By Professor Ricardo “Rick” Ulivi, Ph.D.
January 2018

Last month I wrote about what is likely to end the current euphoria in the stock, bond, and real estate markets. I pointed out that the culprit will probably be un-expected inflation, and its effect on interest rates. Many of you wonder why inflation is likely to accelerate, so below are a few good reasons.

The drop in the value of the dollar versus other currencies

Retailers had a great Christmas season. They sold most of the inventory they bought at the beginning of 2017, and now need to replenish it. The problem is that during 2017 the dollar fell around 10% with respect to most currencies, which means that inventory replenished in 2018 is going to cost that much more. What will retailers do? Pay the price and increase their prices to consumers. This will clearly and strongly impact inflation this year.

Commodity prices have been increasing

You might not know, but cotton, copper, oil and other key commodity prices increased substantially last year. This, in turn, will soon cause prices at the retail level to rise as well.

Minimum wage

A few days ago, the minimum wage went up by $0.50, which is at least a 5% increase. What do you think employers will do to manage this increase? Raise their prices too.

Tax cuts at a time of full employment: never a good idea

It’s getting tougher to find qualified employees, because we are at full employment. If the implemented tax cuts increase economic growth as promised, there will be more demand for workers. Given that we are already at full employment, greater demand for employees will only increase wages. There goes inflation.

By the way, if the tax cuts put more money into people’s pockets, what will these folks do with this extra cash? Spend it! Who will benefit? The Chinese, because most of the stuff we Americans buy comes from China. In other words, Trump’s tax cut will benefit the Chinese. Go figure!

Federal deficit keeps growing and savings rate keeps going down

One very important source of inflation is the temptation to increase federal spending and pay for it, not by raising taxes, but by printing money. Last year the government spent $660 billion more than they collected in taxes. In 2018, the deficit is likely to be worse due to the tax cuts. These huge deficits can result in inflation.

It seems most people don’t save in this country. How bad is it? To put this in perspective, during the 20 years between 1960 and 1980, the savings rate was between 10% and 13%. That was reasonable. Today’s savings rate is horrendous. Between 2013 and mid-2016, the national savings rate was around 5%. That is, for each $100 of income earned, Americans were saving $5. However, that rate plunged in 2017. It was around 3%. A lack of savings, and a spending society, can increase inflation.

OK: Assume Inflation will go up. Where’s the nasty part?

If inflation accelerates beyond an annual rate of 2%, as I am predicting, what are the immediate consequences? First, and most damaging, this increase will put pressure on interest rates to rise too. Secondly, if interest rates go up, you can expect the prices of real estate, stock, and bond to fall from their current record highs. That’s the nasty part.

In sum, the financial party, which has been financed by super low interest rates due to a political decision by the Fed, is coming to an end soon. Inflation will accelerate, and interest rates will go up. Are you prepared for the financial hangover that is likely to occur?

To set an appointment to discuss this further or to review your finances, call me at 1-714-771-6000