Inflation
/By: Drew Hanessian
$6.00 gas, anyone?
The mighty yet humble dollar has seen plenty of ups and downs over its 229-year history. From a standard of 25.8 gold grains to management by the Federal Reserve, the dollar has changed gradually but dramatically in both form and function. Becoming the de facto global reserve currency in the post-World War II era, the United States and its citizens have enjoyed decades of unsurpassed purchasing power throughout the world. But does inflation put that all at risk?
There’s been a lot in the news about the higher than normal rate of inflation this year, over 5% for the first time in over 30 years. So what is it? Do we need to worry? And if so, what steps can we take?
What Is Inflation, Anyway?
Much like anything else, money responds to the laws of supply and demand. The more dollars demanded by consumers and governments around the world, the higher the value of the dollar. Similarly, a greater supply of money will result in less demand for them, driving down the price of the currency. When fewer dollars are in demand or there are more of them available, it takes more dollars to buy the same stuff.
Demand for dollars has been relatively steady compared to other currencies, but there have been a lot more of them in the system lately. With the United States and other nations pushing out massive amounts of stimulus spending in the wake of the Covid-19 pandemic, one measure of money supply (see image below) shows that since March 2020, the US has gone from about $6 trillion in circulation to over $7.5 trillion, a 25% increase. There’s simply more money out there, looking for a place to go. As travel restrictions ease, many of us are looking to “go” quite literally, leading to even higher than average increases in the prices of cars, plane tickets, and hotels.
M2 Money Supply
Do We Need to Worry?
Expectations also tend to compound reality. If we start to expect more inflation, we as consumers tend to try to stock up and pull our future spending into the present, increasing prices even further. Inflation becomes a self-fulfilling prophecy. So what can be done?
The Federal Reserve controls how much money is in circulation, and operates independently from other branches of government under two mandates: full employment for U.S. adults and stable inflation (targeting an average of 2%). During recessions, the Fed makes money much easier to obtain by lowering the rate at which banks borrow money from them, and recently by also buying up assets such as mortgage-backed securities (this is partly why you might have been able to get a really good mortgage or refinance rate!). The hope is that with more money in the economy, businesses will expand and hire more workers.
To control inflation, they can do the opposite: stop buying assets and start selling them back into the market, as well as raise interest rates. This makes borrowing more expensive and, thus, lending and business activity will tend to drop.
So far, Federal Reserve chairman Jerome Powell has indicated that the current level of inflation is simply a result of bouncing back from the disruption of 2020 and that it’s even a good signal in that it shows demand increasing and the overall economy strengthening. While runaway inflation isn’t something the Fed thinks is imminent, they have indicated that they may start increasing interest rates sooner than they otherwise might have - a sign that they’re keeping an eye on things.
What Steps Can We Take?
If inflation does proceed to much higher levels and triggers significant interest rate increases, we can expect a correction in the stock market and perhaps disruption in the job market as well. But those aren’t reasons not to invest!
Our take: The best way to deal with the potential for inflation is to set your asset allocation in accordance with your risk tolerance/time horizon and ensure you have funds on hand to cover short-, medium-, and long-term expenses as they arise.
One additional step you could take is to buy Treasury-issued Series-I bonds. These are inflation-protected bonds issued by the U.S. Government. Some quick facts:
The interest rate is updated to reflect inflation every 6 months. For May - October 2021, the rate was 3.54%. For the next six months, the rate will exceed 7%.
You can buy a maximum of $10,000 per person (or entity) per year.
They are 30-year bonds but can be cashed out after only one year.
If cashed out before 5 years, three months of interest is surrendered.
The earnings are exempt from local and state income taxes.
The earnings can be exempt from federal income tax if used for qualifying educational expenses (subject to income limits).
One of the only downsides is it is difficult and clunky to navigate the government’s website. You can purchase them directly by opening an account at TreasuryDirect.gov.
Pro Tip: To increase the return on the cash you hold in your emergency fund, consider putting half of your emergency fund in a high-yield savings account and up to half of it in I-Bonds.
If you’re not sure about your current asset allocation, savings level, or you have questions about anything else, schedule a call with the BPFP team to discuss your options!
Team Spotlight:
Drew Hanessian, MBA
Drew joined the Ballast Point team in March 2021. He lives in San Diego, CA with his wife, Tristany, one-year-old daughter, Emilia, and the most laid-back cat in the world, Crash.
This time of year is when he really misses Upstate NY for its crisp fall weather and apple-based desserts. He does not, however, miss the (6 months) of winter and cherishes his time on the West Coast.
Drew is excited to be on the path to becoming a lead planner for Ballast Point and is preparing to sit for the CFP exam in March 2022.
