Inflation erodes the purchasing power of money over time. Historically U.S. inflation average about 3% a year, but it’s barely reached 2% in most years since the Financial Crisis.
Today, the U.S. Labor Department reported that inflation was 7% in 2021, the highest level in 39 years.
You don’t need to be an economist to realize that this headline is a big deal for Wall Street and Main Street.
But as someone who works on Wall Street and lives on Main Street, I’m here to tell you why I’m not particularly worried about the recent uptick in inflation.
Inflation Is Good For The Economy
Inflation isn’t a bad thing. In fact, it’s a sign of a healthy, growing economy. Too much inflation can be a bad thing, but we aren’t remotely close to being at that level.
The alternative to rising prices is falling prices, or deflation, which is far worse. Here consumers and businesses hold off spending (why purchase something today if it will be cheaper in a few months?), which triggers a negative feedback loop of even lower prices — and it’s incredibly difficult to break the cycle.
Inflation Is Good For Borrowers
Inflation makes debt less costly. For my mortgage and a commercial loans, I’m paying back debt with dollars that are worth less than the dollars I received from the lender in the first place.
When inflation exceeds the cost of debt (i.e. the interest rate), it’s often referred to as “free money” because I’m repaying the bank with dollars that are worth less than the cost of the loan.
Inflation Is Good For Homeowners
One of the biggest areas contributing to the recent uptick in inflation is housing. I own a home and don’t need to buy another home, so I’m benefiting from the increase in property value.
And as I just stated before, I’m also benefiting from the falling cost of the debt associated with my home, so inflation strengthens my financials as a result of being a homeowner.
Inflation Leads to Higher Wages
One of the key ingredients to an inflationary environment is wage growth. Most successful professionals get raises each year that at least keep up with the rate of inflation.
Your human capital, or your capacity to earn, is arguably the most effective inflation hedge. If your wages keep up with inflation over the long-term, then your ability to purchase goods and services remains intact.
Stocks Protect Against Inflation
The vast majority of my savings are in stocks, which have historically outpaced inflation by a wide margin in the long run.
During inflationary environments, corporations pass on higher prices (wages, input costs, etc) to consumers, which in turn boosts revenue and earnings. Going back to 1928, both U.S. dividends and earnings have grown roughly 5% a year while inflation has averaged about 3% a year.
Inflation Is Already Here And There’s Nothing You Can Do About It
Inflation’s historical average of 3% naturally includes times when when readings fall below that level (as it has for most of the past two decades) and times when it’s higher than average (as it is today).
We are simply witnessing inflation following it’s winding path to an average outcome. The path takes far fewer twists and turns than, say, stocks do on their path to an average outcome, but it’s still easy to notice a big shifts.
You can’t control the path of inflation, but the Federal Reserve can heavily influence it and plan to do so by increasing interest rates in 2022.
So if the reasons I’m less worried about inflation don’t apply to you, know that what’s happening is totally normal and not worth panicking about.