Inflation, How are We Doing?

I recently wrote about the Fed’s fight against inflation. Raising interest rates creates pain, but likely far less pain than runaway inflation. So, let’s see if the plan is working. I saw the effects of runaway inflation while visiting Zimbabwe years ago. In the storefronts were government issued signs that said it was illegal to use foreign currency. Next to the signs were handwritten notices that read, “Zimbabwe dollars not accepted.” Street vendors were selling Zimbabwe $100 billion-dollar notes to tourists. We joked about the worthlessness of the national currency, but it was no laughing matter to those who lived there.

To Americans, higher interest rates are mostly an inconvenience. It makes it more expensive to buy a bigger home, new car or use credit cards so some purchases have to be delayed. Excessive inflation devalues your money faster than wages and savings can go up. The dollar in your pocket just one year ago is worth about 90 cents today. That math spread over a few years could wipe out the middle class. Destructive inflation has not only destroyed third world countries, but historically we have seen similar disasters in major economies like Germany, France and China. For America to survive, it must be brought under control.

To check the Fed’s progress in the fight let’s take a look at the real estate market. Interest on a current 30-year mortgage is up about 3% since June of 2021. A $400,000 mortgage today would cost about $700 more per month. Not many families have seen similar wage increases so it should be no surprise that new home sales fell last month by 8.1%. This same math should transfer to other areas of our economy. As money essentially becomes less valuable, people are forced to focus their spending on essentials with less room for discretionary items. Less demand should lower prices and mitigate the inflation problem. Unfortunately, the prices of essential items that consumers must keep buying, such as food, energy and healthcare will likely be less affected.

It would be simpler if raising interest rates alone could halt inflation, but there are other factors to consider. A major one is the money supply. If government continues printing and spending money it does not have, then the value of money already in existence will likely continue to fall, possibly negating any benefit from higher interest rates. I have to shake my head at the massive spending bill in congress called the “Inflation Reduction Act.” It reminds me of the debt counselling I have provided over the years which always begins with, “you cannot borrow your way out of debt.” Likewise, government cannot spend its way out of inflation. That’s largely how we got into this mess in the first place.

Since I can’t control government at least I can control how I respond to it. During high inflation, available consumer dollars will naturally drift towards buying essentials and away from discretionary spending. So, investors might consider adjusting allocations accordingly. As the saying goes, follow the money.

Dan Wyson, CFP® is author of the book “21 Financial Myths” and owner of Wyson Financial. 1173 S. 250 W #505 St. George, UT 84770 - 435-986-9525 – Securities and Advisory services offered through Commonwealth Financial Network, member FINRA/SIPC, a registered investment advisor