If you’ve been following the news recently,
Chances are that you’ve heard the financial experts and economists talking about inflation and its impacts. While they make it sound like something to worry about, they never really explain the basics and why you should be concerned.
That’s where this article comes in. Today, we’ll discuss what inflation is, why to be concerned, and how it can impact wealth building.
Let’s get started…………..
What Is Inflation?
Inflation is defined as a rise in the general price levels of many goods and services such as housing, food, transportation, fuel, and clothes / apparel. Inflation also decreases the purchasing power of your hard-earned dollars. If it feels like your dollar isn’t going as far as it used to, it’s not your imagination. The reason is inflation………..
The impacts of inflation can be seen not only in the short-term but over decades as well. Inflation is a broad increase in prices across a sector or across several sectors (i.e., automotive, transportation, oil / energy, etc.) that will ultimately affect a country’s economy.
Most economists consider a small, controlled amount of inflation a sign of a healthy economy. A moderate inflation rate encourages spending and investing today rather than stuffing your money in walls and watching its value diminish.
However, inflation can be a destructive force in the economy when it is allowed to get out of hand and rise dramatically. In fact, unchecked inflation can topple a country’s economy. A great example was in 2018 when Venezuela’s inflation rate was more than 1,000,000%! It caused their economy to collapse and forced people to flee the country.
Unchecked inflation can not only topple a country, but it can wreak havoc on your ability to build wealth.
How Does Inflation Impact Wealth Building?
Rising rates impacts wealth building two-fold. First, it erodes the buying power of money causing higher prices and more expensive borrowing. Second, rising rates force you to either take on more aggressive investments or save more to get the same results.
Rising inflation rates means you must spend more money to purchase the same goods or services. Rising rates also discourage spending since the hope is that inflation rates will lower in the future causing prices to lower and become more affordable.
Rising inflation rates also means that borrowing money just became a lot more expensive. For example, let’s say you wanted to upgrade your house and take on a larger mortgage. A few months ago, a 30-year fixed mortgage would have a rate of about 3.5%. Assume in a few months from now, the high inflation rate we are going though raises the mortgage rates to over 4.5%. This means you’ll have to spend tens of thousands of dollars more in interest to purchase the same size house. This causes your mortgage to increase sometimes hundreds of dollars a month.
When it involves your investments, inflation causes your money to work harder to obtain the same results that you’re used to. When prices rise, they rarely, if ever, go backwards.
To stay ahead of inflation, your investments must outperform the inflation rate and forces more aggressive investing. Aggressive investing usually means taking on more risk. If you use more conservative investments (i.e., bonds), the risk is that you’ll actually lose money over the long haul since inflation will outpace the rate of return earned on your investments.
This is why I call inflation the enemy of wealth building. While a little inflation is good for a healthy economy, high inflation really erodes it and can bring an economy and wealth building to a grinding halt.
What To Watch This Year
How did we get to this point of having the highest inflation rate in the past 40 years? Blame the pandemic.
In March of 2020 when the COVID-19 pandemic officially began in the U.S., it essentially pulled the plug on the U.S. economy. Factories shut down, airplane flights were cancelled, restaurants closed, stores were running out of everything, and even mail delivery started suffering delays.
On top of that, millions of people were laid off and confined to their homes to try to stop the spread of the virus. The unemployment rate shot up from 3.5% in February 2020 to over 15% a couple of months later. It was the sharpest economic contraction in U.S. history.
By late summer 2020, demand for consumer goods started to pick up but unemployment was still high. Congress and President Biden stepped in with a $1.9T stimulus bill that gave Americans plenty of cash to spend and unemployment stimulus to help them thru the tough times. Turns out, most Americans did not have an emergency fund to help them through times like this.
When vaccines came out and people started to go back to work, the demand for goods and services came back. Unfortunately, the supply chain had a tough time bouncing back from shutting down. When the plug is pulled on a global economy, you can’t just plug it back in and expect it to hum along like nothing ever happened. For example, cars require over 10,000 parts to be brought in to build cars. These parts come from factories all over the world. Getting those operations back online again takes time and a lot of syncing to make it successfully happen. It’s a symphony of parts that must come in at the right time in the right amount or a lot of mis-built cars can be made. Throw in labor shortages because of people getting sick with COVID and it takes even more time than people thought to get production up and running.
On top of that, suppliers had to find ways to keep their employees safe and have a job to come to. This caused some of them to explore new ways to bring in revenue.
For example, chip shortages have been rampant in the automotive industry. When COVID hit, the automotive industry did what any smart business would do. It shut down temporarily to mitigate losses.
As a result, demand for cars was driven up which is good for business. The problem was that chip suppliers also have employees to take care of. Since the automotive industry shut down, they had to pivot to new businesses with their surplus supply. They signed contracts with electronics, appliances, and cell phone manufacturers to supply them with their increasing demand as well. Even though the automotive industry is ready to ramp up to full capacity, they can’t because they do not have enough parts to build cars with.
This type of high demand and lack of supply in the global supply chain is driving up prices across the economy. Economists describe inflation as too much money chasing too few goods. This is exactly what is happening today.
Inflation is:
High Demand + Limited Supply = High Prices
But when you have:
High Demand + Limited Supply + Production Delays = You Get REALLY High Prices!
Some people think this surge in inflation is temporary while other believe inflation will occur long-term. IMO, it doesn’t look like the inflation rate will lower anytime soon.
Inflation Factors To Watch in 2022
Here are a few other things that may impact inflation in 2022:
Supply Chain Bottlenecks
Policymakers’ top priority for 2022 is to unclog the supply chain bottlenecks in order to get goods moving at their pre-pandemic rates. It’s easier said than done and there is no telling what kind of supply system shocks may occur this year that could set back progress.
Federal Reserve Monetary Policy
Currently, the Fed has committed to tightening monetary policy by raising interest rates in order to slow inflation’s pace. Recent policy changes may allow for inflation to “run hot” more so than in years past. It will be interesting to see how The Fed reacts throughout the year to rising inflation.
Also, the Fed is also planning on dialing back on the emergency stimulus they have used for the past couple of years. The intent is to allow the economy to stand up on its own financial legs.
The idea is that by making the borrowing of money more expensive it takes the heat off price increases and brings the economy back to the gentle simmer we have been experiencing over the past decade.
Whether it works remains to be seen and is worth watching this year.
Energy Prices and EV Development
Oil is vital for producing and transporting goods and its demand is closely related to economic activity. Recently oil and gas prices have been rising reflecting the tighter supply chain and higher demand.
On the flip side, automakers are pulling ahead production expectations of electric vehicles. How this affects oil and gas prices is something to watch the rest of this year.
Consumer Goods
Inflation erodes the average person’s purchasing power. You can expect to pay more for goods and services this year. Essentials like food, gas, utilities, clothing, and rent are expected to increase a lot this year.
This means that your paycheck is not going as far as it once did. Even after being pent up for 2+ years, it is going to be interesting to see how long the high demand will continue to occur and how high prices can go before people realize that they can’t afford what they are buying.
A great group to keep an eye on this year is the rich and ultra-rich. They tend to be ahead of the times and more in tune what might be occurring with the economy.
In fact, many people, including the ultra-rich, are bracing for the worst.
What are the ultra-rich doing to prepare for long-term inflation? Let’s dig into that next.
What The Ultra-Rich Are Doing
Rising inflation is playing a big part in how the ultra-rich are investing in 2022. They want to preserve their assets in this time of uncertainty.
They are developing inflation resistant portfolios that hedge inflation while investing in future growth opportunities. They are also looking into alternative investments and energy alternatives for new investing opportunities.
Watching how the ultra- rich manage finances can be a key insight into how we can manage our own finances in the coming year.
In The Next Article…….
We’ll dig into how inflation impacts investing, the mistakes the ultra – rich do not make, and finally break down specifically what the ultra-rich are investing in for 2022 and beyond. You won’t want to miss it! 😊
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Until next time……
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