Updated: Nov 18
I remember working in commercial real estate during the financial crisis in 2007-2009. The Federal Reserve Bank (Fed) developed tools to protect our banking system from collapsing. They pumped money into our financial system and provided liquidity to the markets. Back then, people were saying we would pay the piper as the Fed’s actions would cause inflation. Years passed by, and inflation never really materialized. Housing and asset prices inflated but not the everyday items we buy, such as food. Inflation stayed below 2% for years. But, as I speculated in previous blogs, the COVID response by global banks and global governments was able to create more inflation than the Fed alone.
In October, U.S. inflation hit a three-decade high of 6.2%, delivering widespread and sizable price increases to households on everything from groceries to cars due to persistent supply shortages and strong consumer demand. We haven’t seen inflation this high since 1990 (31 years ago)!
Inflation is calculated by tracking a basket of goods that, in theory, represent what consumers purchase. The basket includes eight major groups: housing, apparel, transportation, education, recreation, medical care, and food and beverage. The Fed policies have contributed to the historic rise in home prices (and rent) and asset prices (stocks & bonds); however, they are not responsible for the supply chain issues we are experiencing today. Worldwide government policy and the response to COVID19 has increased demand for material items and created problems with the supply chain. Monetary policy cannot fix the supply chain, so we don't want the Fed to try and fix the issue alone. Interest rates would have to increase more than necessary to flatten the demand for non-financial assets.
People have built a war chest of savings due to travel restrictions and government handouts. As a result, bank deposits are sitting at $2.3 TRILLION more than the pandemic’s start in January 2020. However, per the graph below, it appears that cash savings are starting to flatten. I believe the cash levels will decline as government handouts slow and inflation causes people to dip into their savings.
Fortunately, the savings rate is starting to normalize to lower pre-covid levels. I’m usually a huge fan of people saving money, but the amount of savings got a bit ridiculous during COVID. The savings rate peaked at 33.8% in April 2020. However, the rate dropped to 7.5% in September 2021, which is lower than the pre-pandemic level of 8.3% in February 2020. The lower rate is probably due to inflation, declining government handouts, and high long-term unemployment.
Inflation to Ease but Not Energy
I feel inflation will ease as the corporations (not governments) solve the supply chain issues. However, I do think that we will not see 2% inflation for an extended period. Electricity costs will increase significantly due to converting to “Green” energy and the adoption of electric cars. In addition, electricity consumption will increase at the same time we are trying to shut down our most affordable energy source: natural gas & coal. We will see how committed we are to the "green" initiatives if our energy costs double.
iShares Emerging Market ETF was the best performer this week. This index is market-cap-weighted, and larger companies have greater weighting. The top 5 markets China, Taiwan, South Korea, India, and Brazil make up 71% of the holdings.