Inflation May Be Transitory, But This Damage is Permanent

Inflation (especially high inflation) is even worse than you think. Inflation results in a cumulative loss of purchasing power. Today we explain why even temporary inflation permanently damages your purchasing power…

For Peter Reagan at Birch Gold Group

The “whack-a-mole” game of watching inflation fall and rise sharply over the past 25 years is disheartening at best. Here’s why…

Inflation officially sits at 5 percent (the highest since 2008). The last 25 years of inflation rising and falling are shown on the chart below:

Inflation Rate, 1995-2021

As you can see, the blue line remains above zero almost all of the time. This means there has been consistent inflation over the last 25 years, with only a couple of brief exceptions.

Here in 2021, gas prices have risen 56.1%, food prices are still rising 2.2%, and even used car prices have risen 29.7% (numbers based on U.S. Bureau of Labor Statistics data as of June 10th).

That’s harsh. But surprisingly, inflation isn’t the ugliest thing about the U.S. economy over the last 25 years.

That honor belongs to the dollar’s declining buying power.

There’s only one way to boost buying power

If you were to try to hold back the surge of inflation the U.S. economy, you might use deflation. Deflation is an unusual phenomenon, wherein prices fall month-to-month. Falling prices encourage spenders to hang onto their cash, expecting that today’s $100 purchase might only cost $95 (or less) in a few weeks. Debts on the other hand become increasingly expensive over time, which leads to reduced borrowing. As you might expect, deflation tends to reduce economic activity generally.

For example, the Great Depression started as a recession. A plunge in general demand for goods and services led to lower prices, which made companies less profitable… Between 1929 and 1933, wholesale prices plunged 33%Every dollar was now worth $1.33.

If you had any dollars, because unemployment rose to 20%. The resulting economic crisis was the worst America suffered in the 20th century.

That should tell you why adherents to Modern Monetary Theory (MMT) are terrified of deflation. Here’s what Ben Bernanke, former Chairman of the Federal Reserve, said about it:

Regarding the Great Depression, we did it. We’re very sorry. We won’t do it again.

That wasn’t the last time the U.S. saw deflation. Let’s take a look at the Great Recession of 2008-09.

You can see how terrifying deflation actually boosted the dollar’s buying power:

Plummeting purchasing power of U.S. dollar since 2007

via WolfStreet

In response to that brief period of deflation, Bernanke’s Fed team slashed interest rates to zero and began the first of many, many rounds of quantitative easing (QE, or “printing money”) that, over the following 13 years, took the Fed’s balance sheet from under $1 trillion to today’s nearly $8 trillion.

When you consider the numbers together, the correlation looks pretty strong:

Fed Balance Sheet vs CPI, 2008-2021

Federal Reserve assets (blue line) vs. inflation (red line). Data via St. Louis Fed

It seems pretty clear that, while deflation absolutely terrifies the Fed, the opposite really doesn’t worry them at all…

Here’s the bad news about all that inflation: it reduces the buying power of every one of your dollars. Permanently.

Inflation might be transitory, but its damage is permanent

Here’s why inflation is forever…

Consider our imaginary friend Arthur. He nets $100 per month. After year of 5% inflation, Arthur’s monthly money buys 5% less. Next year, it turns out the inflation spike really was transitory, so the inflation rate goes to 0%.

Here’s the thing: Arthur’s monthly income STILL buys 5% less.

It’s as if Chairman Powell reached into Arthur’s pocket and stole $5 every month. Forever.

That’s why we called inflation the Federal Reserve’s tax that no one voted for and everyone pays.

Wolf Richter laid out the ugly scenario that plagues our savings right now:

Inflation is a game of Whac-a-Mole. One pops up as another backs off. So it could very well be that CPI inflation may be 4% next May, down from 5% now, and we’ll be celebrating that the 5% was “temporary,” and was replaced by 4%, hahahaha. But the purchasing power of the dollar that is lost every month is lost permanently. [emphasis added]

Of course this is nothing new. The dollar’s buying power has been on a downhill slide overall since June of 1913, with the exception of a notable four-year recovery from September 1929 to May 1933. (Another interesting correlation is the Federal Reserve was also established in December of 1913.)

Wolf also believes the dollar’s descent hasn’t reached the bottom yet, and that it never will. With a Federal Reserve that’s so terrified of deflation they’ll do anything to prevent it, there’s not much of a chance that any of that lost buying power will return.

(Take another look at that second chart. The last time buying power made even a modest recovery was, you guessed it, when inflation went negative.)

So what’s a saver to do?

Taking a stand against the dollar’s decline

Remember, even if inflation reaches zero, it will be too late — you will have already been robbed. So what can be done about it?

Listen: we cannot tell you what to do. You are the only expert on your financial situation and goals. You are in control of your own savings, and you must make the best decisions for yourself. That’s a heavy responsibility, with huge consequences. Our goal is not to offer you one-size-fits-all answers to your unique situation. Instead, we want to help you understand all your choices, even the ones your investment advisor might not mention.

Having said that, when it comes to protecting your dollars from decay, there are a few apparent choices…

Spend all your cash immediately. While impractical, the strategy of avoiding dollar decline by avoiding dollars is valid, and is more or less the premise of John A. Pugsley’s The Alpha Strategy. Even so, it doesn’t seem like a long-term solution.

Consider inflation-protected securities. TIPS and I-bonds appreciate based on inflation. So your savings grow at the same rate as inflation. That doesn’t increase your buying power, but at least it doesn’t decrease as much (when you factor in the differences between the Fed’s old and new, improved inflation metrics).

Diversify with physical precious metals. While the dollar’s power has plummeted 23% since 2007, gold more than doubled in price (silver merely doubled).

Now might be a good time to examine your savings, and consider diversifying with inflation-resistant types of assets. If you’re interested in physical precious metals, we can help you get started. Gold and silver are stores of wealth that stand up to inflation and could help recapture some of that lost buying power.

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