Several months ago we hosted a webinar entitled The Inflationary Freight Train. During our time together we looked at the history of monetary induced inflation going all the way back to the Roman Empire. We walked through the 1950s and the 1970s and landed on where we are presently, post Covid. We discussed at length the combination of increased money supply along with low interest rates, high unemployment and a Federal reserve focused intently on one of their two mandates, maximum employment. We’re going to have another on Tuesday May 11th, if you’re interested to sign up HERE.
We attempted to lay out the inflationary cycle pretty clearly: Increased money supply leads to a devaluation of currency, which leads to increased asset prices and ultimately wage inflation. Once wage inflation kicks in, regardless of the industry, these prices are passed on to customers and the inflationary super-cycle begins.
We reviewed how one plans, prepares and combats inflation, however in hindsight we fell short in diving deep into one key piece of the puzzle still missing, which is now in full force, the velocity of money. Rather than discussing the velocity of money I discussed how higher unemployment had been keeping us from seeing inflation. While true, increased employment will only transpire when people return to their lives and begin spending money, thus demanding goods and services that require people to work.
Velocity of money can be defined as how many times a dollar is spent in circulation. The chart below from FRED (Federal Reserve Economic Data) shows the last reported velocity of money figures and you don’t have to be an economist to see its significant decline. This is quite simple to explain considering the amount of people who have been sitting at home, not spending money due to Covid and quarantine.
Ironically at the same time money changing hands has been on the decline, we’ve seen a significant increase in the money supply which can be seen in the following chart. I’ve used this chart often and it clearly illustrates the dramatic uptick of money in our system due to stimulus and PPP forgivable loans.
At the time of our seminar, other than the one-off products such as lumber, we hadn’t yet seen a significant uptick in prices across the board. This now seems to be changing and may be changing fast.
With the re-opening of America, we have now begun to experience a labor shortage. I am hearing from many business owners that are finding it extremely difficult to attract and retain employees due in part to the competition from free government money but also from the increased wage competition from other companies. Just the other day I was stopped by an exceptional client in the HVAC industry who let me know he has had several employees poach from him not for $1 or $2 per hour but 20 and 30x that amount. Can you imagine that? Walking in and hearing that an employee is leaving to accept a job making $20 or $30 more an hour? Not $20 flat, but rather, $20 more?
Let me ask you. How do you think the new company who snatched these employees will pay for these wages? Yup, that’s right. It will be passed on to you, the customer.
Whether it is the grocery store, the gas station, a service company or building materials, prices are on the rise and I fear it has only just begun.
Stocks are having an exceptional year. People scratch their head over this but we’ve explained the inflationary asset pricing result countless times and it typically includes stocks as well. In my opinion it isn’t that companies are worth so much more, they’re simply trading higher because of the inflationary result of increased money supply.
While it is my opinion it is critical to be participating and benefiting from this, it will not last forever and the best course of offense is building an even stronger defense through debt reduction.
If you have the ability to reduce your fixed expenses your variable expenses can rise, and you can easily absorb this price increase. If however you have significant fixed expenses through debt payments and very little room for increase on the variable side, this increase in price of goods will begin to hurt your monthly budget very quickly.
Despite the alure of low rates and easy money, it is my opinion that folks should be shoring up the debt side of their balance sheet rather than increasing it.
At some point we’ll begin to talk about the backside of this inflationary cycle when the Fed is finally forced to step in and choose the good of the economy over the stock market, but I believe we’re still far too early in that game so we’ll save that for another day.