Inflation
Monthly ColumnBy Daniel A. Barnes, CFA
With California crying wolf saying “it’s bankrupt”, and the federal government printing trillions of dollars to stimulate the economy, it doesn’t take an economics degree to figure that all those extra dollars chasing the same or fewer goods, will eventually create higher inflation.
The critical benefit of inflation is its power as a force of structural change. There’s no smoother mechanism for redistributing wealth or rebalancing budgets. The current budget crisis is the result of the decisions of politicians who for 40 years increased benefits in good times while failing to reserve for down periods. This has resulted in lower skilled workers enjoying semi-skilled wages, semi-skilled earning higher skilled compensation, and so on. Many public union contracts are iron-clad. So since those contracts cannot be effectively renegotiated, the only mechanism available to rebalance future budgets is inflation.
Over the next thirty years or so, it’s a virtual certainty that inflation will rise more than the cost of living increases written into union contracts. Eventually, the imbalanced cost structures of government budgets will come back into balance.
Some critics claim that deflation is the near-term risk, because the deflationary forces are very strong. This is true, and will remain so for some time. But the critics neglect one key fact: the government controls the printing press. Some hark that the printing press won’t work so well when the dollar loses its status as the global reserve currency. Don’t believe it. Despite enormous fiscal pressure, there is presently, and for the foreseeable distant future no reasonable alternative to the dollar. No other currency is as immune from political and geo-political risks as the dollar. The dollar is and will remain the reserve global currency for decades to come.
The specter of a rising inflationary cycle raises a few questions. First, how will the eventual return of higher inflation affect you? Inflation helps debtors and hurts creditors. It hurts people with conservative investments (creditors), because if inflation is going up 5% annually, and you are making 3% on a CD, but only 2% after paying income and state taxes, then your purchasing power is declining 3% each year, in an inflationary environment. It helps debtors, because if you owe $100,000 in student loans, and inflation averages 7% for a decade, then the real burden of those student loans is cut in half. This principle applies equally to pension obligations and the national debt. So the simple answer to the question of whether inflation will help or hurt you is whether you expect to primarily be a creditor or debtor over the next decades.
Inflation is ultimately, the most populist and egalitarian market force that exists. While inflation will erode the value of many existing assets, and this will exacerbate the challenge of producing real returns for wealth management clients, inflation will ultimately rebalance budgets and repair structural economic imbalances, benefiting society and future generations.
The Bottom Line
Inflation averaged 2.5% per annum in the 1950s and 1960s and 1990s and 2000s. But in the 1940s, 1970s and 1980s it averaged 5.7%, 6.8% and 4.9% (Crestmont Research). I expect a return to the average changes in later set, with inflation averaging 4%-5% over the next few decades.
Looking ahead, the Sandwich Generation is most at risk. Families in their peak spending years (40s and 50s) caring for parents while funding college costs and dealing with other economic dislocations are most vulnerable in the coming inflationary wave. We’ll pick up there in next month’s column.