As supply chain disruptions worsen in today’s economy, we’re all hearing a lot about inflation. But keep in mind that while inflation is often used to mean any increase in prices, not all inflation is the same. Today’s economic environment requires a clear understanding of what’s driving prices higher. More importantly, it can affect portfolios and financial plans in different ways.
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Supply chain disruptions are pushing prices higher
It’s natural for the prices of goods and services to be affected by supply and demand. Common sense tells us that when supply falls or demand rises, prices will tend to rise. This is true whether we’re talking about cars, lumber, houses, computers, sneakers, or concert tickets.
In cases where the availability of an item is disrupted, there can be a so-called “deadweight loss” to society since there are willing buyers who miss out. Recent examples are toilet paper and hand sanitizer at the start of the pandemic when a surge in demand caused widespread shortages. Governments and businesses can try to control prices or impose quotas but this doesn’t solve the underlying problem and can create its own imbalances.
Consumers expect higher rates of inflation in the coming years
Today’s situation is unique
While challenging, few economists would describe the situations above as “inflationary” – it’s just how businesses and markets work. Instead, the term inflation is meant to mean a broad increase in prices across an economy. In other words, it describes a situation where all prices you pay are increasing. Historically, these price increases are attributed to factors that can affect the macro-economy, like monetary policy or an overheating growth rate.
This is what makes today’s situation unique. Prices are rising across the board not necessarily because of the Fed or general economic growth, but because bottlenecks in today’s global world affect nearly all industries. This is not dissimilar to the oil crisis of the 1970s. Just as there is no way to avoid higher energy costs, there is no way to avoid long delays for the materials and supplies that businesses and consumers need. It both reduces the availability of goods and raise costs.
What can investors do to help manage risk?
For all of the reasons cited above, when investors talk about “inflation” today, what they probably mean is “supply chain disruptions.” How this is resolved requires a combination of macro forces related to global energy and port capacity, and micro forces on an industry-by-industry basis.
For savers, inflation slowly erodes the value of hard-earned cash. If your daily purchases cost more, it doesn’t really matter if it’s due to factory shutdowns in Asia or the size of the Fed’s balance sheet — the effect on a household’s bottom line is the same. Unlike traditional gains and losses which are clearly spelled-out on a monthly statement, the balance in one’s checking account may stay the same. However, the amount of goods and services that can be purchased with that cash will fall silently over time.
Ultimately, it’s important for investors to maintain perspective on what’s causing today’s price increases. Inflation is a reason to stay invested to preserve the purchasing power of one’s hard-earned cash.
This material, as well as the insights and data within, have been provided to MoneyLion by Clearnomics, Inc.
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