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(Note: Stay tuned until the end of this post for a fun give away!)
Inflation. It’s everywhere, affecting everything from gas to groceries to rent, and it doesn’t seem to be disappearing anytime soon.
Just last week, the US Bureau of Labor Statistics released their inflation report for June 2022, and US consumer prices clocked a nose-bleed inflation level of 9.1%, the highest in about 40 years.
Inflation surged to a new pandemic-era peak in June, with US consumer prices jumping by 9.1% year-over-year, according to fresh data released Wednesday by the Bureau of Labor Statistics.US inflation hit 40-year high in June, driven by record gas prices, CNN.com
Inflation sucks, in some ways even worse than high unemployment. After all, even in a bad economic downturn when unemployment spikes, not everybody loses their job. But when inflation is this bad, everyone is affected.
Central banks around the world have responded in the only way they know how: By spiking interest rates and trying to slow down the economy. This has caused the real estate market to crash and seriously spiked anxiety amongst over-indebted home owners, but still inflation doesn’t seem to be coming down. Why, you might ask, are we sacrificing if the end result is more inflation, not less?
OK, I get that sentiment. I really do. But here’s the problem.
Inflation is always caused by multiple competing factors but at the end of the day this current economic crisis is the fault of high input costs. Gas is expensive, which makes commodities like wheat and copper expensive, and supply chains are over-allocated causing everything from cars to televisions to cost more. But the really annoying thing about our current supply-side issues is that there’s a pretty significant delay between a government or central bank doing something and it’s actual effects showing up at the gas pump or grocery store.
A long response loop makes any problem way more difficult to solve. Imagine if every time you tapped your brakes, it took your car ten minutes to slow down. How hard would it be to drive? You certainly couldn’t go anywhere very fast, because if an obstacle showed up in front of you, you wouldn’t be able to stop in time. The only way to safely get anywhere would be to go super, super slow.
And that’s with just a ten minute delay. The delay for inflation measures to show up in the real economy is measured in months. That’s why governments around the world are forced to move so slowly. And unfortunately, in an age where we’re all used to news being beamed to our phones seconds after something happens, we just don’t have the patience anymore to wait for that long.
However, there are actually signs that all these measures central banks are taking are have an effect on inflation. You just have to know where to look.
Gas Prices are Falling
The story of inflation in 2022 begins with gas prices. The period of 2020 to 2022 saw demand for gasoline plunge to the point where a barrel of crude oil traded for negative dollars, then rebounding to the point where airports can’t keep up with the flood of revenge travellers. There’s no way that transition would have been smooth under the best of circumstances. And oh yeah, then Russia invaded Ukraine, which of course made everything worse (as wars tend to do).
Something interesting has happened lately, though. Oil prices have come off their highs.
That’s right. Oil just broke below the all-important $100 USD-a-barrel support line.
To see why this is so significant, check out what happens when we overlay the average gasoline price per gallon (orange line) with the crude oil price per barrel (blue line).
Looking at this chart, two things are glaringly obvious. First of all, the last two times crude oil broke below $100 USD in 2008 and 2014, gasoline prices at the pump fell precipitously soon afterwards. And secondly, gas prices are trading way too high relative to crude oil right now. Oil is below $95 USD a barrel, yet gasoline is selling for $4.49 a gallon? That’s way too high. If history serves as a guide, gasoline should be selling below $3.50, so if current trends hold we should be seeing a pretty large price drop at the pump soon.
Supply Chain Issues Are Easing
Another interesting phenomenon the financial media loves to talk about are supply chain issues, but what exactly does that mean? And how do you measure that?
One way of measuring supply chain stress is in freight prices. Since most consumer goods are shipped into Canada and the US in 40-foot shipping containers and transported by massive cargo ships, the price shipping companies charge per container is a useful metric that encapsulates many different factors that go into supply chain bottlenecks: Gas prices, labor shortages, and port delays are all captured by the price per freight container.
That price per freight index shot up like crazy, going from about $1200 USD per container to a nosebleed $11,000 in September 2021. A few months later (remember that delay we talked about?), inflation reared its ugly head. How could it not? Everything cost nearly 10x to get across the ocean!
That price pressure is also starting to ease.
Freight prices, as measured by the FBX (yes, that’s totally a thing) is showing the price to ship a container across the ocean peaked in late 2021, and then started coming down. This was helped by falling oil prices, but more importantly by companies themselves hiring more crew, port workers, and infrastructure people, which in turn brought more ships that had been sidelined by the pandemic back online. Now, importers who previously described having to stay up until midnight to bid on an increasingly shrinking stockpile of empty cargo containers no longer have to do that, and prices have come down accordingly.
At a little of $6k per container, prices have dropped about halfway between their nose-bleed levels in September 2021 and their steady-state price of about $1200. There’s likely more room to drop, but we should start seeing the price of everything from food to toys start to drop as well.
Interest Rate Hikes Are Starting To Work
And finally, what about all these interest rate hikes that central banks have been doing? Are they working, or are they just making thing worse?
Anecdotally, it’s not hard to find stories of over-extended home owners freaking out that their mortgage costs are going up, and are forced to forgo vacations in order to pay off their debts. As FIRECracker would say, “Good. Stay out of my travel spots!”
But is that effect widespread enough to make a difference to inflation? The short answer is: It’s starting to.
The effect can already be seen in a drop in consumer sentiment.
The US consumer sentiment index is a measure of how households feel about the economy, and when it comes to economics, feelings do matter. If you are feeling great about your own personal financial situation, you may be inclined to go out and buy something cool, like a boat or an ATV. But if you think a recession might be around the corner (and recession warnings are a dime a dozen these days), you might think twice about buying a new car.
We’re already seeing this effect show up in spending data.
Tellingly, consumers showed less ardor for buying cars, homes and major appliances, as they shift from purchases of big-ticket goods to more spending on services.Consumers Feel the Effects of Rising Inflation and Interest Rates, US News.com
Interestingly, while overall consumer spending has remained relatively unchanged so far, the things people are spending on has changed, from big-ticket items like cars and refrigerators to lower-priced, locally available things like services. This is exactly what central banks want, since this takes the demand pressure off things that need to be shipped (like cars) and more towards things that don’t (like services).
I know, we’re all sick of inflation and wish it would just go away already, but we have to remember that it took time for inflation to show up, and it’ll take time for the solutions that governments and central banks have implemented to work it’s way through the supply chain.
The trick, of course, is that any unforeseeable world event could potentially appear and blow everything up again. An escalation of war, a natural disaster, or a new COVID variant could shut everything down again. I really hope it doesn’t happen, but who knows? I don’t have a crystal ball.
But as of right now, if things keep on going the way they are, the conditions are there for inflation to start to come down soon.
We all need to be patient, but help is on the way.
What do you think? Do you think that the measures world governments and central banks are taking to bring inflation down will be successful? Or could they be doing more? Let’s hear it in the comments below!
Announcement: Who wants to win a free book?
I’m excited to announce that my friend Dr. Jordan Grumet, also known as “DocG” from the “Earn and Invest” podcast has a book coming out on August 2nd, 2022 called “Taking Stock: A Hospice Doctor’s Advice on Financial Independence, Building Wealth, and Living a Regret-Free Life.”
Written by a hospice doctor with a unique front-row seat to the regrets of his dying patients, this book will remind you to take stock of life now, before it is too late. The goal of financial independence is to have the economic fuel to live a full life and avoid regret.
Jordan has gracious committed 3 copies of his book to give away on our blog today! All you need to do is answer the question “What’s the best unnecessary thing you ever spent money on?” in the comments below and we’ll randomly pick 3 winners!
Note: Due to shipping costs, physical copies will be limited to American readers and international readers will be eligible to receive an e-book. Good luck, everyone!
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