What Goes Up

Inflation has been in the headlines as it has hit “decades highs.” Those headlines are concerning, for sure. But what does it mean to people trying to manage their financial lives? The answer comes in a few parts. 

For starters, when you hear about inflation in the news, they are referring to what is known as a trailing indicator, meaning a measurement of what has already happened.  It does not necessarily tell you anything about what is going to happen. Rising costs of certain goods and services are something Canadians have been dealing with our entire lives. For example, there have been periods of double-digit inflation on university tuition in Canada, which was pretty important if you were paying for higher education, but significantly less important for those who were not.  

That means that everyone’s personal rate of inflation is different.  The various indicators we commonly see,  such as the Consumer Pricing Index (CPI), are based on a static basket of goods whose prices change over time. The CPI may be quite different from your personal experience with higher costs and does not do anything to capture your ability to substitute between goods.  

The history of inflation, and some of our pre-occupation with it, primarily began in the late 1970s. In 1979 the inflation rate in the US was 13.3% and widely seen as a very bad thing. Paul Volcker was introduced as Chairman of the US Federal Reserve with a mandate to bring inflation down. By 1983 inflation dropped to 3.8%! The world was saved, the people rejoiced, and Paul Volcker was declared a hero. I am not usually someone who would ruin a good party, but it is important to note that in 1983 the calculation used to determine the rate of inflation was revised to exclude the cost of renting. The stated reason for this change was that the data was difficult and potentially unreliable; the premise was that by removing that data, the indicator would be more useful. I do not bring this up to besmirch Mr. Volcker’s good name but to point out that how we track inflation changes over time, and sometimes the powers-that-be exclude significant things in the name of consistent and comfortable data points. 

Much of the current commentary on inflation focuses on how to invest in inflationary times. The surprising answer is that inflation really does not change much about how we make investment decisions. While recent inflation numbers are high, we are unsure how much disrupted supply chains have contributed, and how temporary those interruptions might be. It is also worth noting that in studying previous periods of inflation and the performance of various investments, there is no definitive evidence to suggest which assets to buy and which to avoid. So even if you were completely sure that we are, indeed, in a period of ongoing inflation, you still cannot know exactly how it will play out for asset markets. The truth is that asset prices are influenced by more than just inflation. Things like global economic strength, interest rates, job numbers, geopolitical issues, and many others contribute to market direction. 

With ongoing apologies to Mr. Volcker, it is also important to acknowledge inflation can be a good thing. Notice how there is less conversation about government debt? Like a bad neighbour with your leaf-blower, Canada still has not repaid any of the money we borrowed to fight the second world war. The roaring 1950’s and subsequent inflation grew the size of the Canadian economy to the point that the level of debt was manageable. If you make $20,000 per year and owe $5,000 in credit card debt, you have a problem. If you make $150,000 and owe $5,000 in credit card debt, you do not have a problem. Countries live forever (we hope), so if the debt is appropriate relative to the economy, you can thrive. This is neither an endorsement nor indictment of any current government policy, just math. 

At the end of the day, with talk of inflation all around us, our advice remains the same. Keep your short-term money “safe” and your long-term money working for the “long-term.” If you are planning on spending money in the next couple of years, it should not be exposed to market fluctuations unless you are willing to change those plans or borrow money. Long-term money should be invested with the idea that your portfolio needs to grow to maintain its purchasing power.