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Inflation!

4/18/2022

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It's the most important financial headline of this century:  Inflation!

A new generation of Americans is about to face the impact of inflation – on their daily lives, their financial decisions, their investment choices, and their retirement lifestyle.  While many pundits proclaim that this period of inflation will come to a quick end, history shows that inflation has always ended not with a whimper, but with a bang.

Once started, the fires of inflation are not easily tamped down.  Whether in Germany in the 1930s or in Zimbabwe a decade ago (their trillion-dollar note became worthless!) or in the United States in the late 1970s, it has taken a ruthless hand to stamp out the persistent belief that prices would go higher.

It’s important to understand what inflation is—and isn’t, what causes it, what “cures” it –- and the potential impact on your life.

What IS Inflation?
The late, great Nobel laureate Milton Friedman clearly established that inflation is always a monetary phenomenon.  It may show up as higher prices, but the root cause is excessive money creation.  The fear of declining value of the currency leads sensible people to exchange their money for goods and services before prices rise again.  The cycle is exacerbated by workers demanding higher wages to “keep up” with inflation, thereby driving the cost of everything still higher.

We may point to shortages because of supply chain disruptions or the war in Ukraine and its impact on energy prices as contributing factors.  But if governments—ours and in Europe – had not created so much new “liquidity” (a euphemism for money printing in this digital age) to fight the impact of the pandemic, there wouldn’t be excess money in the system to push prices higher.  People would suffer and stop buying.   And with lack of demand, prices would eventually come down.  But not without pain.  That’s Econ 101.

Lessons of History
History tells us the only way to stop inflation is to slow the economic demand by slowing the economy.  That slowdown comes from raising interest rates.  Paul Volcker had the determination and discipline to do that in the early 1980s.  And it cost then-President Jimmy Carter the election (along with other factors).   As Fed chairman, Volcker pushed the prime lending rate to 21%.  Mortgage rates jumped to over 15%.  And the economy moved into a steep recession.  It worked – but not without pain.

So that’s what policymakers face now.  Jerome Powell tried to wish inflation away by pronouncing it transitory. But as of this writing, the Fed has still not started to withdraw liquidity from the economy by selling its bond portfolio.  Interest rates remain historically low.  And inflation is roaring.

The longer the Fed waits, the more likely we will see double-digit inflation in the coming months. In an election year.

And even if the Fed moves soon and more strongly than expected, policy always works with a lag. That means a slowdown (recession?) would come at exactly the wrong time – at election time!

Continue reading in next month's newsletter to find out the impacts and future outlooks of inflation.

Source: Savage, Terry. www.TerrySavage.com. 13 April 2022.
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