Why Is The Inflation Rate Is Rising & Will It Increase Further In 2022
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In this article, I would like to explain what inflation is, should you be worried about it and also voice my opinion on the causes of inflation in 2021 and the likely behaviour moving into 2022.
Last but not least I will also talk about what you can do about it and how you can protect yourself against the impact that inflation has on your wealth.
2. What is inflation
For the benefit of those who are new to finance, inflation is the decline of purchasing power of a given currency over time.
The inflation rate is the rate that measures the extent to which your purchasing power changes – be it for the better or the worst.
The best example I can give you was that 10 years ago, Bic mac costs $5 but now it costs around $8. That $3 differences are what we call inflation and essentially the inflation rate is around 60%.
3. Should you be worried about inflation
Yes, inflation is very real and to a certain extend you should be worried about it because price increase tends to be very sticky, especially so in the long run.
What do I mean by that?
It is very easy for prices to go up and but it is quite difficult for prices to come down due to the behaviour and psychology of the market participants like you and me.
A very good example of this is the impact of inflation on labour wages and salary.
Think about it from your own perspective, during periods of high inflation, chances are is that you will demand higher pay from your employer to compensate for the loss of purchasing power.
But in periods of deflation, how likely are you to accept a lower salary or a pay cut since now, theoretically, your purchasing power had increased and you no longer need the level of salary that you are earning today to purchase the same level of goods and services tomorrow.
In other words, when the price of chicken rice increases, you will demand a higher salary to be able to afford the same quantity of chicken rice. But when the price of chicken rice decreases, you will not take a pay cut even though you don’t need as much salary to afford the same quantity of chicken rice as before.
That said, it is quite normal for inflation to persist over a long period of time and to a certain extend you should be worried about it because what this means is that your purchasing power is bound to decrease over time which will affect your ability to retire in the future.
4. Causes of inflation in 2021
Contrary to popular belief, the main driver of inflation in 2021 was due to the global supply chain issue instead of the massive money printing that was done on a global basis by the different government bodies.
Let me explain.
4.1 Why did the global supply chain issue cause inflation
The main cause of the inflation that we are experiencing today is the direct result of the current global supply chain issues that was caused the pandemic.
So, what happened last year was that when the pandemic began, a lot of countries locked down their economy and some even shut down their factories operations as part of the measures to contain and control the spread of the virus.
Naturally, when that happened, the global supply was impacted and the volume of goods produced is significantly reduced.
The reason why the inflation rate only took off in 2021 instead of 2020 was that back in 2020, people were not spending their money in fear and preparation for an economic recession.
As a result, the impact on the global supply chain was not felt in 2020 but as the economy recovers, more and more people started to resume their spending and consumption habits.
To make matters worse, the bulk of the consumption was focused on purchasing goods.
This is because as most countries’ borders are still closed off, people are unable to spend on experiences or travel and because of that their consumption now is channelled solely into the demand for goods.
When that happen, the impact of the factory shut down and slow down back in 2020 started to surface as the supply of goods available are unable to meet the increasing demand.
Because of that, inflation skyrocketed in 2021 as more money are spent chasing after a limited number of goods thereby driving prices to go up.
4.2 Why didn’t money printing contribute to inflation
From the earlier explanation, it is clear that inflation occurs when a larger amount of money chases after a limited number of goods.
In the case of the increase in money supply, while the money supply did increase as a result of the central bank’s decision to print and flood the economy with cheap and even free money, the amount of money that is chasing after the goods didn’t actually increase and had remained constant.
This can be seen from the velocity of money which measure the number of times that the average unit of currency is used to purchase goods and services within a given period.
As you can see here, as the money supply increases, the velocity of money decreased by almost the same proportion.
This suggests that the amount that is flowing and chasing after the goods and services in the economy had remained pretty constant despite an influx of money supply.
If all that is hard to digest, let me explain it in the form of an analogy.
Previously in the economy, there is a total of $100 chasing after 100 goods. As a result, each good is priced at $1.
Now, because of the printed money, in the economy, there are a total of $200. But instead of spending everything, the economy put away $100 in savings and only used the $100 to chase after the 100 goods.
So even though the money supply increased, the number of monies that are chasing after the available goods remained the same and as a result, the price of the goods did not change.
That is essentially what has happened to the economy even though a ton of money was printed into the current economic system.
5. My opinion on inflation moving in 2022
To a certain extent, the inflation that we are experiencing today is transitory.
That’s because the drivers of today’s inflation are temporary but we do face a real risk of higher inflation driven by the impact of money printing as velocity increases in the future.
Let me explain.
5.1 Why the inflation today is transitory
Given that inflation today is the result of a global supply chain issue, eventually, the issue will get resolved and when that happens, in theory, inflation should come down.
However, these issues will not be solved overnight and it will take time. You can expect inflation to persist or even worsen further before things turn for the better.
This is because companies need time to either increase or adapt their capacity to meet the ongoing demand. Setting up more manufacturing lines or adapting existing manufacturing lines to produce something else takes time to materialize.
Once things get resolved, we may even experience a potential situation of deflation as we go from a situation of shortage to surplus given that companies today are over-ordering in anticipation of today’s supply shortages.
What’s happening today is that a lot of companies are over-ordering in hopes that out of 10 orders 7 orders will be delivered to address their current shortages.
Now that is very dangerous because this results in a phenomenon called a bullwhip effect where if everybody over orders to create a buffer for themselves, eventually these buffers will add up and create a massive situation of oversupply down the supply chain.
When that happens, when supply exceeds demand, that is where we will face other issues that are deflationary of nature instead of the current inflationary issues that we are experiencing today.
5.2 Why inflation might persist beyond supply chain issue
Assuming that the supply chain issue is resolved, another factor that may drive inflation down the road is if the impact of the money printing surfaces.
As I’ve explained earlier, the reason why the money that was printed over 2020 and 2021 did not result in massive inflation is that the velocity of money decreased by the same proportion of the increase in the money supply.
As a result, the amount of money that is chasing after goods and services remained relatively stable.
Now, there are two factors that may cause the velocity of money to increase moving forward.
The first is the increase in economic activity as a result of the recovery after the pandemic and the second is the fear of inflation that may cause people to spend and convert their currency into real goods as soon as possible.
When that happens and the velocity of money increases, the impact of the previous money printing will be felt in the form of higher inflation as more money supply is now chasing after a limited number of goods thereby pushing prices up.
6. What can you do to protect yourself
Now that we know that inflation is real, what can we do about it?
The only way to combat inflation and the decrease in purchasing power is to invest.
If you earn a return that is higher than or equal to the inflation rate, theoretically, your purchasing power will be preserved.
However, just because you need to invest doesn’t mean you should do it blindly.
You should first ensure that your financial situation and your financial plans permit you to take on the level of risk that is needed before you try to dive into the world of investing.
The last thing you want for yourself is to make a loss on your investment AND suffer from the impacts of inflation.
If you’re wondering, what should you invest in, in times of inflationary pressure, you should invest in businesses that can pass on the inflation to the consumer.
I am a huge investor in the Asian market and I would recommend any investor who is looking to grow their wealth to look at this emerging market space.
That topic itself deserves a separate video on its own which is why I have already created a 33-minute investment thesis here:
Daniel is a Licensed Independent Financial Consultant with MAS and a certified Associate Wealth Planner that provides:
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This article is meant to be the opinion of the author
This article is for information purposes only
This article should not be seen as financial advice
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