Inflation in 2021

Stuff is Getting Expensive

We’ve all probably heard about the rise in inflation over the past few months. Throughout America, a large swath of goods—such as gasoline, lumber, groceries, computers, houses, steel, cars, and more—have experienced sharp price increases in the last year. People are starting to become concerned as the United States has not seen high inflation rates since the late 1970s/early 1980s. Because inflation is now a legitimate concern, this blog post will seek to describe what inflation is, its effects, and what is causing the recent bout of inflation.

What is Inflation?

Inflation refers to the general price increase of goods and services in an economy.  If you have $100 today, then inflation decreases how much “purchasing power” your money has. Whenever inflation occurs, you can’t afford to purchase the same amount of goods you had before with the same amount of money. For example, a 2% annual rate of inflation means that you need $102 to purchase the same amount of goods that you purchased last year for $100. Now, a 2% average annual inflation rate is considered a low, stable amount. That’s the benchmark the US Federal Reserve Bank seeks to match when setting monetary policy. However, that 2% inflation rate adds up over time due to compounding.

The Inflation Calculator on the Official Data Website is a useful tool in understanding the effects of inflation. Let’s say inflation runs at 2% for the next fifty years. Guess how much money you’ll need in 2071 to maintain the same purchasing power that you had 2021. You would need $269! That’s a 169% increase in prices over just fifty years.

Let’s just bump up inflation to 3% in that timeframe. In just 50 years, you would need $438 to buy the same set of goods that you bought for $100 fifty years prior.

Clearly, inflation subtly decreases the amount of stuff that your money can buy. While inflation is not a good deal for consumers, we’ll begin to discuss how inflation helps out the biggest single borrower in the US economy: the government.

A Hidden Tax?

The famed economist Milton Friedman once said “Inflation is taxation without legislation.”

I don’t think most people realize that inflation is a type of “hidden tax”. Most taxes we commonly see—such as property taxes or income taxes—are the direct result of government legislation. Consequently, those direct taxes are usually the kinds of taxes that people usually get upset about.

Think about this situation in another way. If you’re a government official, you know that raising income taxes is usually not a popular proposal. On the other hand, government officials understand that taxes fund the government. So, what’s the solution to this “Catch-22”? Well, the solution has been around for thousands of years: inflation.

Governments from ancient Rome to Mexico in the 1990s have learned that inflation is good for borrowers and bad for savers. When inflation occurs, money becomes worth less over time. That’s good news for borrowers because they still owe the same dollar amount even though that dollar amount purchases less goods in the future. For instance, let’s say I borrow $100 at 2% annual interest. Even if inflation runs at 10% that year, then the borrower still only has to pay  back $102. Unfortunately for the lender, the lender currently needs $110 to purchase the goods that cost the borrower $100 to buy last year. Clearly, inflation can be a bad deal for lenders.

Remember that anyone with a savings account is a kind of lender. If put your money in a bank account, then you are effectively lending your money to that bank (i.e. financial institution). Last time I checked, savings accounts yield well below 1% interest annually. So, a savings account won’t do anyone much good when inflation is. We’ll talk about this issue of declining purchasing power later on in this post.

Moving on, governments like some inflation (too much inflation will likely lead to societal unrest & a destabilized economies) because governments are huge borrowers. Remember that governments can just borrow money to finance increased government spending (i.e by selling bonds and other debt securities). Therefore, inflation makes it easier for governments to pay back their debt because money is worth less.

In 2020 and 2021, it feels like the federal government and the Federal Reserve found an infinite money glitch. I’m not even kidding. Just look at the Federal Reserve (FRED) website. To my own surprise, the Federal Reserve has created about 1/3 of the current M2 Money Supply since January 2020. This amount of money creation is unprecedented in US History. Should we actually be surprised that inflation is occurring right now? The asnwer is no.

Here are some actual numbers to prove my point: the M2 money supply hovered around $15.5 trillion in January 2020. Just 14 months later, the M2 money supply increased to nearly $20 trillion in March 2021.

Welcome to the world of Modern Monetary Theory where the government can print as much money as it wants without consequence. Oh wait, but there’s this little thing called inflation. Let’s move on and look at how inflation is stacking up in 2021.

Former Fed Reserve Chairman Jerome Powell says “Money Printer go Brrrrr”

Inflation in 2021

The Consumer Price Index (CPI) is the most commonly used inflation measure in the United States. The Bureau of Labor Statistics (BLS) states that the CPI measures the annual price changes for a basket of consumer goods for an urban household. Some of major categories within the CPI’s basket of goods include food, housing, clothing, medical care, education expenses, transportation costs, technology services, and much more. So basically, the CPI takes into account the price changes of most goods and services that you purchase/use on a regular basis.

In the past week, the US Labor Department announced that the CPI rose by 0.8% in the past month. That number blew past the original estimate of 0.2% for the month of April. On annual basis, the CPI showed that inflation increased by 4.2% in the last year (i.e. April 2020 to April 2021). What’s alarming is that the current inflation rate is the highest it’s been in over a decade, and it’s unlikely to slow down anytime soon.

So many goods are getting more expensive. Here’s a brief list of some of the recent price hikes:

The Effects of Inflation

My biggest problem with inflation is that it most directly hurts low-and-middle income individuals. Decreased purchasing power hurts the people who live paycheck-to-paycheck and don’t own appreciable assets.

Wealthier folks aren’t hurt as much by inflation because their wealth is mainly stored in appreciable assets. Assets such as real estate and stocks allow wealthier folks to “beat inflation”. The S&P 500’s average return is about 10%, and American real estate has a similar return. Now, I am not railing against wealthy people. I am just pointing out that inflation hurts low-and-middle income families who do not have the means to grow their wealth past inflation.

Overall, I hope that you learned a bit today, and enjoy the rest of your day!