What's Up With Prices Up?

Inflation on your mind? 

If you’ve topped-off your gas tank, purchased a steak, hired an employee, bought and sold a house or a vehicle you’ve likely noticed that stuff costs more.  And there is all manner of craziness on the subject floating around in Facebook World.  No surprise there. 

So in the interest of spreading interweb tranquility I’d like to take a stab at making this subject a wee bit understandable.  

Here goes...

Fundamentally, inflation refers to the rise in the prices of wages, goods and services. It is
around us all the time and for most of the past 41 years has been behaving like background noise.  Every day the cost of wages, goods and services fluctuate both up and down.  The average rise has been about 3.5% a year - give or take. That means an item that cost $100 in 1979 would have inflated to $396.75 at the start of 2021.

Sure, some sectors of the economy - healthcare for instance - have risen at a faster rate. While prices in some sectors - consumer electronics comes to mind - have declined.  And for others - such as energy - have experienced greater fluctuations (volatility).  More about that in a bit.

Recent prices for much of what we consume are the highest they’ve been in decades. What gives?

First-off understand this equation: Demand + Supply = Price.

We live in a capitalist economy and that simple equation explains how markets work.  Meddle with this at your own peril.  And know this universal truth: There is no switch whereby any president can dial the price of anything either up or down. Yes, government policy can impact
the equation but that requires the passage of time.  Alas, there is no ON nor OFF switch.

Second, it is useful to know that roughly 70% of our economy is driven by consumer spending.  Manufacturing has a role.  Government spending has a role. Yet you and I play the biggest role.  Our consumption of goods and services drives the lion’s share of the US economy.  

Commit that factoid to memory.

It is noteworthy to recognize that inflation, in and of itself, is not necessarily a bad thing.  As long as it doesn’t get out of whack. However, a deflationary economy as much as runaway inflation invites economic pain, bad psychology and equally bad karma.

In the 1990s Robert Shiller conducted surveys to try to understand why even moderate
inflation frustrated people to an extent greater than economic theory suggested it should.  In his findings what Shiller found was that the idea of inflation evokes “arbitrary injustice, arbitrary redistributions and social bitterness,” as well as “memories of social situations in which morale and a sense of cooperation were lost.”  As a consequence, if the average person begins to feel helpless and powerless at the hands of inflation he will likely become restless.

Consider the prices of natural gas and crude oil - which together heat more than half of U.S. homes - as global prices have soared.  When the heating bills start arriving this month and January average folks will predictably become restless.  Back when I worked at the day job this phenomenon was filed under Behavioral Finance.  The study of which will make your eyes glaze-over and was more or less an academic discussion, but I digress.  

I do not want to be dismissive of the impact of this situation. If you commute to a job in a car or truck, run a business that has to deliver goods or are on that rung of the economic ladder where transportation costs consume a larger share of your household budget this is a big deal.

High energy prices are a political problem for the Current Guy.  Releasing stockpiled oil from our strategic reserve might make acceptable political optics but will not reduce these costs in any significant fashion.

You’re probably scratching your head and wondering how things got out of whack. The short
answer is: Pandemic.

It wasn’t too many years ago that this retired guy was enjoying the economy over-which the
Former Guy presided. It was a well-oiled economic engine humming-along without skipping a
beat. Until COVID paid a call and it became the Former Guy's political problem. 

In the spring of 2020 it was like someone poured a truckload of sand in the gears of that
well-oiled economic engine. It wasn’t only here - it was world-wide. International manufacturing ground to a halt. People stopped going out to eat. Nobody went to the theater. Travel ceased and airlines had no passengers. Lock-downs were imposed.  Consumers here, there and everywhere stopped spending.  My favorite Packer Bar in Paris went out of business.

In a remarkable contrast with present energy costs, in April 2020 an oversupply of oil led to an unprecedented collapse of oil prices, forcing the contract futures price for West Texas Intermediate (WTI) to plummet from $18 a barrel to around -$37 a barrel.  

Yes, minus $37.  Prices went negative for a short period of time.

Small business bankruptcies soared to record-breaking levels and millions of individuals lost their jobs. It was the sharpest economic contraction in memory. To this day I am puzzled that as many people fail to appreciate how close the economy came to being taken off life support. 

As in pulling the plug.

Thankfully the patient did not die and both the Former Guy, the Current Guy and Congress
threw massive amounts of money at the pandemic recession.  We continue to be awash in cash stemming from a lack of spending during lockdown and all of that government largess. 

And beginning in 2020, and continuing to the present moment, consumers found their nerve and began spending.

The inflation problem is found in the equation: High Demand + Limited Supply = Higher Prices.  Consider all of this pent-up demand, further fueled by an ocean of liquidity and a limited supply.  Is it any wonder prices have gone off the rails?

Which brings us to the subject of the supply chain.

Business continues to struggle with backlogged ports, a shortage of truckers and a surge in
demand for imported products.  Nowadays it can take almost 80 days for manufactured goods traveling by ship and truck from a factory in China to make it to an American warehouse - about double from two years ago.

We have plenty of domestic capacity to build cars. But automobiles are complex and are assembled from thousands of parts sourced from hundreds of suppliers scattered all over the globe. For a lack of computer chips - fewer cars roll-off the assembly line. With a dearth of new cars is anyone surprised that the price of a finite supply of used cars has spiked?

The current economic condition began with the pandemic and now is largely a supply chain
issue.  Inasmuch as there is no ON or OFF switch it is likely good counsel to tune-out facile FB outrage proffering simple explanations for slightly more complicated global economic forces. 

It’s going to take some time to clean-up the sand from the economic engine, oil the gears and get things humming again. How soon is anybody’s guess and I don’t make predictions beyond tomorrow. The stock and bond markets can be forward-looking indicators about the state of the economy at any given point in time.  And brace for the possibility of continuing volatility in the energy markets.

What is yet to be known is if current inflationary pressures are ephemeral and will normalize as the world economies return to equilibrium.  Or is this the beginning of a semi-permanent 1970s style of inflation?  We don't know that answer definitively.  So stay-tuned.

In closing you are likely reading this because you know that we embrace critical thought here at The Platz and take economics seriously.  But don’t take my word for it - the single best thing you can do is to reach out to your trusted financial advisor for guidance as it impacts you personally.   A competent advisor has had this on their radar screen for about a year already.

And for the love of God and all that is holy try to avoid taking your financial cues from the Face Book cesspool of lazy economic memes.