The Beginner's Guide to Inflation
Updated: Feb 10
America's Historic Inflation Levels in 2022
If you watch any sort of mainstream media these days, or are friends with a grandparent on Facebook, you’ll see that American seems to be in some sort of inflationary economic crisis. Inflation is one of those economic concepts that you can bring up at the dinner table and half of the people will think you’re smart, and the other half will think you’re full of shit. 99% of the time, you are. Inflation is a concept that in our head makes sense, but when you break it down, it starts to get more and more abstract. Today, I’m going to break down exactly what inflation is, what it isn’t, where America stands today and how that relates to other times in history. Let’s go!
What Is Inflation?
Inflation is the difference in the cost of goods and services from their prices the year before, and is measured as a percentage increase (inflation) or decrease (deflation). Inflation can stem from supply chain shortages, rising wages or federal economic policies.
What is an Example of Inflation?
The best way to think about inflation is a trip to the grocery store. You wander from week to week and see that maybe the artisan oatmilk you’ve been buying went from $7 a gallon to $7.50. While that price rose, maybe your hand-rolled grain bread fell from $3 to $2.50 a loaf. Is that inflation? No, that’s just some things rising and some things falling for any number of reasons. Maybe the oatmilk company had a bad quarter and is raising prices to boost profits, but there’s a wheat surplus and the price of the bread fell. It can be any number of reasons, but they are typically unrelated in nature and are temporary.
But let’s say a month later, the milk and bread are more expensive, but so is the bag of avocados and also the gas you get on the way home. Now we’re getting somewhere. Inflation is when the prices of many different things begin to rise at the same time, and then continue to rise.
So back to the store. Let’s say you now notice that all of the milk is more expensive. This is actually tracked professionally by governmental statisticians, and put into an index for that item. You’ve just stumbled upon “The Milk Index” and that is a column on a spreadsheet somewhere in a brown and grey cubicle that belongs to the federal government. An index can be applied to literally any item, since an index is just a collection of prices for similar items. Grocery indexes, gas indexes, even index that track employee wages are all measured against historically reference points, which is how you measure inflation as a number. The primary index used to measure year-over-year general change is the “Consumer Price Index” or CPI. While the index doesn’t measure inflation as a metric, the difference between the index from last year to this year provides the number that we call “inflation.”
Is Inflation Bad?
It definitely can be, but generally: no. Here’s why – because humans are stupid. When we see prices increase, that can actually change human behavior to buy more, because we think that the price will continue to rise and the price it is right now will be a bargain in a few months or years. This increases the demand in the market, actually driving sales and increasing production and driving the economy forward. The economic machine
requires small amounts of annual inflation in order to continue growing and thriving, but it’s a balancing act, with the plate spinner in question called the Federal Reserve. The ringleader of this circus is Federal Reserve Chairman Jerome Powell.
Sometimes, inflation can run too hot. Due to rapidly rising demand, prices can spiral higher without the wage growth there to meet it, causing the world to just generally get more expensive. In rare cases, prices can accelerate upward effectively without stopping, causing “hyperinflation.” This is what happened to Germany after World War 1, when a loaf of bread ran from 250 Marks in January 1923 to 200,000 in November of that same year. Money became essentially worthless, which brought Germany to the brink of collapse prior to the election of their next chancellor, Adolf Hitler, who ran partially on a platform of ending the hyperinflation. So how do governments fight inflation? Interest rates! When inflation gets too high for too long, the Federal Reserve (and other central banks around the world) will raise interest rates. This tends to slow spending down for the average consumer: mortgages get more expensive, savings account rates get higher which means you get paid more to save, and things tend to slow down. When inflation lowers too much, the Fed will lower interest rates to stimulate the economy and avoid “deflation,” or the slowdown of spending to the point where demand far outstrips supply.
The last major term on the inflation bingo card is “stagflation,” which is a term that makes economists shake in their boots like there’s an earthquake in Nashville. Stagflation is a period of intense and rapid inflation, coupled with an otherwise weak economy. The US has actually experienced two bouts of stagflation, once in the 70’s and again in the 80’s. During these periods, the US actually saw inflation over 10% year-over-year.
Where Is America Now?
That’s the thing: we really aren’t sure. And I don’t mean “we” as in “me,” this guy you found online. I mean “we” as in there’s a turf war going on between economists, Congress and the Federal Reserve. The truth is, we haven’t had a situation like this before. We had a world-altering pandemic in 2020 that shut the world down (just in case you missed it), throwing all of our reference points completely out the window. Year-over-year comparisons are tough because of the outlier that was last year, so we’re at a bit of a loss as to next steps.
The current state of affairs was released on February 10 in the latest quarterly edition of the CPI, which stated the U.S was experiencing 7.5% inflation. Not great. The factors contributing to this are a few fold:
The sudden shock of job loss due to the pandemic, followed by a roaring job market and a sudden labor shortage
The cost of building materials, leading to a skyrocketing housing market
The incredible turnaround of the stock market, generating insane wealth to those holding assets in the shortest bear market since WWII
President Trump’s trade-war with China has now led to a shortage of micro-chips, including those that are built into new cars. This has directly led to an unbelievable run on used cars, seeing historic increases in their value
We have been printing money non-stop, with the Fed pumping billions of dollars into bond-buying programs
These reasons have led to the turf war I mentioned earlier. You have a group of economists, along with Congress, criticizing the Federal Reserve for its bond buying
programs and pumping massive amounts of money into the economy. Then you have the Federal Reserve and another group of economists pushing back, referring to the current inflation as “transitory” due to the reasons I listed above and will naturally pass.
The good news here is that the Fed has the tools to fix it if it is sustained. Though in the last meeting of the Fed, Powell mentioned that they don’t plan on raising rates until 2023, they could move that date up if needed to slow down price growth. The other good news is that what comes up, must come down, and nowhere have we seen that more rapidly proven correct than the lumber market. Over the last 14 weeks, the Lumber Index (now you know what that is) has fallen 70%, causing home prices to begin to tick down.
Let's Compare This To Venezuela
7.5% is not great. As mentioned earlier, a little inflation goes a long way, but this is…high. However, it’s nothing compared to other times in history. I mentioned American Stagflation in the 1900’s that saw over 10% year-over-year inflation, as well as post-WWI Germany. Well if you know an aggressive conservative in your life, you’ve probably been regaled with the story of “Socialist Venezuela.” If not, let me enlighten you.
Venezuela is a country in economic crisis. In a state of turmoil both politically and socioeconomically, the country has been a hamster wheel since 1983. Inflation has increased there each year, eventually becoming the highest in the world in 2014 under Nicholas Maduro at 69%. From there, it gets much, much worse. 2015 leapt to 181% inflation. From 2015-2016, it was 800%. 2017 reached 4,000%, followed by 2018 at 1.7 million percent, which is when the Venezuelan government threw its hands up, said “screw it” and stopped publishing official inflation rates. Since 2016, estimates put their inflation at around 53,798,500%. The International Monetary Fund estimated that the number is closer to 10,000,000% through 2019. So what happened?
The 1980’s saw a historic collapse in the price of oil, a key export for Venezuela. This caused a shock contraction of the economy and a spike in inflation (the signs of stagflation for all of you paying attention). Following this, the country saw a banking meltdown in 1994, plunging the GDP of the country and shocking the poverty line. 66% of the country was in poverty by 1995 and the average annual salary was back to early 1970’s levels. Corruption and currency manipulation followed, plunging the country further and further into hyperinflation, from which it has never recovered.
The Bottom Line
Again, 7.5% is not a great number, but pull back the magnifying glass and you’ll see it’s not exactly Armageddon. The Venezuelan example is the most extreme in modern history and necessitated multiple short-term economic collapses and a scandalous executive branch in order to capitulate the way that it did. The decrease of the lumber index, and the overall rising wages in the all of a sudden hyper-competitive job market are good signs of subsiding inflation, but we aren’t out of the woods yet.
Where do you think we're headed? More inflation? Or do you think it'll pass? Let me know in the comments below. Thanks for reading!