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Inflation Woes

There is a lot of talk about inflation due to the recent stimulus payments, fiscal spending, lower tax revenue due to 2017 changes, etc.


These inflation concerns are not unfounded as there are constant changes to government spending and revenue which impacts GDP, prices of goods and services, taxes, and so on.


Inflation can be defined as the increase in prices of goods and services, which lowers the purchasing power of your savings over time. This blog is far from the history of inflation, what causes it, how to fix it, or anything academic about inflation. There are plenty of smarter economists that can write a better paper than I can on all of that.


This blog is more about some ideas to calm your worries about inflation. Many of these points below help to settle my mind and I hope they do the same for you.


Control What You Can


This may be wholly unhelpful, but inflation is going to rise whether you stress about it or not (this is like telling a stressed person to relax). No single action by an individual can “beat” inflation, aside from potentially winning the lottery or something of the sort. Which we all know is highly unlikely.


Instead, understand what inflation is. It is the decrease in the purchasing power of your money. There are some ways to combat this, and a couple that I want to bring up include:

  1. “Hedge” inflation. Hedging inflation really just means protecting your purchasing power against the decrease that inflation creates. In other words, make sure your money is making you money. Beyond your emergency fund (the purpose of this fund is not to hedge inflation), you can do this by having your money work for you through investing, buying real estate, starting a business, etc. Just finding ways to put your money to work and not sit in an account that is making less than inflation.

  2. Grow your income. Beyond just the money you have already saved, find ways to increase your income. If your expenses are going to continue to rise (in dollar terms, due to lower purchasing power), find ways to make more money! This is much easier said than done, but this is a subset of #1 by finding ways to invest your money that will bring a return, or invest in yourself which can increase your future earnings.

Inflation is going to run its course whether you worry about it or not. So, instead of finding loopholes or blaming the government for what they have done, control what you can and find ways to increase the purchasing power of your money at a faster rate than it is decreasing.


Let the Government Control Inflation


One of the major jobs of the Federal Reserve (“FR” going forward) is to control inflation. They largely do this through the money supply and interest rates.


The FR controls the money supply through two main methods:

  1. Open Market Operations - this is where the FR buys or sells government securities in the form of savings bonds. When they issue bonds, they sell them to banks or the public and accept cash, which lowers the money supply in the economy. When they want to stimulate the economy by adding more money into circulation, they have the ability to buy those securities back.

  2. Reserve requirements - this is a requirement the FR puts on banks which says how much money needs to be available in the banks’ reserves. Higher reserve requirement means more money locked up in the bank’s vault (really, their computer) and less money in circulation.

Secondly, the FR can control inflation through interest rates. When they want to stimulate the economy, they can lower interest rates. Lower borrowing rates increase demand for borrowing which provides more money for spending, thus stimulating the economy. If the FR increases interest rates, less individuals borrow money to spend, which pushes prices down (due to lower demand to buy).


The stimulus payments were something extreme and do not fall among the strategies above, but more of a desperation measure to ensure the economy didn’t crash. This particular strategy of putting money directly into the pockets of individuals is called Helicopter Money. With COVID and so many people out of work, the presidents decided to get money directly in the hands of Americans through this strategy.


Obviously, the stimulus payments (and other government spending) are a large factor in the current concern over high inflation - even though this may cause some short-term concern, it still doesn’t take away the tools that the FR has to control inflation over the long-term.


It Is a Long-Term Game


What I have been alluding to throughout this blog is that inflation is long-term. The FR tracks inflation year over year and implements their tools in order to track a targeted rate of inflation.


The FR targets a long-term inflation rate of 2%. The 2021 annualized inflation rate is currently 4.2%. Sounds high, right? According to Inflation Calculator, even if this inflation rate is maintained for the full year 2021, over the past 11 years the average inflation rate is still below 2%/year.


Source: https://www.usinflationcalculator.com/inflation/current-inflation-rates/


So, although it may be concerning to have high short-term inflation, the bigger concern is the loss of value on your dollar over the long-term, which the FR has the ability to keep in check - and 2% inflation rate per year sounds like a reasonable hurdle rate to beat through smart investing or increasing your income.


Final Thoughts


Although headlines want you to think that inflation is “running away” to get your attention, it is not the right way to be looking at inflation. Looking at 2021 on its own may seem concerning - but that makes sense based on actions the government took to get us through a global pandemic.


There is no easy solution to avoid inflation (especially not crypto), but finding ways for your extra savings to make you money, whether that be investing in assets or yourself, is important.


Inflation is a healthy part of the economy in order to spur economic growth and create healthy competition among businesses. We are currently at a time of higher inflation due to a global pandemic, but this is not the first time that the US economy is managing high inflation. The US has gotten through it before without the world ending or the US currency system failing, and we will get through it again.