Many people misunderstand inflation and the result is that they have misjudged the markets in recent years. One mistake is to believe that the central bank aggressively printing money will always cause inflation.
I recall giving an investment presentation to a local group about a year after the 2008 financial crisis and hearing an audience member insist that such a practice would force inflation up 5% or higher within a year or so.
However, money growth does not always trigger high inflation. Several factors affect inflation and high money growth leads to high inflation only when other factors are constant and proceeding normally.
The most recent Consumer Price Index and other inflation reports show that inflation has been flat or only rising slightly during the last few months.
The 12-month inflation rates are below the Fed’s 2% target, despite years of quantitative easing by the Fed and other central banks, as well as the trillions of dollars of securities on the Fed’s balance sheet.
The Fed’s actions have pushed inflation higher than it would have been. Indeed, we might be in a deflationary environment today if it weren’t for the aggressive monetary policies of the U.S. central bank.
But all that printing hasn’t caused high inflation, nor has inflation reached its post-war average.
Many people just focus on short-term or cyclical factors. They view economic growth and declining unemployment and expect inflation to be around the corner. In normal times, that’s a good assessment.
But other factors presently are in play.
Two factors that check on inflation before the financial crisis and even now are globalization and technology.
Globalization spurs competition. For example, manufacturing and labor-intensive industries shift toward countries with lower wages. In turn, low wages keep the prices of goods down.
When trade is relatively free and open, domestic producers need to compete with overseas producers. Wages in China influence the prices of products in the United States.
Technology can make workers more productive or can lead to their replacement. Either byproduct of technology keeps prices low.
The financial crisis and the debt bubble that preceded it, also moderated inflation and have a lingering effect.
Too much capacity came online during the economic boom. Much of the capacity still is idle and keeps a lid on prices.
While there’s relatively full employment in the United States, there still are a lot of workers seeking jobs in Europe and elsewhere. That’s more unused labor capacity to keeps prices down.
High amounts of debt also keep people from spending. In turn, it holds down prices. The unwinding of a debt bubble is a strong deflationary force. Plus, a major goal of aggressive central bank policies was to counter the deflationary forces of debt reduction.
It is tough to balance the typical cyclical factors with longer-term factors. If the central banks don’t tighten too much, the sustainable growth we have now should push inflation a bit higher in the next year or two.
However, don’t expect inflation like we had in the 1960s and 1970s. A mistake by central banks or some kind of crisis could freeze consumers and cause prices to drop. But a more likely result is a modest, irregular rise in inflation.
Until next time,
Robert Carlson is editor of the monthly newsletter, Retirement Watch. In it, he provides independent, objective research covering all the financial issues of retirement and retirement planning. Carlson also is Chairman of the Board of Trustees of the Fairfax County Employees’ Retirement System and the founder of Carlson Wealth Advisors, L.L.C.