Inflation is Still Running Hot

Written by Justin Sly, CFA on January 18, 2022

There is an inflation target amongst economists and the Federal Reserve that has historically been around 2%. The thought has typically been that some inflation is necessary for an economy to operate at full capacity, but too much inflation can pose serious risks to the system. The most recent headline inflation number came in at 6.8%. What does this mean? What is inflation, what causes it, and what does it mean for you?

WHAT IS INFLATION?

Inflation is the rising price of goods and services over a specific period in which the value of money is decreasing. An important point to note is that inflation is not simply rising prices in some places, but a broad increase in prices across the entire economy. When prices rise on goods and services and your income remains the same, your money doesn’t go as far. This, at its core, is inflation. For example, if you have $100 and a shirt costs $10, you can buy 10 shirts. But what if the same shirts now cost $15? Remember, you cannot “shop” for a better price because the price of all shirts has risen to $15. It becomes easy to see the potential problems that inflation can cause.

HOW CAN INFLATION RISE BY 6.8%?

In October 2021, costs for food, gas and housing were 6.2% higher than they were last year. This number marked the steepest increase in over 30 years. It only took one more month to set a new high at 6.8%. Why is this happening? There are several factors at play, but in general, inflation is caused by rising production costs for companies and/or higher demand from consumers.

When wages or the costs of raw materials rise, companies must pay these higher prices while still producing the same amount of goods. This rise, in turn, puts pressure on profits. To maintain profitability, the company must pass this increase in costs on to the consumer by raising the price of the goods or services they offer. Due in large part to COVID-19, there have been major supply chain disruptions in 2021 that have increased costs in this way. Furthermore, wage inflation has also been high due to many job openings relative to qualified candidates. This has directly led to higher wages as companies are competing to hire talent.

Alternatively, inflation can also occur when the demand for goods and services increases relative to the supply. There is no better example of this phenomenon than in the used car market. The previously mentioned supply chain problems have hit the auto sector hard and dealers are struggling to maintain inventory. However, the demand for autos has not changed.

WHAT DOES INFLATION MEAN TO YOU?

Besides the obvious price increases that we mentioned briefly above, inflation also impacts the capital markets. If you carry debt, say in a mortgage, inflation will decrease your cost of borrowing. If you entered into a mortgage at 4% interest, but inflation is 6.8%, then the real value of your debt is decreasing faster than the combined interest and principal that you’re paying off. Good for you, but bad for the issuers of debt.

For those on Social Security, the current inflation rate has caused the highest anticipated cost of living increase in history. The average cost of living increase for Social Security payments over the last 10 years has been 1.7%. In 2022, approximately 70 million Americans will see a 5.9% increase in their Social Security benefits and Supplemental Security Income (SSI) payments.

LEARN MORE ABOUT WHAT INFLATION MEANS FOR YOU

Ultimately, inflation is what it is. While some people view it positively and some view it negatively, we can’t control it; instead, like we’ve all done for the past two years, we will adapt and grow as we go. If you have any concerns about how inflation affects you personally, please reach out to your advisor for a discussion.

 

Disclosure: You should not assume that any information provided serves as the receipt of, or as a substitute for, personalized investment advice from WA Asset Management. This information should be used as a reference only. Talk to your WA Asset Management advisor, or a professional advisor of your choosing, for guidance specific to your situation.

 

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