Last year the question was, “Is inflation transitory?” Today the question is, “How high will inflation go, and for how long?” Pundits see inflation rising and then falling to 4% by 2024, but this is simply gaslighting that Wall Street normally serves up. The United States is not immune to the inflation that other countries are suffering.
As shown in the following graph, some countries are still experiencing hyperinflation. We’ve witnessed recent hyperinflation, and it has occurred in countries that used to be rich, like Venezuela and Argentina, where billionaires became penniless.
Inflation could rise well above the current 8.5%, even reaching hyperinflationary levels. The Cato Institute’s World Hyperinflations examines the 56 occurrences of hyperinflation across the globe. The worst of the worst was 200% per day in Hungary from August 1945 to July 1946.
To answer the current question about the future of inflation, we need to address its current causes.
The causes of US inflation
There are two kinds of inflation. One is called “Demand-Pull Inflation.” It is caused by demand for goods and services exceeding supply, which is occurring now because supply chains have been disrupted by COVID, and people have slowly returned to work, increasing the costs of goods and labor and generating most of our current 8.5% inflation. Some of this supply shortage, especially in oil, is exacerbated by the Russian war in Ukraine.
This form of inflation should dissipate as people return to work and cargo ships are unloaded. It should be transitory.
The other form of inflation, called “Cost-Push Inflation,” is not transitory. It is classic inflation caused by too many dollars chasing too few goods. It happens when a government prints too much money, as has been happening globally over the past 13 years.
It started with Quantitative Easing (QE) in 2009 to head off the recession that started in 2008. The government printed $5 trillion, with most of it appearing on the Fed’s balance sheet. Money is “printed” by the Treasury issuing bonds. These bonds are normally snapped up, but not in the current global economic crisis, so the Federal Reserve has stepped in to buy them.
Then COVID struck and the government printed another $6 trillion in relief, creating a spike in the Fed’s balance sheet:
Who is paying for COVID? When was the last time you heard the words “balanced budget”?
“Modern Monetary Theory” (MMT) is the justification for the money the US has “printed” over the past 13 years. This theory says that governments that own a printing press can print all they want to solve economic crises unless it causes inflation.
MMT appears to have “worked.” A recession in 2008 was short-lived, stock prices soared, and inflation remained near zero—or did it? The fact is that $5 trillion in Quantitative Easing (QE) artificially increased the prices of both stocks and bonds, so we’ve had asset price inflation that is not reflected in the Consumer Price Index (CPI).
Investors suffer from a behavioral bias called “money illusion” where they believe that this price manipulation has actually made stocks worth more, even rising in the face of a pandemic and a pandemic coupled with a war.
But now MMT has poked the inflationary bear and it is infuriated. MMT guidance says that when inflation happens, that money needs to be taken back with taxes. Printing needs to stop, and money needs to be siphoned out of the economy with taxes. Cowboy wisdom instructs “When you find yourself in a hole, stop digging.”
Can you envision the political will to raise taxes? If excessive money is not taken out of the economy, inflation will escalate out of control.
Quantitative easing (QE) “worked” by not causing inflation as measured by the CPI, but COVID relief helicopter money is causing classic cost-push inflation.
Will the real inflation number please stand up
The calculation of CPI is in question, and it could understate the real number. Frank Holmes reveals that:
“The Bureau of Labor Statistics (BLS), which issues the monthly consumer price index (CPI), has changed its methodology for measuring inflation more than twice over the past few decades. Today’s CPI doesn’t actually tell us how much prices have changed; instead, it allegedly tells us changes in the cost of living. if we use the BLS’s methodology from 1980, prices actually increased 16.8% last month, which is almost double the official CPI print. The data below is courtesy of economist John Williams’ Shadow Government.”
The Fed to the rescue
The Federal Reserve has announced that it will control inflation, but it can’t fix this problem because it created it. Aside from turning the interest rate dial on short-term rates, the Fed also needs to stop the money printing for ZIRP (Zero Interest Rate Policy).
The last time the Fed tapered it caused a “Taper Tantrum” in 2013 because stock prices plummeted. As shown in the following schematic, tapering allows interest rates to rise, and rising interest rates cause stock prices to decline.
The common belief that stocks are an inflation hedge is not true in this situation because stock prices have been buoyed up by ZIRP. 2022 is not like 2013 when inflation was near zero. This time reversing tapering, and buying bonds again, will fuel the very inflation fires that the Fed says it will extinguish.
Early signs of inflation’s impact on 401k savings
An unprecedented event occurred in the first quarter of 2022. All vintages of target-date funds lost the same 5%, which isn’t supposed to happen. 2020 funds for people retiring now are supposed to protect more than 2060 funds for people retiring in 40 years. That’s the purpose of a glidepath. This anomaly happened because both stocks and bonds lost the same 5.5% in the first quarter.
Bonds do not protect in a rising interest rate environment because bond prices fall when interest rates rise. In a normal, unmanipulated non-ZIRP, environment bonds are priced to yield 3% above the rate of inflation, so 11.5% when inflation is 8.5%.
Additionally, 11.5% is 9% higher than the current 2.5%, so interest rates will tend to increase 9% as the Fed tapers by taking its foot off the yield brake. A 9% increase in interest rates will cause bond prices to fall 54% because the duration is six years.
Beware bonds. They are not safe
Also, beware of stocks because rising interest rates will also cause stock prices to fall. Inflation should cause the stock market bubble to burst. After all, a correction is 7.5 years overdue, and many believe that the next Minsky Moment will be worse than 2008, with stock prices falling more than 50%.
Beware stocks. The bubble is due to burst.
So, what is safe? There are a few safe TDFs but they’re not popular. For self-directed beneficiaries, cash will be safe in nominal terms but will suffer from a loss in purchasing power. Treasury inflation-protected securities (TIPS) can help if they’re offered on the 401k platform.
It’s going to get ugly.
Inflation will rise well above the current 8.5%
Quantitative easing (QE) is an experiment of magnitude that has never been conducted before. $5 trillion is more than the US spent on all of World War II. Then add $6 trillion for COVID and at least another $5 trillion for Biden programs and you have a whopping $16 trillion, which is more than we’ve spent on all our most expensive wars combined.
A trillion is an enormous number. It’s a one followed by 12 zeros, like this: 1,000,000,000,000.
It’s so big that we don’t truly comprehend its significance. It’s like trying to wrap our heads around the size of the Earth in the Universe.
We can hope for a miracle, and that inflation won’t rise above its all-time high of 30% reached in 1778, but hyperinflation is a real possibility. Aside from the harm to the economy, hyperinflation could take away the US dollar’s status as the world’s reserve currency, especially if China’s yuan remains stable.
Relinquishing reserve currency status would end U.S. dominance as the number one world economic power.
Ron Surz is President of Target Date Solutions, a DBA of PPCA inc. He is also the author of Baby Boomer Investing in the Perilous Decade of the 2020s. He can be reached at Ron@TargetDateSolutions.com.