A contractor at my house told me he needed to raise his prices because supply costs had gone up dramatically. He made a comment that caught my attention saying, “The solution to inflation is simple. Rather than sending out little stimulus checks, the government should just give everyone a million dollars and we would all be millionaires.” Before I started to laugh at his joke, I realized he was completely serious. This led to a lengthy conversation.
Inflation makes us think of the rising price of milk, gas and theater tickets. We say things are getting more expensive, which is true, but that doesn’t necessarily mean they are becoming more valuable. For example, a gallon of gasoline today will basically push my car about 20 miles down the road, just as it did 2 years ago. Gasoline hasn’t become more valuable, just more expensive. There are two main factors that contribute to inflation. Either the delicate balance of supply and demand has been upset, or the value of the dollars we are using to purchase products has gone down. In reality, both of these have occurred.
Since inflation can be a supply and demand problem, fixing it may require either reducing demand, or increasing supply, or both. By raising interest rates, the Federal Reserve is trying to slow demand by making it more expensive to do business. We are already seeing this in the real estate market. Keep in mind the government inflation numbers are compared to 12 months ago so as we get a few months down the road they should start looking better.
Increasing the supply side might be a more challenging matter because of politics. In a free market I would expect supplies to normalize naturally but political interests often get in the way of capitalism. We are seeing this in the energy sector, and it is difficult to guess how it will play out.
The other leg in the inflation problem is the huge increase in the money supply due to stimulus spending. Dollars are more abundant than they were two years ago and as such, they have less value. Thus, the value of products has not gone up so much as the value of the dollar in relation to them has gone down. Relating to my conversation with the contractor, imagine how worthless those dollars would become if the government actually did send out million-dollar checks to everyone. An economic catastrophe would follow the short-term fun.
Some inflation is necessary. Rising prices encourage consumers to spend money today before things get more expensive, and money in motion is good for the economy. Imagine what would happen if prices were regularly falling. People would sit on their money and the economy would grind to a halt.
I expect our inflationary problems to begin to resolve in the coming months. Higher interest rates will encourage saving, slow down spending, and reduce demand. We just need to be patient and keep investing in assets of value.Oh, and hope some politician doesn’t hear about the million-dollar check idea.
Dan Wyson, CFP® is author of “The Gold Egg," and “21 Financial Myths” and owner of Wyson Financial/Wealth Management 375 E. Riverside Dr. St. George, UT 84790 - 435-986-9525 – Securities and Advisory services offered through Commonwealth Financial Network, member FINRA/SIPC, a registered investment advisor