The Transitory Debate

Printing Money

At the beginning of this year, I wrote a blog post on how inflation doesn’t get enough attention. You can check that out here.  Boy, what a difference a handful of months can make. The last three months have seen some inflation numbers that have not occurred for close to three decades. In June, the Consumer Price Index rose 5.4% year-over-year; the first time that has happened since the early 1990’s. In fact, the CPI averaged 4.8% during the second quarter this year. Now, half of the emails I get from investment companies are about the threat of inflation.

When I wrote that post earlier this year, I was making the point that inflation - whether low or high - will have a tremendous impact on your wealth over the course of your life. Because it has been so tame the last few decades, people seemed to forget about it. During the late 1970’s when inflation peaked, most financial decisions middle class Americans made were influenced by the rapid increase in prices.

Today, the argument about inflation is whether it is “transitory” or not. (Transitory meaning that it will subside relatively quickly) To be sure, the only way to know the answer to this is with hindsight. Let’s examine some of the arguments for and against.

Those who are in the transitory camp will point to the reopening of the economy and the euphoria surrounding getting back to a normal life as the main driver of inflation. Moreover, many supply chains were severely disrupted by the pandemic. The bottlenecks that ensued are obviously fixable over time. Among the broader categories within the CPI, energy was by far the highest for June, up 24% year-over-year. However, that monthly number last year averaged -8%. Energy inflation has literally been nonexistent for the last decade or so. The price of a barrel of oil declined 23% during the decade of the 2010’s. It was down 34% halfway through last year. The volatile price movements in energy are very likely transitory. During the raging inflation years a few generations ago, the energy situation was the exact opposite. During the 1970’s oil prices rose 870%, or 25% per year!

There are a few arguments that can be made against the transitory theory. One is the sheer size of stimulus that has been injected into the economy. Some measurements estimate that the money supply increased by 20% last year. That dwarfs the amount from the financial crisis in 2008. And when the money supply increases by a lot very quickly, bad things can happen. (Again, see my previous blog post).  Another argument is demographics. According to the 2020 US census, the 10 most common ages are between 25 and 35. Folks typically hit their peak spending years around 40 to 45. When you consider how expensive having a few teenagers can be, it easy to see why this is. Much like in the 1970’s and 80’s, Baby Boomers (the largest generation then) were raising their children, many of them of the teen variety. Today, Millennials are most populous. Many of which are just starting their families.

If inflation is transitory then there will not be much to worry about. However, if it is persistent, then The Fed will presumably take steps to address it. The first major step will be to stop buying assets or what is known as quantitative easing. Since June of 2020 it has been buying $80 billion of treasuries and $40 billion mortgage-backed securities per month (essentially printing money). But the biggest tool in its box is to raise interest rates. Here, there is quite a lot of fire power because rates are next to zero.