Finance How inflation “happens” Before we answer those questions, let’s take a closer look at what exactly inflation is. A simple working definition is that inflation is the name that economists give to a phenomenon with which we’re all familiar: the prices for goods and services increasing over time, typically expressed as a percentage increase year-over-year. Or, to look at it from the opposite perspective, if the prices of goods and services are increasing, then the “value” of a dollar (i.e., how much that dollar can purchase) must be decreasing; in this way, inflation is a measure of how much value a dollar has lost in a given 12-month period. For everyday consumers such as you and me, it often seems that inflation just “happens” – that it’s natural for the prices of things to rise over time, because … well, that’s just what prices do. But economists know better; inflation usually has very specific causes, and most of those causes are fairly easy to understand: Supply shortages are one example that we’ve been experiencing since the onset of Covid19. When factories around the world are shut down, there will be fewer products to buy in stores. So the prices of things that are still available tend to move up. Closely related to the above is demand shock. If, for example, everyone suddenly wants to buy a used car (something else we saw during Covid), you can bet that the prices of used cars will increase. A sharp rise in input or production costs is another reason for inflation. Say that the price of oil spikes sharply because of a war in a major oil-producing nation (such as Russia). Expect to pay more to fill up your tank. Money policy can have a dramatic impact on inflation. If a government cuts taxes or a central bank lowers interest rates, businesses and consumers will have more money to spend, which can cause prices of certain assets to go up (housing is an example here). Since the financial crisis from 2007-2008 to about 2021, inflation rose very slowly in Canada – about 1.7% a year. However, starting in 2022, inflation jumped sharply, touching a high of 8.1% in June of 2022. Looking back, we can see that the spike was because several inflationary pressures were occurring all at once. Supply of basic goods was curtailed because of Covid-19-related shutdowns, so demand increased. As we moved out of Covid-19 lockdowns, input and production costs (including labour costs) went up, at the same time as many central banks were raising interest rates. All of this has created something of a “perfect storm” for inflation. Noticed what’s happened to the price of milk lately? Bread? Chicken? Or pretty much anything else? Of course you have. Over the past year or so, the prices for everything in the grocery store – and the shopping mall, and the gas station, and the local restaurant, and almost everywhere else – have gone through the roof. Some economic analysts believe that this soaring inflation is a temporary phenomenon: once we move past Covid-sparked supply chain issues; once the war in Ukraine winds down; once the U.S. Federal Reserve fully exits its quantitative easing program; and so on, inflation will settle down to more moderate levels in and around 2% per year. Others believe the opposite: that we’re living in a new era, one in which prices will keep rising for the foreseeable future. Which perspective is correct? And if we are, indeed, headed toward a “brave new world” of inflation, how will this affect your portfolio? How can you adjust, trim, reallocate and reposition your existing portfolio to survive inflationary pressures, while identifying and seizing the opportunities that this new inflationary world presents? Brave new world of inflation How to survive and thrive in a world of rising prices by James Dolan 26 | www.snowbirds.org
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