unemployment that the 1970s brought, prices increased in accordance with salary increases. This is similar to what we’re experiencing today as we continue to witness positive changes taking place within the labor market. 

Increased oil prices were the topic of concern during the Iraq and Iran Wars as well as the First Gulf War. This was the result of cost-push inflation driving up the price of these raw materials that people needed access to.

And, last but not least, with the 2008 housing crash, there was an increase in the subprime mortgage market. This meant that loans with higher interest rates and variable payments were given to high-risk buyers. 

When combined with higher rates of household debt and the interest rate policies created by the Fed, this created the perfect situation for a full collapse in home sales. 

And when we compare this to today’s crisis, it’s important to also factor in how these rates are playing a major role in dictating what people can and cannot afford and are pushing so many into bidding wars over properties that are less expensive. 

Inflation Expectations

At this moment, it’s unclear where US inflation is headed in the coming months. The timeline could depend on how long companies are expected to struggle to meet demands. 

For example, the Fed anticipates that inflation could stay above the 2% annual inflation target well into 2024, so we will have to be patient until we get a better understanding of what the economy may do. 

In the meantime, President Joe Biden has taken measures to pass a monetary policy to tackle inflation by lowering prescription drug costs, health care costs, and energy costs for families, creating lucrative job opportunities for workers, and growing the economy from the ground up. 

The Inflation Reduction Act will support the Fed's plan to handle inflation by reducing the national deficit. 

Fed officials will also continue to raise interest rates in an effort to bring down inflation while being mindful not to raise them enough to trigger a massive recession. 

Slowing inflation remains a top government priority because, if left unchecked, it is expected to lead to hyperinflation, an extreme instance where inflation rises above 50% in a month. 

How to Invest During Inflation

Though inflation spells bad news for the economy, it isn’t necessarily bad for the stock market. The trick to keeping your money safe during this time is knowing how to invest during inflation.

At Rule #1, we recommend investing in businesses and commodities that will hold their value and continue to produce returns during recessionary periods. Investing in wonderful companies is a great way to guarantee that your money will be able to withstand inflation and any other risks ahead.

Within the past year, inflation has risen uncontrollably due to a variety of different factors. 

However, if you want to support your continued financial growth, spend time researching wonderful companies that you can add to your portfolio that will help you increase your returns year after year.

Rising inflation is unfortunate, but it’s important to remember that what goes up must come down. And until it does, you can continue to put your money into the stock market to passively grow your income.

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