While this sudden jump may be concerning, the inflation from October 2019 to October 2020 was just 1.2%, so the two-year inflation was about 3.7% on an annualized basis. Although inflation is higher than average, it is nowhere near hyperinflation territory.
In this chart, you can see how much prices have jumped year over year. Generally, the cost of goods is still higher across the board but it varies between categories.
What is Causing Inflation?
Right now, we are experiencing higher inflation than average. Much of this can be attributed to the aftermath of the pandemic. Here are a few of the main reasons:
1. Supply Chain
The shutdowns during the pandemic disrupted our supply chain. And now the pent up demand following the pandemic has made things worse.
Recently, over a hundred container ships were waiting to unload in the ports of California. Before the pandemic, it was unusual for any ships to wait offshore.
The semiconductor supply chain is having negative effects on numerous industries. Auto prices have rocketed upward because of the lack of chips. Apple is set to cut production goals due to the chip shortage as well.
Businesses have a strong profit incentive to fix their supply chain. The problem is it will likely take more than a year to figure out, rather than a few months.
2. Labor Shortage
There are fewer workers in the labor market than before the pandemic.
Job openings hit an all- time high of almost 11 million openings. The quit rate, which measures the number of people who voluntarily resign, is at the highest it’s been since December 2000.
Part of the shortage could be due to household finances being in better shape than ever before. A large part of this is people were given unemployment insurance and stimulus checks.
The personal savings rate jumped to all-time highs during the pandemic and has continued to drop since then.
As people continue to deplete their savings, they will need to go back to work. I think this is a good sign for the labor force going forward.
3. Base Effects
Comparing prices to last year can be deceiving. Prices dropped considerably in 2020 as state government-imposed lockdowns which reduced demand and disrupted our supply chain. So, any year over year comparison will most likely look huge.
For example, the price of gasoline has jumped the most over the past year: up 51%. But if you looked at the past decade, gas has largely gone nowhere. Gas is still 16% lower than its 2008 high.
I wouldn’t be surprised if prices come closer to the long-term averages over the next year as the pent-up demand subsidizes.
How to Combat Inflation?
To combat inflation, you can’t rely on savings in your bank account. You need to invest in assets that have the potential to outpace the rate of inflation. Investing is not just about building wealth, it’s also to prevent destroying wealth due to inflation.
Types of assets that have done well historically are equities (stocks) and real estate, which makes sense because these assets are based on payments made to businesses or landowners.
Equities (stocks) can sell their goods at higher prices, which lead to higher revenue, earnings, and stock prices. Think of it this way, if every ingredient in your Chipotle burrito cost more, then Chipotle will charge more for the burrito.
Businesses tend to retain their value during inflationary periods because they can push inflation (higher prices) to their consumers.
Another strategy is to take on debt. It has never been a better time to be a borrower.
The rate on a 30-year mortgage is roughly 3% while inflation is around 6%. If inflation stays high, the payments you make on your mortgage will shrink (in real terms) over time.
This strategy is not for everyone. It may or may not be a good idea based on your financial position.
In my opinion, it’s best to keep it simple and own an appropriate amount of equities (stocks) and real estate based on your personal situation and goals.
The Federal Reserve exists to do two things: ensure modest inflation and work towards full employment. In other words, the Fed wants some inflation. This is part of the reason everyone needs a portion of their portfolio in a growth component.
Your investments should always match your timeline and needs. Make sure you are covered in the short term and that you invest to outpace inflation long-term.
Real return is what is earned on an investment after accounting for taxes and inflation.
Disclaimers and Sources:
Why Do Prices Keep Going Up and What’s the Cause of Inflation? Link here
Inflation 6.2% in October: Link here
Apple Set to Cut Production: Link here
Inflation Chart: Link here
Personal Savings Chart: Link here
Has there ever been a better time to be a borrower? Link here
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