By David Guttery
Economists suggest that personal consumption accounts for 70% of Gross Domestic Product. If that’s true, then we should really pay attention to inflation, and the impact that such can have on personal consumption. We have heard the terms base effect and transient within the general business media lately. There is very little consensus among economists as to the nature of inflation. Personally, I have maintained throughout that the inflation we are experiencing today is more systemic than transient.
Over the course of the last two weeks however, I have noticed an increasingly greater number of these economists beginning to align behind the thought that inflation is indeed not transient. This is important because if the nature of the inflation that we are experiencing now is more systemic, then that would imply higher prices for general goods and services over a longer and sustained period of time and that is not a good thing if you are looking for durable economic growth.
Simply put, transient implies temporary. Chairman Powell has often suggested that the higher-than-average inflation we are experiencing now is transient. What he is suggesting is that the factors causing the inflation are temporary, and that in the opinion of the Federal Reserve, these factors will abate over time, and we will not be left with higher, long-term inflation acting upon the economy. Systemic on the other hand implies longer-term. Personally, I believe that the nature of the forces behind the inflation we are experiencing today are more systemic than transient.
A good example of base effect inflation can be found by looking at the automotive industry. During the COVID19 economic shutdown, many parts of the economy continue to function remotely. Building cars was not one of them. For months, we made ventilators instead of cars, while the demand for transportation remained latently in place. Ultimately, we returned to the factories and began building cars again and this started the game of catch up, and keep up. Unfortunately, you can’t simultaneously, and unilaterally restart your chains of supply.
So, while we are back to manufacturing automobiles, we are limited in the number of cars that we can actually produce because we are constrained by existing disruptions in the up chain of supply. This creates artificial, and temporary inflation at the producer level, that is passed along to the consumer for the reduced number of units that can be produced. I believe that such base effect inflation is clearly part of the significant rise in recent months, but I believe it is the smaller of the two sources of inflation.
Just last week, Brian Wesberry, the chief economist with First Trust, produced a video making this very point, within a video entitled “Inflation is NOT Transitory”. I believe that the Federal Reserve board is creating systemic inflation through debasing the currency, which occurs when you continue to increase the money supply.
As late as last week, chairman Powell reiterated that the Federal Reserve will continue to support the economy for as long as it takes. He confirmed that the Federal Reserve has no immediate plans of departing from its schedule of purchasing $80 billion worth of treasury debt, and $40 billion of agency debt on a monthly basis. In order to perpetuate this bond buying strategy, the Fed must increase the money supply.
With each new dollar printed, the dollars that existed before become weaker in value. A weak dollar is just another way to express inflation. So, in my opinion, the Federal Reserve is creating their own inflationary problem through the printing of a record amount of money. This isn’t something that can be neutralized quickly. It could potentially require years for the currency to strengthen and stabilize.
Even if the Federal Reserve discontinued its strategy of increasing the money supply, the dollar could continue to weaken. Remember, this is a story of relativity. Relative to the global basket of currencies, the dollar could continue to weaken if foreign currencies strengthen at a more rapid rate. Therefore, the inflationary trends that we are experiencing today could very likely be more systemic than transient in nature.
If this proves to be true, then such could be detrimental to patterns of consumption. Let me summarize why this is of concern to by referencing three images. First, let’s take a look at personal income.
Again, there is very little consensus among economists as to why personal income has fluctuated so dramatically in recent months. Some say that extended unemployment benefits have dramatically impacted personal income, while others continue to clean to the one-time receipt of COVID stimulus checks. You are looking at a graphic that depicts the changes in personal income. Personal income has declined in four of the last five months.
Next, consider this graphic that depicts the change in the consumer price index on a year-over-year basis as of June.
The inflation that we feel at the consumer price level has increased by 5.8% over the last 12 months. That is a higher rate of inflation than we have seen in a one-year period of time since 1983. Understanding that the consumer price index is averaged an increase of 2.26% per year over the last 20 years, this gives me reason to worry that current inflation running at 157% higher than the 20-year average during a time when personal income has been unusually volatile could negatively impact the economy.
The third graphic to which I will draw all reference is something that impacts our daily lives.
You are looking at the national average for a gallon of gasoline. Since May of last year, the national average for a gallon of gasoline has risen from $1.80 to $3.14 per gallon. This is an increase of over 74%. Gasoline is an economically inelastic commodity. It touches every aspect of our life. Gasoline is a desolate of oil. US oil production is down sharply over the last 12 months, so scarcity is playing a larger role. That diminishing supply of domestic oil is denominated in a dollar that continues to weaken. Therefore, the inflationary effects on this economically inelastic commodity in particular are not abating. They are systemic. And these forces continue to strengthen
So, how do you manage long term investment objectives during such times of upheaval? At a very high level, we are recommending to our clients that they overweight areas that could potentially thrive under changing conditions, and especially in areas of the economy that will benefit under weakening dollar and higher inflation conditions. There is no one-size-fits-all answer to that question, and it is entirely a function of individualized financial planning, and resulting investment strategies for the achievement of individual goals. I would strongly suggest that this is not the time for an autopilot approach to investment management. Be aware of changing economic conditions, as they are already showing patterns of evolution, and remember that we haven’t yet received the formal proposal for potential changes to the tax code for next year.
(*) David R. Guttery, RFC, RFS, CAM, is a financial advisor, and has been in practice for 30 years, and is the President of Keystone Financial Group in Trussville. David offers products and services using the following business names: Keystone Financial Group – insurance and financial services | Ameritas Investment Company, LLC (AIC), Member FINRA / SIPC – securities and investments | Ameritas Advisory Services – investment advisory services. AIC and AAS are not affiliated with Keystone Financial Group. Information provided is gathered from sources believed to be reliable; however, we cannot guarantee their accuracy. This information should not be interpreted as a recommendation to buy or sell any security. Past performance is not an indicator of future results.