Inflation: The Scary Headlines and the Real Story

The spooky season may be over, but scary headlines about inflation are still frightening investors. There’s always something to “worry” about regarding the markets and investing, and inflation is the trendy topic today. But should we worry about inflation? Is it coming? And will it last? 

Not all inflation is the same.

Inflation can occur for many reasons, and it’s essential to make the distinctions. Supply and demand impact the prices of goods and services. Basic economics tells us that prices will rise in a competitive market when demand increases and/or supply falls. 

Recently, we’ve seen “artificial” disruptions to supply chains. Logistics bottlenecks are wreaking havoc on an array of industries, made more intense by the hyper-globalized economy. It’s been about two years since Covid reared its ugly head and forced shutdowns worldwide. These shutdowns stopped manufacturers in their tracks, but consumers did what consumers do best, consume. So while producers were at home binging Tiger King with the rest of us, consumers took to the interwebs and ordered to their heart’s delight. 

I believe the inflation we’ve seen in recent months can be attributed to supply chain disruptions, not Fed policy. 

A Just-in-time Predicament

As consumption outpaced production, inventories declined. It’s also important to note that many companies do their best to keep as little inventory as possible. Just-in-time (JIT) systems have become the holy grail of inventory control. Instead of keeping large reserves on hand, companies strive to order supplies as close to when needed as possible. JIT increases return on equity (ROE), thus pushing share prices higher and justifying executive bonuses but leaving little margin for supply chain disruptions like we’re seeing now. 

What’s Next?

With the holidays around the corner, there’s a logjam of vessels waiting to dock at the west coast ports. Both private and government entities are working to provide relief and get goods moving again, but these issues won’t be solved overnight. While I’m not predicting a toy-less Christmas, I believe these challenges will remain into next year. Seasonal holiday demand and supply shortages could push prices higher, keeping the inflation narrative alive and well, at least for a bit longer. 

Stockpiling will lead to excess inventory. 

I’m much more optimistic when zooming out a bit. Reacting to shortages, many companies are over-ordering inventory. Sound familiar? That’s precisely what consumers did when people hoarded more toilet paper than they could use in a year at the start of the covid pandemic. Stockpiling perpetuates supply constraints in the short term, but once the global logistics difficulties are sorted out, companies will find themselves with excess inventories. Many companies will decide to lower prices, perhaps even fire selling some goods to get them off the books in short order. This unloading may reverse the inflationary effects we’re dealing with today. 

Technology is deflationary. 

I’ve written about Wright’s law and the rapid cost declines in key technologies. Tech is becoming an increasing part of our lives and spending, so naturally, their deflationary effects will grow. Cathie Wood of Ark Invest points to Artificial Intelligence cost declines as an example, saying, “artificial intelligence (AI) training costs, for example, are dropping 40–70% at an annual rate, a record-breaking deflationary force. AI is likely to transform every sector, industry, and company during the 5 to 10 years.” Relating this to inflation, she continues,

“when costs and prices decline, velocity and disinflation — if not deflation — follow. If consumers and businesses believe that prices will fall in the future, they will wait to buy goods and services, pushing the velocity of money down.”

It’s easy to call for hyper-inflation due to the Federal Reserve’s policies; people have been doing it for years. But as goods and services become cheaper, thanks to innovation, the velocity of money declines, keeping inflation at bay.  Ultimately, I don’t think hyperinflation is on the horizon and caution investors from abandoning their strategies due to fear. Contrarily, inflation is a reason to stay invested, to counter the reduction of purchasing power that inflation produces. 

Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from James Vermillion, and all rights are reserved.