Here are three need-to-know truths about inflation

One cannot escape the discussion of inflation these days, whether it be from one’s daily inflow of news or just from conversations in the grocery store or around the gas pump.

Even those used to tuning out talking heads find the discussion inescapable when the reality of prices for food, energy, housing, and basic consumer goods becomes the talk around the water cooler.

KROGER MANAGING INFLATION WITH SELECT PRICE INCREASES

Inflation has long been any government’s preferred way of dealing with excessive spending, as it allows governments to spend above their means and pay the debts back with inflated dollars.  Spending one dollar today and paying it back in the future with a "dollar" that can only purchase $0.70 cents of what it used to purchase is a very clever way of legally shaving 30 percent off the real cost of your debt payback.

Only politicians can get away with it. The problem is when the inflation level gets out of control and the people start feeling it. Politicians are keenly aware that the people barely notice one to three percent annual inflation, but once five to ten percent inflation kicks in, the natives get restless!

The inflation levels the country are experiencing right now in the post-pandemic phase of American life are complicated, because there are a lot of nuances around the supply chain, labor shortages, port efficiencies, availability of truck drivers, and other such events that we have previously not associated with price levels. While the finger-pointing and politicking pick up steam, most Americans simply want to know why they are paying more for the things they have to spend money on, and when it may get better. We will understand inflation better when we remember these three unbreakable truths.

Inflation is highest where the government intervenes the most

I use housing, college tuition, and health care as examples in my preceding paragraph for a reason: They are the three areas the government has most interfered in, and the three areas with the greatest runaway inflation over time!  From the use of Fannie Mae and Freddie Mac to bring lower cost of capital to housing, to a literal takeover of the student loan market, to both Medicare and ObamaCare as the primary payment mechanisms of national health care, these three top priorities in American living have seen dramatic price increases for over 30 years, proving the wisdom of the late P.J. O’Rourke’s maxim: "If you think something is expensive now, wait until the government makes it free!"

Inflation is relative to what you are spending money on

Imagine you inherited a house free and clear thirty years ago, did not have kids to put through college, and really never had to pay health insurance premiums.  Imagine all you spent money on was consumer electronics (a VCR cost $800 in 1982, whereas tens of thousands of movies are now available for $11.99/month).  You could be forgiven for not believing there had been much inflation. Alternatively, imagine someone whose primary spending included rent over the last 30-40 years, saving for college, and the cost of health care.  That person’s wallet is focused on the three areas that have seen the greatest price inflation.  Prices do not go up and down in unison across different categories of goods and services, and across different geographies.  And yet we are used to talking about "national averages."  I equate this to telling a golfer the "average weather" for this weekend is 65 degrees and sunny, as opposed to the specific weather in the specific city in which they want to golf. 

Inflation is too much money chasing too few goods (and services)

Milton Friedman, who I quote heavily in my new book on basic economic truths, taught us exactly what inflation is, and right now we are seeing this play out in spades. The government shutdowns of 2020 crushed production of new goods and services in response to the complete erosion of demand. As the economy has slowly but surely re-opened, politicians find themselves shocked that the people are interested in spending money, traveling, consuming, doing things, and being normal human beings.

Well, another big theme of my book is that humans act rationally and the fact of the matter is that we do not have a problem because demand is too high – that is just humans being humans. We have a problem because our supply of goods and services is woefully below the level of demand for them, and until we can get supply (production) higher, prices end up escalating.

Yes, the Fed can try to make money out of the system to lower inflation, but the truth is that a higher cost of capital and removal of excessive liquidity in our financial markets will only work to bring down excessive financial asset prices. It cannot get the ports in California running smoothly, for example. A greater supply-side resolution must be pursued to manage the other end of Milton’s famous equation – we need more goods and services. That is the key to bringing back price equilibrium, especially where semiconductors and more complicated goods like automobiles and appliances are concerned.

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We would be wise to remember that governments never mind higher inflation if it helps them spend above their means. It is only when the train gets too far out of the station and the people start getting mad that they feel the need to rein it in. But two percent inflation still erodes your purchasing power over time. What we need is a productive economy creating goods and services in response to the needs of mankind. What we need, is a government that gets out of the way.

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David Bahnsen, author of There’s No Free Lunch: 250 Economic Truths, is Chief Investment Officer of The Bahnsen Group, a national wealth management firm managing over $3.5 billion in assets.