Inflation we hardly knew ye,
these past many years
Interest rates low, markets up
only savers in tears
The Fed kept rates low
Longer than was wise
Now the bloom is off the rose
And prices are on the rise
Okay, we made it through January and collected all the bills from the holiday season. Did you overspend a little? Most people do.
Now comes inflation. What is inflation, you might ask?
Inflation is “A persistent increase in the level of consumer prices
or a persistent decline in the purchasing power of money.”
An increase in consumer prices and a decline in purchasing power is the same thing. As the price of hamburger goes up, you can buy less of it. You non-meat eaters do not get a break either. Some companies have become creative in hiding price increases. They put less in the box, i.e., what was once a box with 13 ounces of cereal becomes a 12-ounce box of cereal for the same price. Same with Quinoa and tofu and pasta. And they think we didn’t notice!
"Inflation is when you pay fifteen dollars for the ten-dollar haircut
you used to get for five dollars when you had hair." —Sam Ewing
Many economists and market forecasters predicted inflation back in mid- 2021. Their premise was that you cannot dump trillions of dollars (yes, trillions, we do not talk in billions anymore) into an economy without creating inflation.
The Federal Reserve and the White House disagreed. An indefatigable truth is that you can find someone to support your thesis if you look long enough. So, the White House trotted out their experts (Nobel Laureate economists, at that) to push back.
As you watch gas, meat, produce, and other commodities rise in price, you see who was right. Kind of like when 50 intelligence experts pooh-poohed a laptop story.
The highest inflation in 40 years has arrived. In 1980 when last we saw this kind of inflation, the 6-month CD rate ranged from 17.19% in March to 8.27% at the end of the year.1
Mortgage rates were between 11% to 13%.2 My first mortgage was at 11.25% and I was happy to get it. What does that mean in real terms? It means you cannot afford the same house you could buy when rates were 3.5%. A $500,000 loan at 3.5% costs $2,528.56 per month. The same $500,000 costs $5,139.64 per month at 11.25%.3
"The way to crush the bourgeoisie is to grind them
between the millstones of taxation and inflation." —Vladimir Lenin
How do we tame the inflation monster? Great question. The experts, predictably, are all over the place. The one thing they agree on is the Federal Reserve must raise interest rates. What they do not agree on is how many times and how much each time.
How does raising interest rates stop inflation? Higher rates slow demand. Higher rates increase the cost of borrowing which decreases demand. See the mortgage example above. As demand slows, so does everything else. Companies do not need to produce as much and consumers do not consume as much.
The first raise comes in March. Taming inflation without creating a recession is the balancing act we will watch play out over the next two years. At least that’s what the experts I listen to say. We all hope the Fed gets it right.
"I don't mind going back to daylight saving time. With inflation,
the hour will be the only thing I've saved all year." —Victor Borge
Give me a call.
- Historical CD Rates: How Things Have Changed Since the 1980s, Lending Tree.
- ERATE.com/mortgage-rates-history 1980 – 2017.