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My Biggest Concern For Our Clients Today: Inflation

As I have said many times in the past, inflation is a long cycle and not a short cycle phenomenon.

So is disinflation. The disinflation cycle that ended last year began around 1981. It lasted about 40 years. Historically the inflation cycles following deflation have lasted longer than the preceding disinflation cycle. If history is repeated, we face more than 40 years of rising prices.

I worry about our clients because we have all become accustomed to declining inflation rates. I am not confident that we are all prepared for what the future would bring with sustained higher inflation.

Since inflation is currently about 7.5%, all fixed income investments are losing money unless they earn more than 7.5%. Most fixed rate investments are earning less than 3% and most are closer to 1%.

When inflation is 7.5% like it is now the consumer needs at least 7.5% more income to stay even.  Only income over and above the 7.5% inflation rate is real and can be spent on additional goods and services.

As I am writing this, I keep thinking I am writing the obvious. However, I have been in the financial services business too long to believe anything is that obvious when it comes to understanding the real value of money.

In 1980 I remember vividly how investors and savors bragged about earning 13%-14% on 3–6-month CD’s.  But if they really understood they would have said they were earning 0% because the inflation rate was 13.5% in 1980.

Today it is even worse.  A 1.5% CD rate is far behind the current 7.5% inflation rate.  In this example the rate earned is 6 points less than inflation. At least in 1980 the 13.5% CD broke even against the inflation. So yes, now is much worse for savers than it was in 1980 when rates were closer to the inflation rate.

Today interest rates would need to be 7.5% to breakeven vs. inflation. In 1980 13.5% was needed to breakeven vs. inflation. 

FIXED INCOME INVESTORS MUST ACCEPT THE ONLY RATE THAT MATTERS IS WHAT THEY EARN OVER AND ABOVE INFLATION.

It is called the real return.  The real return is adjusted for inflation.  Before the adjustment the rate is known as the nominal return.

It is not only income investors who are being hurt by inflation. The U.S. Bureau of Labor Statistics publishes monthly real average weekly earnings for private sector employees. For one year ending January 2022 the average real earnings declined 3.1%.

Here's a chart for reference: 

For more details, please refer to this article in The Economics Daily a publication from the U.S Bureau of Labor Statistics.