Most people affected by inflation are unlikely to really know what caused its recent surge.
Over the past few weeks, I’ve written about how many investors fail to appreciate the progress made over the past few decades. These advances range from civil rights to improved standards of living to record levels of income and household net worth.
For example, polls regularly show that between half and three-quarters of Americans no longer believe in the American dream.
The reasons vary.
Some cite stagnant wages and rising costs. Others are pessimistic due to job insecurity. Still others point to the worsening of economic inequalities. (The gap between rich and poor has widened considerably, with wealth increasingly concentrated in the hands of the richest 1%.)
However, a broader perspective on these issues helps alleviate anxiety.
I will address these three questions in the next three articles.
Indeed, once you broaden your perspective, you will likely become more optimistic about the economy and your own financial prospects.
Let’s start today with stagnant wages and rising costs…
We have just gone through a period where inflation has reached the highest levels in 40 years, although it has recently moved closer to the 2% annual target set by the Federal Reserve.
High prices are difficult for consumers to bear, especially those in lower income brackets who struggle to afford the rising costs of basic necessities such as groceries, gasoline and electricity.
Although the Census Bureau reported that inflation-adjusted median household income recently reached $80,610, this only brought consumer purchasing power back to where it was in 2019.
Five years of declining or stagnant income are enough to make the dream bitter.
However, it is important to understand that this is a short-term aberration, not a long-term trend.
Let’s first look at the reasons for the price surge.
When the COVID pandemic hit, governments around the world overreacted.
Instead of taking strong action to protect the most vulnerable (primarily the elderly and those with pre-existing conditions), they shut down much of the global economy. This has greatly reduced the supply of products that all consumers need. (Which led to a massive run on toilet paper, among other things.)
Anyone who has taken basic economics knows that when demand remains constant and supply decreases, prices increase.
Supply has actually fallen. But demand has not remained constant, it has increased.
To ease the hardship caused by COVID, policymakers around the world have added trillions of dollars to their already sizable deficits. This excess cash in consumers’ pockets has boosted demand. This also contributed to the rise in the consumer price index.
To top it all off, central banks around the world have decided to let inflation run out of control during the pandemic and its immediate aftermath by keeping short-term interest rates near zero.
These three factors – the shutdown of the global supply chain, multi-trillion deficit spending, and zero interest rates – have combined to temporarily give us very high inflation.
But these three factors, or at least two of them, are now behind us.
The global economy is running at full speed again. Central banks have raised interest rates to combat rising prices. (And deficits of several trillions have given way to deficits of “only” one or two trillion dollars. This remains a problem that we will have to live with.)
If the rise in prices has moderated, this is not the case for the prices themselves.
When costs rise this much – and it takes five years for a household to earn the income needed to cover them – it’s not hard to understand consumers’ frustration.
Most people affected by inflation are unlikely to really know what caused its recent surge or understand that it was caused by unusual circumstances that are mostly behind us today.
Therefore, many investors are pessimistic about the future of Western countries. This is especially true if they are worried about job security.
After all, if costs are rising, income is lagging, and you don’t know if you’ll still have a job in a few months, it’s completely natural to feel pessimistic.
Still, most people should be optimistic.
High inflation is behind us. Job insecurity is a fact of life and – counterintuitively – a side effect of what makes Western countries such dynamic economies.
