Inflation surged above 9% recently, its highest rate in more than 40 years. Household budgets are being strained…savings are being decimated. Add in the steep stock market losses of the first half of 2022, and millions of people who felt financially comfortable just a year ago are wondering whether their retirement plans remain on track. Americans haven’t had to worry about inflation for quite some time—the last stretch of persistently steep inflation ended in the early 1980s. David Stockman, then director of the Office of Management and Budget, helped the US climb out of that inflationary rut. Bottom Line Personal asked him what he expects this time around…
The roots of this inflation run deep, and there is no easy solution. In 2020, the inflation rate was just 1.7%, and rates had remained largely below 2% for a decade. That created the impression that today’s steep inflation is entirely the result of everything that has happened since 2020—a global pandemic that disrupted supply chains…pandemic-era government programs that dumped massive amounts of money into the economy…and the war in Ukraine that undermined commodity markets.
Reality: The US Federal Reserve and other nations’ central banks have been setting the stage for this inflation for decades. During the 10 to 20 years before the pandemic, the Fed and many of the world’s other central banks engaged in extremely loose monetary policy designed to encourage growth. The Fed wanted to spur inflation—it set 2% annual inflation as its target and considered the sub-2% rates common in the 2010s troublingly low. The Fed argues that too-low inflation can weaken the economy, in part because it leads to low interest rates that undermine the government’s ability to boost the economy and employment by lowering interest rates during economic downturns.
What the Fed should have given greater consideration was that inflation was below its 2% target only because it was being held down by the off-shoring of manufacturing from the US and other first-world nations to China and other low-cost countries. The price of durable goods fell an astounding 40% between 1995 and 2019, obscuring the inflation that existed elsewhere in the economy. Example: The inflation rate in services was 2.5% or 2.6% between 2012 and 2019, well above the Fed’s 2% target—yet the Fed kept its foot on the gas. It took the pandemic and the war in Ukraine to push inflation above 9%, but even without those events, inflation was certain to rebound. The off-shoring of manufacturing offsets inflation elsewhere in the economy only during the transitional phase while manufacturing is moving overseas—falling prices created by shifting from high-cost domestic production to low-cost foreign production balances the rising prices of services that cannot be off-shored.
Once that process was essentially complete—and thanks to the Fed’s decades of loose monetary policy—there was no question that inflation would come roaring back…it was just a matter of when. Inflation rates aren’t going to fall back to where they were this last decade even if supply chains return to normal and the war in Ukraine ends.
Don’t be fooled by the modest decrease in gas prices, from a peak above $5 down to $3.94. Gas prices are among the first things consumers notice in times of inflation, but commodity energy prices make up only about 5% of the Consumer Price Index (CPI), a key inflation measure. The majority of the CPI consists of shelter and services, areas where prices continue to climb.
The Fed’s 2022 interest rate hikes are only the beginning—rates likely will have to be increased by 100 basis points several more times in 2023 before inflation is under control. Those increases not only will drive the US into recession—if it isn’t in one already—they will crash Main Street and Wall Street.
Stockman’s prediction: We’re headed for stagflation—steep inflation with high unemployment and low demand for goods and services. Some analysts question whether the Fed has the willpower to continue increasing interest rates as unemployment rises and the economy shrinks, but the Fed strongly believes its 2% inflation target is a priority.
Here’s how this inflation could affect aspects of our lives in years ahead…
Prediction: Inflation will prove especially persistent with services. The rising cost of some durable goods and commodities could start to ease as supply chains recover, but prices are likely to continue to climb in labor-intensive sectors such as health care, travel and restaurants, as employers struggle to find people willing to work for entry-level wages. Retirees will be among the biggest losers, because they spend an especially large share of their budgets on health care and travel. What to do…
Replace pricey labor-intensive services—perhaps a robotic mower could substitute for a weekly visit from a landscaping company, for example.
Scale back travel plans.
Review health insurance or Medicare/Medicare Advantage/Medigap options to confirm that your coverage is appropriate for your needs. Health-care costs are likely to climb sharply—this would be a bad time to discover that one of your providers isn’t in-network or your plan has a high out-of-pocket maximum.
Prediction: Real estate won’t provide the inflation protection it did in the 1970s. Home values more than doubled during the 1970s. That’s why some people believe real estate is a smart hedge against today’s inflation. It isn’t. Home values fared well in the 1970s because homes were reasonably priced when the decade began—the average price of homes sold in 1970 was $27,000, less than three times the median household income of $9,870. But in early 2022, the average home sales price was $525,000, nearly six times the median household income of $90,000. Because homes are already quite expensive, it’s unlikely that they will continue to increase significantly in value in the years ahead as they did in the 1970s. Also, the tax benefits of home ownership are less substantial now than in the 1970s. What to do…
Don’t buy real estate as an inflation hedge. In fact, downsizing to a smaller home might be prudent, depending on your housing needs and budget.
Prediction: Stock market losses will continue. Stocks recovered some of their first-half losses in July, as investors became optimistic that the worst of the Fed’s interest rate hikes were behind us. Don’t believe it. Interest rate increases will continue, and further stock and bond market losses are among the likely consequences. This is not the time to “buy on the dip.” What to do…
Consider Treasury Inflation-Protected Securities (TIPS) and gold. These bonds provide a modest return but are indexed to keep pace with inflation. Gold is a hedge against market risk—it’s likely to preserve its value and could appreciate as investors realize that stock and bond market losses are not over.
Prediction: Hiring soon will give way to firing. Some prominent companies, including Tesla and Netflix, already have announced job cuts, and many more layoff announcements will follow. When recessions arrive, downsizing inevitably follows. What to do…
If you have a stable job, don’t leave it. Job hopping has been a savvy career move in recent years, but recently hired employees often are the first to be let go.
Remind your employer of your value—don’t look for greener pastures.
If you do explore the job market, target employers that seem stable. Don’t just jump at an attractive pay package.
Prediction: Social Security’s inflation protection won’t really keep pace with the cost of living. The good news—Social Security benefits are adjusted to keep pace with inflation. The bad news—Social Security’s cost of living adjustments (COLAs) are based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which doesn’t accurately reflect the average retiree’s spending. Most retirees spend a disproportionate share of their income on medical costs and travel, as well as on housing-related expenses—all costs that seem likely to continue to increase faster than the overall rate of inflation. What to do…
If you’re receiving Social Security benefits, the sizeable cost-of-living increase you receive in 2023 should help you cope with inflation, but don’t expect it to provide a complete solution. You still might have to reduce your spending and make other adjustments.
