Page 88 - August 2021

FINANCIAL PLANNING
INFLATIONARY PERIODS
Throughout the past several months, the primary monetary concern has been inflation. The record spending by the Fed is something that comes with consequences. Quite predict- ably, when a massive amount of money is printed, you can assume that an inflationary period will follow. From my personal experi- ence, there has been a great deal of talk about inflation, but not much mention of what is being done about it or how inflation can be counter- acted. Inflation continues to be the primary con- cern for investors. The price of commodities has skyrocketed, and it has left many people wonder- ing how much longer will this continue? In order to fight against inflation, governments typically employ monetary and fiscal policy. However, this can lead to recession and job losses. With the equity markets performing so well these past few years, we don’t want to give back those gains by imposing excessive measures aimed at slowing the economy. I’ll attempt to provide some insight into previous periods of inflation and how those situations were handled. I’d also like to talk about the available options to keep your money growing rather than losing value and what infla- tion could mean for the stock market.
FAILED MONETARY POLICIES
The federal reserve is the central bank of the U.S. The fed’s main objectives are to: maximize employment, stabilize interest rates, and manage inflation. The time frame from 1965- 1982 is when the ability of the fed was first put to the test. This time period is often referred to as the great inflation. Interest rates during this era rose to nearly 15% in the United States. The Nixon Administration tried to use price and wage controls in order to reduce interest rates. This proved to be largely ineffective. The former chairman of the fed, Paul Volker, took dramatic steps in trying to slow the spread of
inflation. It took a few years of suffering until the positive effects of Volker’s policies began
to show. The stock market faced several bear market years and the U.S. dollar was extremely volatile. We have made tremendous progress since this time frame. During the last several years, many Americans were able to borrow money for homes and vehicles at a rate lower than 3%. Several people I’ve talked to who were around during the 70’s have referred to these low rates as “free money.” They experienced
the outrageous interest rates and inflation
back in the 70’s and they are truly amazed
with how fortunate these younger couples are regarding borrowing costs. Within this period of severe inflation, there was also an increase in unemployment. The increase in both inflation and interest rates caused the unemployment rate to increase to 10.8% by 1982. The United States wasn’t the only country hit with excessive inflation. Countries like Germany, the UK, Canada, Italy, France, and Japan were also involved in failed monetary policies. What’s
to say we won’t end up in a similar situation? I believe the government has learned from previous mistakes, but it’s hard to be certain.
CONTRACTIONARY MONETARY POLICY
How did the great inflation come to
an end? A strategy called contractionary monetary policy was largely responsible
for containing rising prices and halting the decline of the dollar. This policy is typically used during periods of extreme growth
to slow down the economy and contain rising inflation. The main purpose of this policy is to decrease the amount of cash circulating in the economy. What exactly does contractionary monetary policy do? Well, there are three main levels. The first being increasing short-term interest rates.
When these rates are increased, it becomes more expensive for banks to borrow money, therefore leaving them with a decreased amount to lend to customers. The second is selling government securities such as Treasury bonds and bills. The fed will sell these securities to banks and once again, they will have less cash to lend out. Finally, the reserve requirement is raised. This also results in less cash circulating because banks will be required to have more cash on hand. This forces the banks to either up their lending standards or provide much smaller loans. Contractionary monetary policy is a great way to decrease the amount of spending and ensure that there isn’t as much cash flowing through the economy. This policy has proved successful in previous inflationary periods. It is a very delicate procedure, however. Imposing too much contraction or keeping these restrictions in place for even a month too long can cause the economy to nosedive into a deep recession. At present, government regulators, specifically those at the federal reserve, are not talking about inflationary concerns and are not taking steps to counter it.
HEDGING AGAINST INFLATION
From the second half of 2020 until the middle of 2021, interest rates have been staggeringly low. Government officials assume that borrowing from future generations isn’t such a bad idea because rates are extremely low and there should be a net positive affect to the economy. Currently, our country owes over $28 trillion with no plan whatsoever
for repayment. That’s over $86,000 for every man, woman and child in America (Peter G. Peterson Foundation). As of right now, having debt at a rate of 3% or lower isn’t necessarily a bad thing. With the right financial planner, it
by Cade Peterson, Financial Planning Associate
86 SPEEDHORSE August 2021