Dear Clients & Friends,
This weekend, we are going to talk about inflation because it’s pretty hard to ignore the news media seemingly freaking out about the topic. You’ve heard us criticizing the news media for years about their tendency to sensationalize just about everything - and they are doing it again. Why? Because scaring people increases readership, and increased readership is good for advertising revenue. I would not exactly call it “fake” news, but I’d certainly refer to it as “exaggerated” news.
Let’s get a few things straight before we begin. Is inflation a concern? Yes. In addition, it’s actually higher than the headline numbers indicate, because the metrics used to evaluate inflation are antiquated. Does this mean that the world is coming apart? No. Is the dollar collapsing? No. Will we wind up with 1960s era inflation? No. Is it a challenge that requires adjustments to your portfolio? Absolutely! And we began prepping for increased inflation last year, before the news media had a coronary.
The most important thing that all clients should find solace in is that, for the past 10 years, ever since inflation dropped to a laughably low level, we have NOT decreased our long-term inflation expectations within your financial models. We did this because we knew that inflation would pick back up someday. Inflation is more than twice what it was a few years ago, and yet it’s barely higher than the inflation forecasts we’ve been using for long-term planning. You might ask why we’ve always used high inflation forecasts. Well, our approach is to use higher than expected inflation expectations, higher than expected taxes, and lower than expected investment returns. And if your financial model looks healthy using worse than expected parameters, then you are lookin’ pretty good.
The most hysterical article I read recently was intended to alarm readers because inflation has risen 800% over the past year. Well, sure - when you start from 0.5% inflation in the middle of a global pandemic, even returning to where inflation was immediately prior to the pandemic is a 400% increase! Oh, how I miss reliable, usable news.
Now that you are feeling more confident, let’s get into the topic at hand.
A big part of the stories out there is a labor shortage and consequent wage inflation. One of the core assumptions in American business is that there is a virtually inexhaustible labor supply, at or close to minimum wage. In many markets, that assumption is being challenged, with many companies being forced to raise their pay well above the minimum. Arguably, this shift is due to COVID; many people are reluctant to return to work, which is artificially suppressing the available labor supply. This is the assumption that is driving many states to eliminate the supplemental federal unemployment payments that make it more lucrative to stay at home. That move will probably work, and in any event, the federal payments expire in September. But what if it doesn’t?
With large parts of the boomer generation unlikely to return to the workforce, with other formerly reliable labor sources such as immigration under attack, and with the millennials aging out of junior, lower-wage jobs, it is very possible that lower-wage jobs might have a much tougher time getting filled. I will be watching the participation rates and employment cost indices closely through the rest of this year to see if this really is an emerging risk.
Supply Chain Problems
Another reliable source of headlines is supply chain problems, for everything from simple commodities like iron to complex manufactured goods like electronic chips. Here, too, the core assumption has been that supplies of everything will be generally available, although the cost may vary. Just as with labor, that assumption is now not working, and shortages are driving costs—and inflation—up.
Here, I think the problem is probably shorter term than the labor question, as miners and manufacturers can drive up production in fairly short order, while producing a new worker takes at least 16 years due to child labor laws. And while that statement is a bit flip, it is also accurate. Commodity producers can scale up production in the short term and open new mines in the longer term. Manufacturers can add new shifts or assembly lines in the short term and build new factories in the longer term. These are solvable problems, in terms of the amount of production. But how quickly they can be solved is a real question. Again, this is something that I will be watching through the rest of the year. How quickly can we normalize? And what effect is that having on the economy?
Note, though, that I was careful to say we could solve the production problem. But I did not say anything about cost. This is the real inflation threat going forward, and it is one that touches both of the above points. Even if the world economy remains integrated, China’s labor force is now shrinking, so there will be more labor constraints going forward. Labor costs may not be forced up, but they will not be declining either. And, if relations between the U.S. and China get worse, we could see companies forced to reshore operations here, which will worsen any labor shortages in the U.S. and certainly drive up relative costs.
The same holds for commodities and manufactured goods. A substantial portion of everything we consume is sourced and made abroad because it is cheaper and more efficient to do it there. If and when globalization starts to turn, costs will go up and efficiency will go down—and that could drive inflation here higher. This is likely to be a slow and multiyear trend, but there are signs it is already starting. This risk, too, is something I will be watching.
Is the Dollar Collapsing?
Obviously, inflation and the value of the dollar are closely related. So, let’s shift gears a bit and talk about the dollar. Despite what some say, the dollar is not collapsing. I feel like the theory of an eventual apocalyptic dollar collapse gains momentum every few years. We talked about this in 2013, 2015, and, of course, in 2020 mid-COVID. Is the dollar collapsing? Not quite, and in the next section, we’ll tackle this topic.
The Pandemic and the Dollar
Let’s start with the past two years, which captures the entirety of the pandemic. In the chart below, we can see the dollar rallied at the start, but it has since slumped. It recently dropped again to the lowest point of the pandemic. This is what is generating the concern—the fact that, for months now, the trend has been significantly down. Should we be worried?
To help answer that question, let’s make the chart a bit more representative. Note below that the decline for both the Federal Reserve Board (FRB) and Wall Street Journal (WSJ) lines are both less than 10 percent. The way the axes are set, it looks much worse than that.
In fact, if we reset the scale on the graph, using exactly the same data, that change looks even smaller (see below). If we were to set the scale to show the full 0-128 range, it would look even smaller. In other words, even using this short time frame, while the decline is real, the magnitude is much smaller than most of the charts in the media would suggest. And, at the proper scale, it is self-evidently not something to panic about.
The Long View
Just as rescaling the data on the basis of magnitude puts the relatively small decline into perspective, so too does rescaling it on a longer time period. If we take the period from the past 2 years to the past 20 years, we see a few things. First, the rally at the start of the pandemic was typical given the rising risk around the world, and the pullback on decreasing risk is reasonable on that basis alone. As the conditions that led to the spike (i.e., the pandemic) abate, so should the spike itself, which is what we see happening. Second, as that spike abates, the dollar is now at the level where it has spent most of the past 5 years. In other words, rather than a decline to worry about, this is just a return to normal. Third, rather than collapsing, the dollar is actually quite strong and still at high levels compared with the past 20 years.
A Normal Response
In fact, if you look at the bigger picture, the dollar tends to spike during times of trouble, then drift back down. It happened in 2000, it happened in 2008, it happened in 2016, and it is happening now. We might see more of a downtrend, and that would actually be a good thing. As other economies around the world recover, we should see their currencies become more attractive, and the dollar should trend down in response. This is a normal response to a normalizing global economy.
Yes, the dollar is trending down—and it could go lower. But that’s a good thing. And one more time: the dollar is not collapsing.
Trends Are Changing
The current spike in inflation is likely to fade. But when we look at the bigger picture, we can see that the many tailwinds we have had over the past decade that have kept inflation low are likely to reverse. Inflation over the next 10 years will probably be higher than it was over the past 10 years. That does not mean we are moving back to the 1970s or to hyperinflation. It is something to watch, not something to panic over.
For that reason, the current inflation spike—while due to pandemic effects—is a great opportunity to think through how the world is changing and what that means for your portfolio. Don’t panic about inflation. Instead, use this time to think through where you are now and where you want to be as things change - because they are changing. Whether it’s inflation, job changes, retirement, etc., your financial plan is always changing. This is why we review your plan every year!
Speaking of which, it has been two years for most of you because we were a little locked down last year. So, expect a call from us very soon. It’s time to get together with every single one of you. Aren’t you excited to spend 2-3 hours with us talking about money? That’s more fun than golf, right?
Until then, we wish all of you a wonderful weekend!
* Interesting inflation related factoid- when my dad was born, a US first class stamp cost 3 cents.
-Your proud math geeks at MORWM
Matthew Ramer, AIF®
Principal, Financial Advisor
MOR Wealth Management, LLC
1801 Market Street, Suite 2435
Philadelphia, PA 19103
P: 267.930-8301 | c: 215-694-4784 | f: 267.284.4847 |
601 21st Street, Suite 300
Vero Beach, FL 32960
email@example.com | www.morwm.com
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