Todd Erkis is a visiting professor of finance at St. Joe’s who writes weekly columns answering students’ financial questions.
I have been hearing some people talking about how the spending in Washington D.C. might lead to inflation. Is this something I should be concerned about?
– Lee P. ’23, finance major.
At this point, not many people seem to be concerned about inflation. Inflation is when prices rise from previous levels, hurting a person’s purchasing power. Since 1992, U.S. consumer price inflation has been in the 1–3% per year range with a couple of small exceptions. The last time the U.S. had high inflation was in the 1970s and early 1980s. During that period, annual price increases averaged about 9% per year and consumer prices more than doubled.
The causes of high inflation can be complex and it’s not possible to predict when high inflation will occur again, if ever. Sometimes, increases in the money available in the economy lead to inflation. But over the past 10 to 15 years, the money in the economy has increased dramatically without significant inflation. Some people believe that inflation is a relic of the past and is not something that an investor should worry about. I am not one of those people.
The problem with inflation is that once it gets out of control, it’s very difficult to stop. The only way to stop inflation is to raise interest rates and slow down the economy which will be terrible for investment returns. I am also worried about the size of the federal debt, the historically low interest rates and the amount of “stimulus spending” that has been passed and with even more being proposed in Washington D.C.
The spending levels under the new Biden administration ($1.9 trillion in the first Biden spending bill and another maybe $3 trillion on the way) are huge. The nonpartisan Congressional Budget Office (CBO) projects a $2.3 trillion deficit in 2021 (not including the impact of the $1.9 trillion and the proposed spending on infrastructure). The national debt held by the public is more than $22 trillion and growing rapidly. All of this debt will need to be paid back at some point by future generations (i.e., current college students).
It does not appear that this extreme level of spending will immediately lead to high inflation, but it’s likely to be an issue at some point. I believe interest rates will need to be raised in the near future and the federal budget deficit must be much lower to slow down the growth in the size of the federal debt. It is not going to be pretty if inflation does take off, as likely the stock market will have significant losses as the economy is slowed down.
The best way to invest over the long run is to be diversified. This is true no matter what the federal government is doing. Traditional ways to protect against inflation are to own some gold, real estate and Treasury Inflation-Protected Securities (TIPS) in your portfolio. Mutual funds are the best way to get exposure to these asset classes.
This column has previously discussed how to invest in mutual funds. Note that TIPS are better held in a tax-advantaged account (as part of retirement savings) as they can lead to large tax liabilities due to their unfavorable tax treatment when held in taxable accounts.
No one can consistently time the market. If we worry too much about bad things happening, we will not take risks and will miss out on the long-term rewards that come with investing. I am concerned but I am going to stay invested, be diversified and expect ups and downs in my portfolio.