As we watch the news with daily vaccination updates, optimism is starting to creep back. The economic picture is improving. We’re starting to dream of travel, vacations and a resumption of what life was Pre-COVID. Clearly, the stock market and investors expect an economic rebound in 2021 with stock market surges to new all-time highs. However, U.S. debt has ballooned in 2020, and it’s unclear how that will affect the U.S. dollar over the long term, or what will become of our economy when the Fed’s zero rates policy sunsets. Naturally, with housing prices surging and stock prices climbing, our clients are wondering if there is evidence of inflation on the horizon. Here’s what the data says.
The money injected into the economy by the government and the Federal Reserve has been beyond record breaking. Far beyond exceptional. $9 Trillion in new money was created and put into our economy, constituting 44% to our total economy. We have never before seen such a coordinated, worldwide liquidity injection of new money like this so we do not have historical context to base a long-term projection on. We do know when money is created, it makes the existing dollars in circulation worth less and should trigger inflation.
One way to look at inflation is the Consumer Price Index (CPI). As we scan across the globe, it is plain to see that inflation as measured in CPI here in the United States hasn’t moved much, and other developed countries in the EU and Japan actually experienced DEFLATION, which means the price of goods and services go down year over year. The most surprising aspect of these inflation indicators is that it flies in the face of conventional wisdom. Scholars and economists from decades past would have almost certainly been convinced that if both the Fed and the Treasury created trillions of dollars inflation would have followed. But that hasn’t been the case so far. In fact, with the Federal Reserve printing money in a continual flow since the 2008 financial crisis, we haven’t experienced any meaningful inflation….Yet.
Right now, the Fed estimates are calling for a 2.5% rate of inflation in 2021. To us this feels more like an optimistic hope rather than a true reflection of what the data predicts. Part of this estimate is what the Federal Reserve believes U.S. economic growth will look like, and right now they project a 4.2% increase in GDP in 2021. If we see this kind of U.S. surge in total output this would be a massive increase in economic activity. We haven’t seen that kind of annual growth since the late 1990’s. On one hand, it makes sense that the U.S. economic growth in 2021, when compared to an economic lock down in 2020, should be remarkably better thanks to vaccinations, resuming of normal life and the release of pent up demand for travel and entertainment. On the other hand, can the economy perform at full speed with more bankrupt companies, hotels and restaurants closed during the extreme COVID shut down? 2021 is going to be an interesting year to watch all these factors collide.
If we do end up with high inflation, the U.S. dollar would lose value which makes you wonder…. How do I protect myself? Where do I go? Many experts and clients think if the dollar goes down, inflation goes up…. So, I should buy gold, right? There is reasonably solid data to show gold does indeed go up when the U.S. dollar goes down. That is a reasonably strong negative correlation.
This begs the next question, does Bitcoin also serve as a good hedge? The data indicates Bitcoin is very closely related to the Nasdaq (AKA technology stocks). That does not necessarily mean that Bitcoin can’t be a decent hedge in high inflation environments. In fact, one investment that performs best during high inflation…. Stocks! That’s right, stocks.
And if you are seeking the key to understanding Bitcoin’s long term value, a quick note here – the more people who have Bitcoin, the more places that accept Bitcoin as currency. The further the currency spreads, the higher the value goes. If for some reason any one of those factors doesn’t happen, expect Bitcoin to lose value. The formula is actually fairly simple!
We are acutely aware of massive money creation and what the text books say happens when a country creates money out of thin air. One of the best historical examples of money creation and a currency collapsing is Germany in 1923. When Germany was trying to recover from WWI the government created cash and the currency became nearly worthless. There are famous pictures of women wearing skirts made from cash and children playing with stacks of real currency like it was monopoly money. With those images locked in our subconscious, it’s easy to worry when you see our country creating trillions of dollars virtually out of thin air. Yet, the key to having inflation goes beyond pure money creation. Economic growth is needed in tandem with money creation to create runaway inflation. Keep your eyes closely tuned on economic growth projections. It’s likely that if and when we see our economy heating up and growing quickly then at that point, we may have some inflationary concerns to worry about.
Feel free to contact your Henry+Horne Wealth Management adviser with any questions.
Michael Carlin, AIF®