If you are 50 or older, you probably remember the late 1970s and early 1980s when inflation was rampant and interest rates on consumer loans and mortgages were in the mid-to-upper teens. By comparison, the past 30 years represent a period of remarkable stability.
The Federal Reserve has, when necessary, raised interest rates aggressively to keep inflation in check. Volatile gasoline and diesel prices over the past decade have led to relatively sharp increases in the Consumer Price Index (CPI) from time to time. For that reason, many economists look primarily at what is called “core inflation” — inflation minus energy and food.
On one level, assessing inflation without counting energy and food is a bit like asking, “Other than that, Mrs. Lincoln, how did you enjoy the play?” Energy and food are major household expenses, and you can’t just pretend they don’t exist. But extracting those costs from the calculation does expose trends that could get lost in the volatility.
We have become so accustomed to virtually no change in core inflation that even a 0.2 percent increase — the scope of increases in three of the last four months — is noteworthy. The CPI for all items minus energy and food rose 1.3 percent during the 12 months ended in April.
That might not sound like much, but it’s higher than recent months. Don’t be surprised, however, if inflation surges in the coming months.
Remember almost three years ago when the nation’s financial system nearly crashed? Some things began happening in September 2008 that could have serious repercussions in the years to come.
First, the federal government began pumping hundreds of billions of dollars into the financial system and the U.S. economy to prevent a collapse and to encourage more lending and borrowing.
The collapse was averted, but the second goal simply didn’t materialize. Meanwhile, the Federal Reserve has continued to use monetary policy in an effort to spur economic growth.
Inflation could reshape your standard practices.
Where did the money go? For the most part, it’s just sitting there. Banks, for example, are sitting on more than $1.5 trillion in reserves, according to the latest Federal Reserve numbers reported late last month. Unless you track bank reserves, this number is meaningless. Perhaps that’s normal, right? It absolutely is not.
Prior to September 2008, bank reserves consistently stood at between $42 billion and $46 billion. When the crisis hit in 2008, the government poured money into the financial system, and the financial system reacted by doing nothing.
After all, the economy was a wreck, and banks didn’t want to take chances. Not that there were too many people looking to borrow anyway.
By January 2009, bank reserves topped $850 billion and were still rising. Just this year, banks have added another $400 billion in reserves.
Banks are not alone. Businesses throughout the economy are sitting on cash they haven’t been willing to part with. Eventually, they will do so, and when the supply of currency actually circulating surges to that degree, we may very well see inflation we haven’t seen in three decades.
Why does this matter to you? An inflationary economy requires businesses to act quite differently. Today, many business owners think it is wise to conserve cash as a cushion. But if we see inflation even close to the scale of the late 1970s, holding cash could be the worst possible strategy.
For example, rather than keeping parts inventories lean, you might do better by stocking up on parts — perhaps even at some risk of obsolescence — because the price of those parts to you will be rising quickly. You also need to watch interest rates closely — especially if you are considering investing in new facilities or have adjustable-rate debt now.
Your financial team is in the best position to assess your specific strategy for dealing with inflation. Just don’t overlook this potential crisis.
Avery Vise is executive director, trucking research and analysis for Randall-Reilly Business Media and Information.
