Sometime during Covid we launched our first Zoom webinar entitled the Inflationary Freight Train. Many wondered just why we would be concerned about such a topic when the economy had screeched to a halt, consumer spending was nonexistent and inflation was nowhere to be found. Fast forward a few months and you can’t turn a corner without hearing about inflation and its damaging effects. Last week’s CPI report of 4.2%, compared to the less than 2% we’ve become accustomed to, and was a number we hadn’t seen in over 10 years since coming out of the financial crisis.

As you know, the primary tool to fight inflation is interest rates; however, the Federal Reserve has stood firm on their belief that recent inflationary data is transitory and therefore there is no need to consider raising rates any time soon. Not a day goes by where a CEO doesn’t discuss the impacts of higher input costs (inflation) and the natural price increases that will follow, which seems to be in direct contrast to what the Fed is seeing and saying. So who is correct?

In my opinion, they both are and here’s why. For the last few decades, we have seen very little to no inflationary pressure. Mainly, this has been due to technological innovation, which has pushed prices down and simultaneously increased efficiency and productivity. When the first flat screen television was sold it cost several thousand dollars — now you can pick one up for a few hundred. I no longer pay late fees at Blockbuster but have thousands of movies at my fingertips from Netflix and, looking forward, business travel expenses will likely be cut in half due to the acceptance of Zoom as a viable professional meeting option.

Yes, certain areas such as healthcare and groceries have steadily increased in prices over this time, but the broad basket of goods and services has moved very little.

While inflation can be defined as a general rise in prices, there are two primary methods by which this transpires. The first and most easily understood is due to supply and demand. If there is a limited supply and significant demand, prices will rise. I’ve used the example of sports tickets. Let’s assume that UK Basketball goes on an incredible hot streak after arguably one of their worst seasons ever last year. Since there is a fixed number of seats in Rupp  Arena (supply), combined with an uptick in demand due to the winning streak, we can naturally expect ticket prices to rise (inflation).

What we’re seeing in many areas of our country right now are directly correlated with a similar situation. For several months during Covid, production of many products came to a screeching halt. Not only were very few folks actually working, but there wasn’t a single business manager that thought stocking inventory would be a good idea. Think for a moment if you were a large store owner who was forced to close during Covid and didn’t know if you’d ever reopen. Would you be ordering supplies to stock your shelves? Absolutely not.

Fast forward to today and we now have the country reopening. Millions of Americans are traveling, shopping and getting back to normal lives. Meanwhile, just about every product that has any sort of lead time in manufacturing is in limited supply…which creates what? You guessed it, a price shock.

Lumber was one of the first to see this due to the fact that during Covid, home projects never slowed but soared and home building continued. Following quickly were other input prices such as Steel, Copper, Rubber, Plastics as well as large finished goods such as automobiles or appliances.

Just a few weeks ago I had an interesting chat with a family member who runs a large auto dealership in the West. He relayed to me that due to the semiconductor shortage, his new car supply was nonexistent and his used car supply was dwindling fast. He was raising prices weekly and still couldn’t keep anything in stock. It was the best of times and the worst of times!

You see, limited supply, combined with the fact that the country is reopening all at once, we are seeing the unique situation where Americans were flush with cash and ready to spend. Not only was this due to consumer inactivity over several months but that our government had doled out free money like never before. Add this fuel to the fire and you have the recipe for an amazing round of inflationary pressure.

I believe this is all the Fed is looking at and therefore concluding that it is short term and will work itself out. On one hand, they’re right and we’re already seeing this transpire as last week’s housing starts fell unexpectedly by 1MM. Economists were shocked by this and I was once again reminded just how out of touch these folks are from reality. Just about every builder I know or anyone looking to build a home has put plans on hold until prices come under control. If you’re in the process of starting construction on a $500,000 house and learn that it will be 20% more than just a few weeks earlier, you too may hold off a bit before forking over the extra $100k. Housing starts fell and lumber tumbled along with it. In my opinion many of these short-term inflationary pressures will subside and subside quickly.

If that happens, the Fed will be right and vindicated for their conviction. They will trumpet their decision making and more than likely be praised by the media. Unfortunately, they will still be wrong, at least as I see it.

You see, the other area of inflation that was the basis for the webinar is a result of monetary devaluation, which erodes purchasing power and thus increases prices. This results in wage increases, which results in further increased prices. The cycle repeats and thus inflation kicks in.

It is my opinion that while the Fed will be right about the short-term transitory nature of many input prices, they are missing the bigger picture, and the increased money supply in circulation will be what sparks the longer-term price increases.

The equation for this is a bit more complex, with currency devaluation being at the root, followed by asset appreciation, resulting in wage inflation. Ironically, we may also be seeing wage inflation sparked due to our labor shortage, which can be attributed at least in part to government benefits. Regardless of how it starts, the results are higher prices for consumers that will steadily increase and potentially not go back down. Think groceries, utilities, travel and leisure.

At present, the markets are throwing a bit of a fit over this subject matter, which I find interesting since we’re already starting to see some of the data points such as lumber prices, come down and come down fast. It is my opinion that this weakness is more of an opportunity than a warning and we’re still in the early stages of a much longer-term inflationary cycle that will take years to play out and ultimately raise all asset prices, including stocks.

This will continue to be a subject matter of great concern going forward, so I suspect we’ll be writing about this for some time. In the meantime, my mantra remains the same: debt reduction and proper investment allocation are your best defense against longer-term inflation. We’re happy to dialog with you if needed to ensure you’re on the right path. Just let us know.

Oh, one more thing, take a look at our Logan making waves in the financial circuit! We couldn’t be more proud. Click to view his TV video HERE