The damage of the US inflation cycle is getting worse

The hyperinflation cycle in the US is 29 months long and counting. The recent low, yet positive, 12-month inflation rate is a misleading indicator. It ignores the multiplier effect.

Another aspect of inflation is the decrease in the purchasing power of money. So, it’s like the opposite of compound interest, because each month’s positive inflation rate (regardless of size) makes the accumulated purchasing power loss worse.

How big is the loss? Very. First, a picture of “only 2%” inflation

A good way to see what has happened is to examine the period before the inflationary inflection point of March 2021. At the time, inflation was operating at the Federal Reserve’s desired level of 2%. Here is a graph of the two primary CPI inflation measures, “All Goods” and “All Goods Less Food and Energy.” The latter is less volatile mainly because energy prices can move widely. In the long run, they end up at the same point.

That picture shows a steady, seemingly worry-free progress. Nevertheless, continued erosion still produces a large hole over time. For example, that 5-year, 2-month gain spiked to about 11%, meaning that the purchasing power of a dollar fell to about 90 cents. Therefore, to maintain the same financial position, the assets need to deliver a return of 11% (net of taxes and expenses) during the period. And it needs to increase by 2% (net of taxes) every year to maintain the same net income position.

With the Fed keeping interest rates low and companies focused on controlling costs, those requirements were hard to meet for many.

The Real Trouble: The hyperinflation cycle has taken hold

Note: The hyperinflation cycle was ignited by two actions of the Federal Reserve. With the US economy shut down due to COVID-19, the Fed lowered interest rates back to 0%. In addition, it bought trillions of dollars worth of bonds to vastly increase the money supply. They thought they were filling an economic hole, but, instead, they were putting together the same conditions that create high inflation. It erupted in March 2021.

The inflationary inflection point is clearly visible on this graph.

The Federal Reserve was surprised by the sharp, large jump in prices. Because he did not believe he had caused the inflationary jump, he used some unusual conditions (for example, shortages and shipping problems) to argue that the jump in prices was only temporary. Then, as the months passed, he changed the descriptor to “temporary,” whatever that meant. Eventually, he gave up and said he would raise interest rates to fight high inflation. Fed Chairman Jerome Powell warned that there would be pain ahead.

It is a big mistake to think that interest rates can tame the beast. What was happening was that the inflationary forces that had created havoc from 1966 to 1982 were reappearing. Companies gave top priority to price-inflation strategies to maintain earnings and profit margins. Second, of course, was the need to control rising costs (someone else’s expense). As a result, a staffing crisis (cry inflation) was created. Salaries and wages have always lagged behind cost inflation, so large consumer price gains have made the income issue a serious concern. This is why we are seeing an increasing number of attempts to unionize alongside union contract negotiations.

Now on to the explanation of worsening inflation…

The key to understanding what is happening is to track the cumulative high inflation from the March 2021 inflection point. As shown in the graph below, both CPI indices are up about 15%. The fact that the volatile CPI-All Items Index was up only 3+% over the past 12 months is irrelevant. That lower rate still drives up cumulative inflation even more.

Recall that the media-centric CPI-all-items 12-month rate of 3.2% is down because of a huge 15.7% decline in energy. This is why the rate of 4.7% for the CPI—all items less food and energy—remains the more relevant fiat-money inflation measure. Additionally, the latest all-item rate still holds the higher cumulative growth as shown in the graph: 16.1% versus 14.3% (6.4% versus 5.7% annually).

Compare those rates to the Federal Reserve’s 2% target (4.9% cumulative for 29 months). As I discussed earlier, a detailed analysis of the CPI results indicates a fiat money inflation rate of around 5% (12.5% ​​cumulative). The higher real CPI rates are due to some remaining demand/supply issues. As those are worked out, a short 12 month report is expected which can be taken as a further course of action. Once they run out, we’ll still be left with harmful fiat-money inflation, which we have yet to deal with.

Bottom line: The Federal Reserve talks, but fails to fully explain or act

To end the hyperinflation cycle created by the Fed, it needs to raise interest rates by more than the inflation rate. At the same time, it needs to reverse its massive, unmodified Fed COVID-19 action: the money created by the Fed’s trillions of dollars of long-term bond purchases in 2020-21. The Fed has said it is dealing with the issue, but it is not. It has not sold the bonds because they were bought at very low yields (very high prices) and the unrealized losses (not reported until the bonds were sold) are huge. This is the same problem many regional banks have created for themselves.

Unless the Fed takes those steps, this high-inflation cycle will continue, creating more pain and suffering, unequally distributed. As always, inflation particularly affects those who lack the resources and capacity to fight the ever-increasing prices.