September 2021 E-Newsletter: Understanding Inflation in 2021

Jonathan M. Gardey, MBA, CFA®, CFP®

President and Chief Executive Officer

Inflation is a loaded word that conjures a host of emotions. It’s also one that has been dominating media headlines this year—and consumers are worried. In fact, reports show that the word inflation hasn’t been Googled this much since 2008. But why is inflation causing such widespread concern right now? And, is it warranted?

There are a couple of reasons we can point to, and will explain, but shock factor has a huge part to play in each of them. You see, consumers are experiencing inflation in two very obvious ways right now—in their newsfeed and in their wallets. Consumers are hearing that they should be worried about inflation from the media and feeling it in their wallets. Bank accounts seems to be dipping faster, even when buying the same things from food to vehicles to housing. So suddenly what’s being amplified in the news—especially with the recent elevated CPI numbers—is beginning to be felt at home, in some cases, as well.

Understanding Inflation in 2021

Inflation is defined as an upward movement in the average level of prices. Our high school textbooks teach us that this is the result of too many dollars chasing too few goods. In a growing economy, increasing consumer spending pushes demand up to where it exceeds supply which drives up prices.

Sound familiar? That’s because that’s exactly what we see happening right now.

With each round of COVID-relief stimulus injected into the economy, the M2 money supply ballooned. And as Americans emerge from year-long social distancing and stay-at-home orders, demand for everything from deodorant to fitness equipment has been on the rise. This unleashed, pent-up demand is wreaking havoc on weakened manufacturers that scaled back production during the pandemic.

Is Inflation Here to Stay?

Fed Chair Jerome Powell has said that inflation is likely to pick up as the economy recovers from the pandemic, but he believes it will be temporary. Powell has also stated that the central bank plans to keep short-term rates anchored near zero through 2023 unless inflation grows unchecked.

The numbers so far this year have confirmed his suspicion that inflation was likely to rise as the economy recovers, but this is no surprise if you understand how the CPI numbers are measured.

Measuring Inflation: The Consumer Price Index (CPI)

Each month, the Bureau of Labor Statistics releases a report called the Consumer Price Index (CPI) to track these fluctuations in the price of goods and services. It is calculated from information provided by families and individuals on purchases made in the following categories:

Food and beverages
Housing
Apparel
Transportation
Medical Care
Recreation
Education and Communication
Other groups and services

Elevated CPI Numbers from 2020-2021

The CPI numbers for April through August 2021 thus far have been ridiculously high. Higher than we have seen in decades, in some cases. In August the annualized CPI number was 5.3%. Until now, the rate of inflation has not breached 5% since 1990 (see Figure 1 below).

Figure 1. United States: Inflation Rate from 1990 to 2020.

Figure 2. Monthly 12-month Inflation Rate in the US from July 2020 to July 2021.

This year’s elevated CPI numbers then (Figure 2) are a huge part of the discussion on inflation. But, there is a piece missing here: these numbers reflect a percent change over two periods, of which the former period was in severe contraction and the latter in ballooning expansion. The margin between the two numbers, then, was always expected to be high.

Keep It in Context

It remains imperative that we digest these figures in the context of the pandemic, which resembles nothing we have ever witnessed historically from an economic perspective.

Let’s break it down. The rate of inflation, or Consumer Price Index (CPI), is tracked on a year-over-year basis. For each month, the CPI is compared to the same month of the prior year. But this comparison may distort our view since 2020 was such an economic anomaly.

In August 2021, the year-over-year change was compared against a 0% inflation rate in 2020. This is because most of the country was shut down, and demand for goods and services was very low as a result.

This year, we are on an economic rebound and have seen a surge in demand for the goods and services we weren’t buying last year. So regardless of how small the increases were from 2020 to 2021, the CPI was bound to show a significant jump.

Even though the month-to-month decrease in CPI from July to August was just 0.1%, the year-over-year rate was 5.3%, before being seasonally adjusted. So 5.3% looks like a huge jump! But in reality, we are comparing a year of economic recovery and high demand—2021—to a year where we were all pent up in our homes and demand reached record lows.

Don’t Overvalue the Outliers

What’s more is that there are outliers in the CPI causing it to be higher, as well. Some of those include used cars, hotel rooms, and airline ticket prices. These industries alone caused a tremendous spike to the CPI numbers. But, in reality, we aren’t buying used cars every day or staying in hotel rooms every night so some of these more inflated goods and services will not affect our day-to-day purchasing power.

The most recent numbers may provide a marginal shock factor, but they remain much less impactful from a long-term perspective. Given the previous ten years CPI figures, which have actually lagged behind the Fed’s 2% target, we could theoretically even finish 2021 with a CPI as high as 4.5% and still be on equal footing with the Fed’s target over the previous decade.

Inflation is the Sign of a Recovering Economy

Given these conditions, the current rise in inflation is less to be alarmed about than headlines would make it seem, and in fact, indicates a healthy and thriving economy. Even though prices are rising, there is potential for wages to rise, as well. Not to mention that historically, equities have also thrived in periods of higher inflation. When the companies that comprise the index are doing well, the shareholders stand to benefit.

As always, we will continue to monitor the situation. In the meantime, if you have concerns or questions about how inflation could affect you, we encourage you to reach out to us at Gardey Financial Advisors for more information. Whether you are a current client or an individual looking for the right comprehensive wealth manager to lead the way, we are here to help. Simply dial 1-989-791-3880 or 1-800-550-3880 to schedule a complimentary and confidential introductory phone call.

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