by Sean Kelly
It was the economic buzz word of the 1980’s and the big bad wolf of spending, purchasing power, and economic growth. ‘Inflation’ was top of mind whether you were buying a loaf of bread or pumping a gallon of gas. Those were the days that 48-month car loans were over 15% and 30-year fixed mortgage rates hovered at 18%. For those of us that lived through it, inflation sapped our spirit and tapped our paychecks. It was an altered reality where the cost of everything was rising all at once, and the value of money just couldn’t keep up.
Ronald Reagan famously called inflation “as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man.” Indeed, it triggers a fall in real income, raises the cost of borrowing, suppresses business sentiment, and undermines our overall standard of living. The most perilous aspect of inflation, however, is that it is self-perpetuating and self-feeding. It unleashes an animal spirit that creates even more inflation.
In the decades following the second World War, the U.S. inflation rate averaged under 4%. The oil embargo of 1973-1974, however, pushed it into double digits — crippling consumer purchasing power and stretching American households. The surge was blamed on everything from supply side issues, to increased defense spending, rising wages, currency manipulation, and flat-out greed.
Hindsight has taught us, however, that monetary policy mistakes also played a role. ‘The Great Inflation’ report by the Federal Reserve Bank of Atlanta claimed that a combination of bad data and miscalculations caused policymakers to underestimate the inflationary impact of their policies:
“Motivated by a mandate to create full employment with little or no anchor for the management of reserves, the Federal Reserve accommodated large and rising fiscal imbalances and leaned against the headwinds produced by energy costs. These policies accelerated the expansion of the money supply and raised overall prices without reducing unemployment.”
Despite running as a fiscal Conservative, President Richard Nixon continued to fund the Vietnam War, increase social welfare spending, and rack up massive budget deficits throughout the early 1970’s. He also pushed the Fed to maintain low interest rates which temporarily stimulated the economy before eventually fueling higher inflation. Wharton Professor Jeremy Siegel called it, “the greatest failure of American macroeconomic policy in the postwar period.”
As we approach a new decade, much of this sounds familiar and yet we find ourselves in a wholly different predicament. Since the Fed established its 2% target seven years ago, the inflation rate has spent the majority of time hovering below it. Why is this a concern? Because too-low inflation can signal a coming recession and limit the Fed’s ability to turn things around. This has prompted calls to revamp inflation benchmarks across the globe. The rationale is that higher inflation will result in higher interest rates and this will give central banks more tools to fight the next crisis.
According to Alan Greenspan however, a re-calibration of inflation targets may not be necessary. The economist and former Fed Chair recently issued a warning that the rise of loose money and historic deficits could bring inflation back in a big way. Current interest rates remain historically low and the U.S. deficit for 2019 is just shy of an unfathomable $1 trillion. Historically, when cheap money abounds and federal expenditures dramatically exceed revenue, inflation follows.
And in some places, it’s already here. Venezuela’s inflation rate is an astonishing 282,972.80%. Zimbabwe’s is over 175% and Argentina, North Korea and South Sudan are all over 50%. Food inflation is making headlines in India and China, credit inflation is soaring around the world, and the cost of education, healthcare, and housing in the U.S. has skyrocketed. In an economy where consumer spending accounts for 70% of economic growth, even a modest rise in these areas is worrisome.
Indeed, Credit Suisse’s chief economist stated that U.S. inflation could be “surprisingly high” if global growth holds in light of the Fed’s decision to stop raising rates. Similarly, some market strategists are warning of an “inflation scare” in 2020. While fund managers around the world are re-examining asset allocations due to inflationary risks.
In the current low rate, high debt environment — inflation is not going down. So, if you want to protect your purchasing power, now the time to diversify. Rising inflation will likely put gold back in the headlines as a safe haven and one of the most durable assets to hold in the face of an eroding dollar.