June 12, 2021
Publisher Trish Regan has been pounding the table on inflation for months now… And today, we’re sharing an essay from American Consequences contributor Dr. David “Doc” Eifrig that details a familiar topic.
Doc has one of the most impressive resumes of anyone we know in this industry… After spending a decade on Wall Street, he quit his vice president position to become a doctor – earning his MD with clinical honors and becoming a board-certified eye surgeon.
Then, retiring a second time, Doc brought his incredible health and wealth expertise to Stansberry Research.
This Threat Is Coming After Your Portfolio
by Dr. David Eifrig
As long as we have money, we’ll have inflation…
And inflation hampers those who live on savings and generate income from wealth. If you have planned to earn a certain amount per year from investments, that same amount is now worth less.
When an indebted government inflates a currency and makes it easier to pay what it owes, the lender suffers by receiving a payment worth less. As an investor, you are a lender when you put money into bonds in exchange for interest, or into stocks in exchange for an equity stake.
Another concern is that while inflation has threatened to rise since 2013… we still haven’t seen a true inflation disaster.
Low-interest rates and an increasing money supply set up some of the conditions for inflation – but it didn’t happen. And that’s as we predicted. We bet that inflation wouldn’t come when we started in 2013, so we spent more time worrying about deflation until around 2015. Inflation has remained low ever since the financial crisis of 2008 to 2009.
In 2019, we did predict that inflation would start to creep in… We were right again, as expected-inflation levels almost broke 2%. But when the COVID-19 pandemic struck, the economic calamity pushed expectations almost toward deflation.
That’s where we are now. And though expectations are high (by recent historical standards), we think that all the conditions are in place for inflation to buck up and sustainable levels greater than 3%.
Now, let’s clarify… At this point, we’re not fearing hyperinflation – the phenomenon by which runaway prices turn a currency worthless. Our modern monetary system isn’t perfect, but policymakers have a simple remedy for inflation: higher interest rates.
Even so, the difference between 1% inflation and 4% inflation is significant. Due to the power of compounding, a $100 weekly grocery bill turns into $110 over 10 years at 1% inflation… or $148 at 4%. If you spread that across all of your daily costs, retirement gets a lot more expensive.
What’s more, the expectations for inflation will drive investment returns. When you expect inflation, you position yourself differently than you would if you expect deflation. And other investors doing the same thing will drive some investments to lead and others to lag.
In the most basic terms, the combination of a hot economy and an abundance of money leads to inflation. The relationships may not be as direct as Economics 101 tells you, but that’s where it comes from.
Today, we’d like to offer a practical walk-through of the current inflation statistics, show where they are, and demonstrate that the threat of inflation pushing to 3% or higher is very real… and already underway. And we’ll discuss how you should prepare your portfolio for it.
The wealth gap in America has never been wider — we’ve still never fully recovered from the Great Recession of 2008, and it’s only going to get worse from here. But the effects of the Big Con are going to devastate those who don’t take action. So do something now while you still can.
The Three Ways You Get Inflation
If you wanted to point to three sources of inflation, you’d look to accommodative monetary policy, expansionary fiscal policy, and a strong economy. There’s no question that we have the first two ingredients – and we think the third is about to kick in as well.
Let’s start with monetary policy. We don’t need to spend many pixels on charts or statistics here. The Federal Reserve is loose with money, and everyone knows it.
You can measure it by money supply, interest rates, or financial conditions. There’s a lot of money out there. It’s easy for corporations, banks, or homebuyers to borrow it, and that pushes asset prices higher.
We’ve covered in prior issues how an expanding money supply doesn’t automatically mean inflation. Money growth in excess of money demand does. Yes, the money supply has grown dramatically… But since the financial crisis, banks have held extra reserves, and corporations have beefed up their balance sheets. The money hadn’t made it out “into the system” so to speak.
So monetary policy alone didn’t create inflation. But now the government has stepped in.
The Trouble at the Capitol
No, we’re still not talking about guys in MAGA ballcaps. When no one is occupying its chambers, Congress controls fiscal policy – the taxing and spending of American wealth.
While the Fed’s control of monetary policy means it can tinker on the margins of important financial instruments, only fiscal policy can inject trillions of dollars in stimulus, or starve the country of government payments.
Today, the fiscal valves have been opened to full bore… The money is flowing.
Let’s start before the pandemic. Despite the booming economy, President Donald Trump (with the complicity of Congress) drove the nation deeper into debt. From 2016 to 2020, government tax revenues declined by $1.6 trillion from $17.6 trillion to $16 trillion. Meanwhile, total outlays rose from $20.5 trillion to $21 trillion in 2019. Once you add pandemic-related spending, outlays for 2020 came to a stunning $32 trillion.
This pushed the deficit to 2.9% of gross domestic product (“GDP”) in 2019, to say nothing of the 14.4% in 2020.
The Trump administration’s approach was counter to history. Typically, the deficit grows when the economy is weak and GDP declines, and then the government spends to help turn things around. Then, when the economy is strong, GDP expands and stimulus spending shrinks. The GDP gap measures the output of the economy against its full potential, which tells us how hot the economy is running.
The Trump administration actively broke this relationship. It’s the first extended period in six decades in which both the deficit and the economy grew together.
Now, with the pandemic, the gap has ramped much further.
You could spend a lifetime exploring the intricacies of the stimulus packages that Congress introduced, but let’s just try and look at the headline numbers to see how much money it pumped into the economy.
We’ll start with the $2.2 trillion CARES Act that Congress passed in March 2020. This included up to $349 billion in Paycheck Protection Program forgivable loans to businesses, an additional $600 per week in unemployment benefits, and $1,200 checks for many taxpayers.
Second, in December 2020, Congress passed an appropriations bill that funded the government and included roughly $900 billion in pandemic relief. That includes the much-talked-about $600 checks to most individuals, but more importantly, $600 weekly in extra unemployment benefits and $284 billion in forgivable small business loans.
That puts us at more than $3 trillion, but we can take back out about a half-trillion in funds that were earmarked but not utilized in various loan programs.
The American Rescue Plan passed in March added a $1.9 trillion addendum, with $1,400 checks.
Next up appears to be an infrastructure plan with a price tag between $500 billion and $1 trillion, depending on how you count it.
It’s possible this plan won’t make it through the 50/50 split Senate, but we suspect the Democrats can pass something still pass something substantial.
We’re going to come back to judging whether this stimulus was properly designed in a moment, but fiscal policy clearly lines up with monetary policy as an inflationary force.
We have the potential to see around $4.5 trillion injected into an economy that runs at a little over $20 trillion per year.
And the size of the stimulus is about double the peak-to-trough decline in the economy. In other words, we’re pumping in $2 for every $1 lost…
I’m not sure if you remember books, America, but it’s what people used to sink their faces into to avoid dealing with family and strangers. Our editor-in-chief, P.J. O’Rourke, has written a few in his time, and he’s re-releasing his bestselling Eat the Rich, complete with a new chapter to take on the absurdity of 2021 economics. And as an American Consequences subscriber, you can have access to the newly released edition for free! Claim Your Copy!
And Things Are Going… Well
We believe that the biggest factor in driving inflation is simply a strong economy.
Consumer demand bids up prices on goods, services, and commodities.
A tight labor market leads to higher wages – raising costs to businesses along with the buying power of workers.
In our pre-pandemic assessment, the central point in our inflation prediction was the extremely tight labor market and upward pressure on wages.
Now, the economy doesn’t look the same as it did in late 2019… but it’s headed in the right direction.
Personal income is actually higher than its pre-pandemic levels. We didn’t just make people whole – we made them rich. As of November 2020, wages had declined only about $43 billion, but the government filled it in with nearly $1 trillion in personal income transfers.
That doesn’t mean that no one is hurting. The most recent employment numbers showed a loss of jobs, but it was almost entirely isolated to hospitality and service jobs – those directly affected by the virus. Overall, the picture is slowly improving.
Had you asked anyone – from an economic forecaster down to the man on the street – what sort of economic decline we’d see in response to the pandemic, you’d have gotten a big number.
But it looks like the economy declined about 3.5% after inflation.
Now, clearly many people are hurting and out of work – and that’s not to mention the health and mental toll the pandemic took on everyone. But the number is better than you’d expect.
That brings us back to the effectiveness of the fiscal stimulus. The Federal Reserve acted remarkably fast to prevent credit markets from seizing up. After that, Congress worked to try and prop up the real economy.
The folks who want more stimulus spending see people in need and want to help them. And despite overall numbers improving, there are people truly hurting. At the same time, those who want to keep the stimulus smaller are worried about deficit spending and concerned about long-term implications.
These views are based on empathy and prudence – both virtues we admire. For the purposes of this analysis, though, we aren’t looking at any of that. We want to judge the effectiveness of the stimulus in its ability to precisely fill the hole in the economy, without running over.
The question is, did we minimize economic pain without risking higher inflation?
In our view, the proposed upcoming stimulus under President Biden will push us past the sweet spot and over into the risk of inflation. Again, that’s not to say it’s right or wrong for a broader policy perspective. On the full spectrum of values, you may conclude that risking inflation to help those in need is the right thing to do.
But we do think that this stimulus will cause inflation to pick up in 2021 and beyond.
The biggest player here is the Federal Reserve… It’s the stance of the Federal Reserve that makes us confident that inflation will happen, but that it won’t be too destructive.
(Yes, fiscal policy matters. But the Fed will react more directly to inflation while Congress cares more about political points.)
In 2018, the Federal Reserve completely bungled its interest-rate decision. It decided to raise rates, even though the economy wasn’t running at full bore just yet and there was no threat of inflation. The market outright rejected the decision, and the Federal Reserve retreated and cut rates again.
Now, it’s taking a different tack. The Federal Reserve now says it’s not concerned with inflation at 2%. While its target is 2% inflation, it’s now describing that as a midpoint, not a ceiling. The Fed will be happy with inflation at 4% – within 2% as its target.
The Fed will not make a brash move to stem inflation. And the move from 2% to 4% can do a lot for asset prices.
But the Fed will act before hyperinflation, which is why we don’t have much fear of such a threat.
So What Do You Do?
How do you protect your portfolio from this level of inflation? It’s not terribly difficult to do.
For one, own stocks over bonds.
Fixed-income instruments pay just that: fixed incomes. And when inflation reduces the value of each dollar, those income streams are worth less.
Additionally, even with stocks at high valuations, they still look cheap relative to bonds. Yields are remarkably low – and with inflation coming, many bonds likely have negative real yields.
The features of the underlying businesses also suggest stocks fare better under inflation.
Businesses – especially good ones – can react to inflation. They have pricing power.
The other general advice under inflation is to own “hard assets” like real estate and gold.
We’ve always got to watch out for inflation, but today, it’s particularly important to keep your antennae up. It may seem like we’ve already got a lot to watch out for, but if you don’t inflation-proof your portfolio… your standard of living can feel the effects for decades.
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Managing Editor, American Consequences
With Editorial Staff
June 12, 2021