Incomes and Inflation - Tuesday 23rd Morning Muse
All of us have experienced the impact of inflation over the last several years. The costs which seemed to have increased the most for the majority of consumers is food, whether at home or away from home, utilities, homeowners insurance, mortgage payments, personal services, and medical services. And for those who rent, rent costs have increased significantly.
INFLATION
What is inflation? The erosion of purchasing power.
IMPACT
However, the impact of inflation varies by income. Households with incomes in the lowest income quintile spend more of their income on rent, food, and energy (gasoline) than those in the highest income quintile. For those in the higher income quintiles, inflation is an inconvenience. For those in the lower income quintiles, inflation as we have experienced can be an existential threat.
RESEARCH
Research for this article led to interesting discoveries. Organizations as diverse as The Wharton School at UPenn, the Congressional Budget Office (CBO), the Dallas Fed, and McKinsey Consulting have weighed in on the impact of inflation. The Dallas Fed evaluated the impact of inflation on household stress levels, by quintile.
In a very interesting analysis, the CBO evaluated the ability to purchase a basket of 2019 goods and services in the four following years. But included transfer payments and tax credits in “income”. And all else being equal, transfer payments and tax credits are the domain of those who are lower on the income scale. So our assessment? The government isn’t really interested in showcasing the impact of inflation on lower income households without the benefit of government subsidies.
TYPES OF INFLATION
Economists assign two causes to inflation. Demand-pull and Cost-push.
Demand-pull inflation occurs when the demand for goods and services outstrips the economy’s ability to produce them. For example, when demand for new cars recovered more quickly than anticipated from the sharp dip in early 2020, a shortage of semiconductors made it hard for automakers to keep up with demand. Prices for both new and used vehicles soared.
Cost-push inflation occurs when the rising price of inputs, such as raw materials, plant/equipment, technology, and labor, increases the price of final goods and services. For example, supply disruptions of commodities during the 2020 and 2021 worldwide shutdown caused commodity prices to spike. In addition, there were radical shifts in demand, buying patterns, costs to serve, and perceived value. The result? Significant price increases.
SIMPLICITY
Inflation and its causes doesn’t lend itself to a simple explanation or resolution, given the complexity of both the U.S. and world economies. But let me give it a shot.
We experience inflation when more dollars are chasing the same amount of goods and services. We experience inflation when a fixed amount of dollars are chasing fewer goods and services.
THESIS
Let me journey into the realm of “What wouldn’t surprise me”, in bullet point format:
1. The political class will not address the federal debt and it will continue to grow.
2. The political class will continue to increase the number and amount of transfer payments.
3. The impact of recession will be reduced on those households in the lower income quintiles due to the referenced transfer payments.
4. Those households in the lower income quintiles will be able to pay rent and buy groceries and gasoline due to the referenced transfer payments.
5. Demand for food, energy, housing, and medical services will remain constant and/or grow, due to referenced transfer payments and other considerations such as staff shortages.
6. Inflation will be a constant as dollars are dumped into the economy and demand remains stable.
7. The political class and their yeomen will deem inflation and interest rates in the 6% to 8% annual range to be very acceptable. This allows the government to make its interest payments in the future with cheaper dollars.
Personally, I hope I’m wrong about these assumptions. I do hope our elected officials, regardless of party affiliation, understand the value and importance of living within their means, as the rest of us must. And I hope that those who live at the margins can move up the income quintiles. History tells us neither are likely.
SUMMARY
What does this mean for you and me? In short, the lowest income quintile will struggle, while the higher income quintiles will benefit from inflation. The higher income quintiles have cash flow such that inflation is an inconvenience. And they tend to have assets. And can take steps to position those assets to capitalize on inflation.
Which assets benefit most during inflationary environments? Great question. Look for that discussion in a future article. And we haven’t touched the secular supply/demand trends of capital and labor which will have an impact. Look for that article as well.
And until we see you again, wishing you only the best.