Inflation's Winners and Losers
I got together with a few other neighborhood dads recently to play a board game called Q.E. The name is short for “Quantitative Easing,” a term that entered the public conscious when Ben Bernanke’s Federal Reserve started buying investment securities to improve banks’ balance sheets during the financial crisis of 2008-09. The game was published in 2019, and while its theme harkens back to 2008-09, it also accidentally anticipated the Covid-19 pandemic.
Players assume the roles of central bankers around the world competing to bail out too-big-to-fail national industries, printing huge amounts of money in the process. One of the game’s rules is that the player who prints the most money destroys his or her national currency and automatically loses the game. The strategy is to abuse your national currency as much as possible without totally destroying it. It is funny how this game mechanic seems to agree with the incentives that drive real-world governments and central banks. Its designers must know a thing or two about political economy. Throughout history, governments have almost universally favored higher inflation while trying to avoid the disruptive and humiliating consequences of straying too far into hyperinflation.
As we played the Q.E. board game, our conversation turned to real-world money printing and inflation. One of the other dads surprised me by arguing that we should all cheer for inflation to be as high as possible. He wanted his home value to increase, and he trusted his paycheck would keep up with rising prices. He was being intentionally sardonic, but I was still taken aback because you rarely hear people argue from a pro-inflationary stance. I had to agree with him that for our group of working dads, faster inflation was probably a net positive. Our salaries would likely rise faster than inflation. Our mortgages would shrink relative to our home values. Our student loans would become less costly in real terms. There was no obvious downside for us.
There are two problems with this stance, however. One is that too much inflation could be disruptive to the economy. The same way that a spate of bad weather can harm GDP briefly, an inflationary storm can make the business climate more restrictive. It costs time and money to reprint menus with higher prices. Contracts become more complicated when you don’t know the future value of the underlying currency.
The second problem, and the motivation for this Viewpoint, is that the whole country isn’t made up entirely of youngish working dads with mortgages. It is also full of retired people on fixed incomes, as well as savers with bonds, annuities, and other investments that fail to keep up with inflation. These are inflation’s natural victims, and they are at an elevated risk right now.
Measured inflation has been rising recently. June’s Consumer Price Index (CPI) report from the Bureau of Labor Statistics showed an annual increase of 5.4%. Producer Prices rose even faster, with a core increase of 6.1%. These rates are at the very high end of the range we have experienced over the past 40 years and are causing some concern that recent monetary and fiscal policies may have broken the spell of low, predictable inflation Americans have enjoyed ever since the bad old days of double-digit inflation in the 1970’s.
Some of the recent surge in the headline numbers is simply an artifact created by comparing recent prices against year-ago prices that were artificially low during the most restrictive periods of the pandemic. Yes, June’s CPI reading showed 5.4% inflation during the 12 months since June of 2020, but the increase was only 4.7% in the 16 months since February of 2020, as pandemic lockdowns caused a modest amount of measured deflation. It is possible that as we lap artificially low data from 2020 the inflation rate will ease from here and that 2021’s inflation numbers will ultimately go down in the record books as little more than a post-pandemic artifact. The opposite could happen, however. Inflation could remain in the 5%-6%, or could even accelerate, as economic activity returns to its pre-pandemic path. The Federal Reserve has a great deal of influence over inflation’s future path, and it is hard to guess what the Fed’s future stance will be or how effective its policies will be in matching that stance.
How bad could things get? Arguably, our government already cheats a little and inflates the currency faster than its own data admits. I have written in the past about how inflation is officially measured differently than most people assume and how all the deviations suspiciously tilt toward more money printing. Not everybody agrees with this admittedly cynical view, but I think it is pretty mainstream among economists and investment professionals.
I admit the consequences of suppressing reported inflation are not necessarily severe. Social Security’s cost of living adjustment (COLA) and inflation-adjusted pensions might struggle to keep up with real-world price inflation over very long periods of time, but the slippage from year to year, or even decade to decade, is not huge.
However, the Covid-19 pandemic has made me realize a new way that inflation creates winners and losers, which has to do with productivity growth. Productivity is defined as the amount of economic production per unit of labor, and it depends on many factors including technological progress. A surprise silver lining of the pandemic has been more rapid adoption of many productivity-enhancing technologies, especially pertaining to remote work and cloud computing. Productivity growth is naturally deflationary. When work becomes easier, society can produce more with the same amount of effort, or produce the same amount with less effort. Both of these options equate to getting richer.
Except we don’t all get richer together. In an inflation regime people on fixed incomes fail to benefit from productivity gains. The only way for a retired person to benefit from productivity growth is for prices to fall. Prices should fall when the economy becomes more efficient, but the Federal Reserve’s inflationary posture exceeds productivity gains. People on fixed incomes might get a personal productivity benefit if, say, their internet service provider boosts their home bandwidth for no extra charge, as mine did during the pandemic, but quality improvements in consumer goods are already deducted from inflation statistics due to the “hedonic adjustment.” Your Netflix might get a little better, but your Social Security check adjusts slightly downward as an offset.
Inflation does not harm everybody equally, and the risk of accelerating inflation is not borne equally either. Stock investors have some protection because equities are real assets, as do working people. Pensioners can only rely on inflation adjustments, and these are imperfect. Bond investors have no protection at all. After a very long period of low inflation, I think we have become complacent about what a rigged game inflation can be. The higher inflation runs, the more it matters. If inflation does accelerate further, then more people are going to realize it is harming them. They will be frustrated and angry, and rightfully so. I might be in a demographic that generally profits from higher inflation, but I’m not cheering it on in the least.
Miles Putnam, CFA