Inflation or Deflation?

By Eric Reich

We have certainly all felt the effects of the highest inflation we have seen in nearly 50 years. We have felt it in everything from gas prices, food prices and nearly everything else we buy. Inflation, however, is far more of a problem than just some higher prices. Untamed inflation can have a disastrous effect on the economy.

So what is inflation and how does it happen? Inflation can be defined as the rise in prices over time. It can also be the decrease in purchasing power over time. As prices rise over time, it takes more dollars to buy the same amount of something. Therefore, each dollar you have is worth less than it was before. It is the goal of the Federal Reserve to maintain inflation at a rate of roughly 2.5%. A small amount of inflation is good for the economy. Too much inflation though can cause economic hardships for those on a fixed income or low wage earners. They are least able to handle a dramatic rise in prices. When people have less disposable income, they are forced to make choices on where to cut back spending. Those cutbacks are usually discretionary expenses like eating out or luxury purchases. This in turn causes the economy as a whole to decline which can lead to higher unemployment, etc.

One of the more obvious causes of the recent rise in inflation has been the Fed’s policy of easy money, seemingly endless stimulus packages, extended unemployment, etc. We should not have expected that these mostly unnecessary efforts would have no effect on the future of the economy, and we are now paying that price. The Fed’s inability to act sooner I believe has contributed to the magnitude of inflation we are now experiencing. The good news, is that the Fed now seems to have a good handle on how bad the situation is and has been aggressively increasing interest rates in order to slow the economy and inflation. We have seen multiple 0.75% consecutive interest rate hikes in the last few months. This is intended to make the cost of borrowing money more expensive, thereby slowing business spending, and ultimately slowing down the economy.

But is the Fed going too far too fast? The difficulty for the Fed is that they have to wait for last month’s data to make decisions about what to do going forward. If they raise rates and next month inflation is still high, as we have seen, then the raise rates again and keep repeating the cycle. My concern, however, is that they aren’t pausing long enough to see if the rate hikes are actually working. It seems as though they are compensating for starting to raise rates too late by raising them too fast now. We should not expect the rate increases to have an instant effect on inflation. Recently, the noise in the economic community is getting louder that perhaps the Fed is moving so fast that they are going to severely damage the economy at the current rate of interest rate increases. I happen to be in agreement with this crowd. I believe that the Fed, if they aren’t taking time to pause runs the risk of creating a deflationary environment which is worse than inflation.

Deflation is the opposite of inflation. It’s when prices for everything drop. This might sound good, but it isn’t. The price of goods, wages, etc. should all trend up over time. A contraction of the economy is not healthy.  At the very least, we could be looking at stagflation which is when inflation runs high but the economy is not growing. Stagflation plagued Japan for 20 years. This is not something we want to see in the U.S.

Overall, I’d say the Fed has done a terrible job at managing the economy. They are struggling to fix inflation that they in large part created themselves. Sadly, we are the ones paying the price. My hope is that the Fed pause to access the effects of the interest rate increases and sees the obvious global slowdown that is occurring when making future interest rate decisions. For now, I think the current path will continue, so I would expect to see interest rates rise above 4% and even as high as 4.5% in the coming year before the Fed starts to go the other way and cut rates.

I do expect to see rate cuts happen next year which means those who have not refinanced or purchased a home might still get a chance at reasonable rates in the future. Until then, we will keep an eye on the Fed’s decisions and continue to relay what the effects on you and your money might be.

The information contained in this message may be CONFIDENTIAL and is for the intended addressee only. Any unauthorized use, dissemination of the information, or copying of this message is prohibited. If you are not the intended addressee, please notify the Broker/Dealer immediately and delete this message.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS.  Click here to view Form CRS. 

Eric is President and founder of Reich Asset Management, LLC. He relies on his 25 years of experience to help clients have an enjoyable retirement.  He is a Certified Financial Planner™ and Certified Investment Management AnalystSM (CIMA®) and has earned his Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®) designations. A lifelong resident of Cape May County, Eric resides in Seaville, NJ with his wife Chrissy and their sons ,CJ and Cooper, and daughter Riley.

Facebook
Twitter
LinkedIn
Pinterest
RECENT POSTS