Spiking U.S. Inflation – Is It Really Temporary?

Yet as higher than expected inflation readings come out month after month, consumers are increasingly coming to question the Fed’s assurances about this being only a temporary jump in inflation. And perhaps for good reasons.

Today, I will focus on what the primary causes of the latest spike in inflation are and whether or not they are likely to be temporary, as the Fed argues, or more structural and long-term, as more economists are concluding. Obviously, the answer could significantly affect our saving and investment strategies.

Consumer Price Index Leaps To 5.4% Annual Rate In June

The Commerce Department reported the CPI jumped to an annual rate of 5.4% in June, the highest level since August 2008. “Core” CPI (minus volatile food and energy components) rose at an annual rate of 4.5% last month, the highest reading in 30 years. Both figures were once again well above most economists’ pre-report expectations.

Inflation has been escalating due to several factors, including pandemic-related supply-chain bottlenecks, extraordinarily high demand as the Covid-19 crisis eases and year-over-year comparisons to a time when the economy was struggling to reopen in the early months of the crisis. Add to those the fact that prices of several big-ticket items have literally exploded.

As the most egregious example, prices for used cars and trucks leapt 10.5% from the previous month in June, accounting for one-third of the rise in the overall CPI reading – and marking the third straight month of big price increases amid a supply shortage of vehicles (more on this below). The prices for airline fares, rental cars, hotels, entertainment, recreation, apparel and more also rose sharply in June.

Rising prices reflect robust consumer demand boosted by widespread vaccinations, the ending of many business restrictions, trillions of dollars in federal pandemic relief and ample household savings. Stronger demand also has pushed employers to seek more workers and pay higher wages, as they struggle to hire more employees.

Annual inflation measurements are also being amplified by comparisons with figures from last year during Covid-19 lockdowns, when prices plummeted because of collapsing demand for many goods and services. This so-called “base effect” (lower numbers from this time last year being pushed out of the 12-month window by higher numbers this year) has been pushing up inflation readings for the last several months. Again, the Fed says not to worry. We’ll see.

Is the Latest Spike in US Inflation Really Temporary?

For the last several months, Fed Chairman Jerome Powell has assured us the latest surge in inflation is “transitory,” and prices should begin to subside later this year and presumably get back to normal (whatever that is) next year. In fact, Mr. Powell resolutely stuck to this line of thinking when he testified before Congress for two days last week.

While most forecasters and the financial media seemed to buy into the transitory theory earlier this year, it is clear from the grilling Powell took in Congress last week that such confidence is waning. There is growing uncertainty as to whether the Fed really knows what it’s doing.

In any event, let’s look at the reasoning behind the transitory theory to see if we think it holds water. And then we’ll look at some reasoning which suggests the current trend to higher inflation is more likely structural and long-term. This seems to be the question of the day now.

The transitory theory holds that prices have risen significantly for many consumer goods due mainly to COVID-19 related effects on the economy, such as widespread shutdowns, some of which are gradually disappearing. In theory, the shortages of these items should end as soon as the economy catches back up.

The transitory theory focuses intently on the dramatic surge in prices for a handful of consumer products, as shown below. The assumption by the transitory crowd is that these prices were driven sharply higher due to purely pandemic related issues/shortages. And prices should come down significantly as the bottlenecks are alleviated later this year. Here are the biggest price increases.

Other consumer products and services also saw large increases, just not as large as those shown above. Public transportation, moving, storage, freight expense, propane and others all rose by 17-18% in the last year alone. Almost all consumer goods and services went up by at least 5% in the last year.

But do we really believe the prices for these popular items will come down to normal over the next year? I think the odds are good vehicle prices will come down significantly, but not until the microchip shortage is over, and that could be awhile. And I have my doubts if vehicle prices will come back to the levels they were before the pandemic struck.

According to the government, the surge in vehicle prices accounted for fully one-third of all the inflation increase over the last three months. We’ve never seen anything like it! Yet according to J.D. Power, car and light truck sales rose 32% in the first half of this year. Keep in mind, however, this number looks more impressive than it is because auto sales were severely depressed last year during the pandemic recession. Naturally, this year looks great.

I’m not ruling out the transitory theory. I just doubt whether it will have as much positive economic impact as Chairman Powell and the Biden administration would like us to believe.

The “Non-Transitory” Crowd Has a Different View

While the transitory camp has its views as described above, the non-transitory crowd has a different take. Most in the non-transitory camp believe today’s much higher inflation rates are here to stay. They believe the economic forces which drove prices to where they are today are largely permanent/structural and are not likely to decline much in the months ahead.

Many in this camp also believe US inflation is destined to go even higher later this year and next. Some in this group are convinced we’ll see CPI inflation of up to 10% or more before this cycle is over. They point to the fact that the Fed has pumped an unprecedented $8 trillion of stimulus into the economy in the last year or so and argue this money will result in continued higher consumer prices. Ditto for huge government stimulus spending.

Many with the non-transitory view fall into the “gloom-and-doom” crowd, in my opinion, which has been warning of hyperinflation for decades. They maintain this view despite the fact that we’ve been in a generally disinflationary environment since the 1980s when Fed Chairman Paul Volcker crushed runaway inflation. But that’s another story for another time.

At the end of the day, we have two widely different views on where the economy (and of course, the markets) are going in the next few years. The transitory crowd, led by Fed Chair Jerome Powell, believes the sharp price increases and inflation we’ve seen this year are only temporary. Prices will come back to “normal” in the next year. I guess we can’t rule it out.

The non-transitory crowd, on the other hand, believes the inflationary forces unleashed this year are here to stay and are likely to get even worse. Think 10% inflation. I guess we can’t rule this out either, but I don’t see it as the most likely scenario.

As usual, I see something in the middle as the most likely scenario just ahead. I don’t see inflation receding to the 1.8% level we averaged in 2020. The disinflation trend we saw since the early 1980s is probably over.

On the other hand, I don’t see inflation soaring to 1970s levels as many in the non-transitory crowd are warning. The gloom-and-doom/bet against America crowd has been wrong for as long as I can remember.

One final caveat, however: As I have warned for decades, our out-of-control national debt is going to catch-up with us at some point, probably when the world decides it can no longer trust the US to repay its debts in full. Whenever that happens, all bets are off.

No one knows what will happen when that day comes, but it won’t be pretty.

Let’s hope we don’t get there anytime soon! I’ll leave it there for today.

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All the best,

Gary Halbert

© Halbert Wealth Management

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