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Inflation is the number one topic on the minds of nearly everyone right now.
The prevailing idea is that the Federal Reserve is the cause of and the solution to inflation. The reasoning goes something like this: in response to the COVID-19 pandemic, the Fed dropped interest rates to zero and started printing trillions of dollars, flooding the world with cheap capital. Printing so many dollars devalues the currency and its purchasing power, sending prices higher for essentially everything.
But there are some important holes in that argument.
For starters, if there are too many dollars floating around and the currency has lost its value, then why is the US Dollar at multi-year highs relative to other currencies? Shouldn’t the value of the Dollar be low right now?
Similarly, Gold has typically been seen as a hedge against inflation. This has been the case for hundreds of years. So with inflation at 40 year highs, why has gold fallen so much in 2022?
And finally, the Fed has been printing trillions of dollars for more than a decade, why do we only suddenly have inflation now?
The answer? In response to COVID-19, we shut down the services side of the economy (restaurants, travel, etc.), Congress mailed out $3 trillion in checks & debit cards, and people could only spend the money on goods.
Look at what happened to durable goods prices in 2020 and 2021:
After decades of falling prices in home appliances and furniture, a sudden demand shock. But in the second half of 2022, the rate of change in price is starting to slow down.
After two years of outsized spending on durable goods, many of us have bought all the goods we intended to buy. And now people are feeling more comfortable going out to restaurants and traveling. So look at what’s happening to goods inflation vs. services inflation.
What we are experiencing isn’t the typical kind of inflation you read about in economics textbooks (and hopefully you’re reading something more interesting than that!).
Instead, just as spending shifted dramatically from goods to services over the last few months, so has inflation. These rolling changes in spending creates rolling inflation—not the economy-wide inflation last seen in the 1970’s.
Now that prices are falling in the segments that were first affected, we should expect service prices to begin to follow suit over the next many months. That won’t happen overnight.