We’ve done it before, several times.
Inflation, even if it is mild, destroys the purchasing power of your dollars. So, the bigger question beyond “could we see double-digit inflation?” is “how to protect your family and your savings from its ravages?” This question is especially important if you invest in bonds, annuities, CDs, or mortgages. All of these are denominated in dollars and normally suffer more loss in value from inflation than other assets.
We have already seen three periods of double-digit inflation since the Federal Reserve Bank (The Fed) began tracking it in 1913. The latest time was during the Carter years, running into the late 1970s and early 1980s.
From 1915-1919, the U.S. averaged over 15% inflation per year for four straight years, with inflation during 1918 reaching 20%! This level of inflation means that a $100,000 CD would only buy $52,000 worth of groceries and other goods at the end of four years. This equates to a loss of the ability to buy $47,000 of goods and services. Inflation like this is why you hear stories of social security recipients having to choose between buying food and buying medicine because they can’t afford both. It is not the number of dollars (referred to as nominal value) that is important; it is what those dollars can buy.
Are we on the cusp of the fourth period of double-digit inflation? Many experts say we are.
The Federal Government won’t be able to continue its deficit spending ($302 billion in the month of July 2021 alone)1, unless it can sell bonds to finance the debt. Fortunately, the world still wants to invest in our debt, even with it paying only 1% or so interest, so the Treasury is still able to sell all those bonds. With interest rates so low, the cost of paying interest on that debt is manageable. Instead of paying off bonds as they mature, our government has been refinancing older, higher-paying bonds with today’s newer bonds at lower rates. Between issuing new bonds and refinancing older bonds, the total U.S. debt continues to go up.
Right now, the U.S. Federal debt is around $28.5 Trillion2, and in 2020 the government paid $345 billion in interest to its bondholders3. That is an average rate of 1.21%.
Interest rates can’t remain this low forever. If interest rates take off and the Treasury must continue to sell bonds to avoid an economic recession in the US, then carrying that higher-interest debt can become a real burden. It could take money away from national defense, welfare programs, education, infrastructure, perhaps even social security. So far, the Federal Reserve Board, in charge of such things, has done a remarkable job of keeping interest rates from going up. That is a pretty neat trick, something I could not imagine before seeing it done.
If interest rates were to go back to historic norms (around 6%), then the cost of paying interest on our debt would be over $1 Trillion, requiring another neat trick.
This chart from my Yavapai College course Fundamentals of Investing for Retirees shows inflation, measured by the Consumer Price Index, from 1913-2021.
The three peaks in inflation correspond to the periods during and after World War I, II, and the Vietnam war, when the debt from fighting those wars was greatest. Luke Gromen, of Forest For The Trees Investment Advisory, points out that Covid has negatively impacted U.S. finances to the tune of over $2 Trillion, similar to a major war. Should we prepare for another post-war spike in inflation? Gromen says, “yes.”
The declining red line across the peaks suggests that the Fed is getting better at pulling the levers of our money supply because each peak has been lower than the last. But it also indicates that the next time inflation takes off, it may approach 10%.
The gridlines on the chart are at 10-year intervals, showing roughly 30 years between inflation spikes. We are now about 40 years from the last one. Is a spike overdue, and are we at the beginning of one? Many would agree that it is, and we are.
So, we have a government that is creating inflation by printing money to finance deficit spending when we have a major inflation cycle that is overdue. The cynical side of me recognizes that politicians will keep printing money to buy votes until something gives. Will that “something” be inflation so high that the voters can no longer ignore it? Could be, so get ready.
There are things that can be done to protect your portfolio. We call ours the Inflation Protection strategy, which holds up to 5 investments that are expected to have stronger performance during inflation than dollar-denominated investments.
If inflation is a concern for your portfolio, please call the office at (888) 434-1427 to request an appointment to see if the strategies used in your portfolio will adequately protect your accounts from inflation or if you would benefit from having our new inflation model added to your mix.