Inflation – It’s Back! Should You be Worried?

If you’re as old as me you remember the high inflation of the 1970s and early 1980s. That inflation was caused by years of very low interest rates and high federal spending in the 1950s for fear the post-war economy would regress to Depression days, then runaway federal spending on Viet Nam and other programs in the 1960s and then a final large shove by the Arab oil embargo of the mid-1970s. It was not caused by the Arab oil embargo, Pres. Nixon had instituted price controls in the early 1970s to try and stop inflation.
If that all sounds a bit like today, it should. Except that the rates are actually lower today and the spending is far, far higher in relation to tax revenue. And that has me worried.
Well, since 2008, the Federal Reserve Bank, in all its economic wisdom has been trying to recreate a “modest” level of inflation because it thinks the economy is healthier with some inflation. So, it has kept record low interest rates going even after the strong economic recovery post 2008-09 and kept on purchasing of trillions of dollars of U.S. Treasury bonds, mortgages, corporate bonds and such, acting as an enormous buyer to keep demand up and bond prices high.
There is a political side to this despite what the Fed says as Washington cannot keep spending far above what it collects in taxes and keep building debt unless the interest cost on that debt stays very low.
Well, now we have it, but the Fed still doesn’t think so.
That’s because the Fed often looks at the Consumer Price Index (CPI) to gauge inflation but that measure has several serious flaws, the biggest one being that it does not use housing prices. Nope, despite that being most consumers’ largest cost, it looks at “price-equivalent rent” which is actually down right now because of the demand for housing while housing prices are going at a rate of 10% on average across the country. Look, when 30% of your budget is up 10%, you have 3% inflation right there, plus the cost increases in other things.
But, the CPI is reading +1.4%, so the Fed is saying it has to keep rates low and keep buying income investments ’cause there’s not enough inflation yet.
This is a terribly serious error and what do you think will happen when rates start going up? I’ll tell you what. Bond prices other than inflation-protected securities will go down and investors will lose money on bonds. Governments will have to pay more interest and that means bigger deficits calling for higher taxes.
You say, “Well the Fed controls interest rates.” If you mean “completely” you would be dead wrong about that. No, the bond market is bigger than the Fed. The interest rate on the 30-year Treasury bond went from 1.5% to 3% recently, signifying the bond market needs to account for inflation and the Fed could do nothing about that rise in rates or the drop in the prices on those 30-year bonds.
If bonds are a big part of your portfolio, you might want to rethink that. If your 401(k) has bonds in it to dampen volatility, the cost of that dampening is probably going up and part of your 401(k) may end up losing money, the very part you relied on not to do that.