Inflation and Historical Norms

Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time, which decreases the purchasing power of money. In other words, it takes more money to buy the exact same goods or services, in the future. 

If one item is in short supply and sees a high demand, the new holiday toy for example, and the price for that toy goes up, is that inflation? Technically, no, one item seeing a high price increase is not inflation.  Rather, the term inflation refers to broad increase in prices across a wide range of goods and services. 

Let’s summarize the key characteristics of inflation.

• Broad increase in prices - housing, transportation, groceries are all facing higher prices, negatively impacting the overall cost of living (it becomes more expensive).

• Less purchasing power - when you still make $15/hour working, but to buy 1 gallon gas now costs you $8, and one month ago it cost your $4. Your dollar will simply not buy as much as before.

What typically causes inflation?  Two common factors are:

1. Cost-push inflation: When the cost of production increases, prices are pushed higher to account for the higher input costs. An example would be a spike in fuel costs, impacting all goods transported by air, sea, or land through higher gas and diesel prices. This input costs ripples through the economy and drives costs up throughout the supply chain, resulting in inflation.

2. Demand-pull inflation When the demand for goods or services outpace the economy’s capabilities to produce enough to meet the demand, then prices are pushed higher. An example would be a movie comes out featuring new pickup trucks, and suddenly the buying patterns shift, and prior roadster, station wagon, SUV and sedan buyers all become pickup truck buyers, you could see inflation.

Based on analysis of the image above, inflation over the past 100 years has been on average 3%.  June 1920 saw a record high of 23.7% inflation, followed by a sharp decline, in fact deflation, of -15.8% a year later in June 1921.  Inflation returned again to the US in the 1940s, ranging from 10-15%, and again in the 1970s and 1980s.  Since the 1980s, inflation has been relatively stable until we saw an exogenous shock to the system in 2020 with the Covid pandemic. 

The image below from the Bureau of Labor Statistics (BLS) highlights the period just after the 100 year view. Depicted from April 2020 to April 2023, we saw inflation exceed 9% in June  2022 for the first time in nearly four decades.  Pretty good timing of Central Banks to start buying gold in 2010.