Each year, it seems there is a “buzz word” used in every news story about the economy or the markets. This year everyone is talking about inflation. Inflation is defined as an increase in prices occurring simultaneously with a fall in purchasing power. Or in other words, trying to buy a product that is increasing in price as the dollars you are using are worth less. By that definition, deflation is the reverse, a decrease in prices with an increase in purchasing power. You likely have noticed some of the impacts of inflation or have heard stories recently of crazy prices paid for items. It’s popped up everywhere, at the grocery store, the lumber aisle at your favorite DIY store, and, yikes, have you tried to buy a house or used car lately? What should we make of all this? It’s a topic with no shortage of opinions; ranging from runaway inflation fears to ‘this too shall pass’. The reality is likely somewhere in-between. Let’s take a look at how we got to this point, and if it should impact how we invest your money.
When COVID came into full view in the first quarter of 2020, the world experienced rolling lock downs for several months. The economic impact was massive, as demand for goods and services was drained out of the system. People weren’t going out to eat, schools closed, vacations were canceled. Zoom meetings and working from home quickly became the norm. From an economic point of view, this was a negative demand shock and caused significant deflation (remember how cheap those airline tickets were in 2020). In an effort to stabilize markets and the economy, The Federal Reserve (the Fed) and Congress took unpresented steps which lead to an increase in the Federal Reserve’s balance sheet to over $8 trillion.
Raising the balance sheet of the Fed funded massive stimulus programs in the US, sending money to businesses and people in an attempt to increase demand by flooding the economy with liquidity. This strategy was adopted across the world by other governmental bodies. When we combine a massive increase in liquidity across the globe with economies and industries all opening at varying speeds, it creates the perfect recipe for inflation.