The Forces Converging to Drive Up Inflation

The United States’ financial response to the COVID-19 pandemic relied heavily on the Federal Reserve’s monetary levers: slashed interest rates, a surge of liquidity, and direct lending to banks being among several tactics employed by the Fed to help prevent (or at least forestall) a repeat of the 2008 financial crisis.

These efforts, alongside broader stimulus payments to millions of Americans, helped prevent economic catastrophe as the world came to grips with a new, uncharted reality. But now in our second year of the pandemic, we’re beginning to see signs that these efforts may lead to the kind of inflation that has bearish economists worried.

So what exactly is driving inflation? The answer goes beyond monetary policy. Supply scarcity, disrupted supply chains, increased consumer demand, cheap money, and a labor shortage all play a role in shaping our current economic conditions.

Here’s what you need to know about inflation and, perhaps even more importantly, steps you can take to safeguard your portfolio against it.

Long-Term Costs of the Fed’s COVID Response

Global economic growth showed signs of slowing down before COVID-19 became a full-blown pandemic, even if only slightly. It took until December 2019 for the Dow Jones Industrial Average to regain its previous high from back in January 2018. At the same time, Fed policy slashed interest rates and brought 10-year Treasury Bond rates down to a fraction of a percent. Interbank lending interest rates plummeted by May 2019 to a fraction of a percent as well.

Sources: Yahoo! (1) (2), Macrotrends

The economy already showed signs of slowing prior to the pandemic. A lingering trade war between the United States and China began to take its toll, the United Kingdom’s rocky departure from the European Union, and tariffs were all key issues prior to the pandemic. That only exacerbated the global factors behind weaker economic growth.

Consumer Spending Through COVID-19

Some economists and policy wonks worried that consumer confidence would plummet as the pandemic led to lockdowns, all but forcing main street shoppers to stay home and order online—if they wanted to do any spending beyond what was necessary for everyday life. This wreaked havoc for small and medium-sized businesses, especially if they did not have a robust ecommerce presence (or couldn’t create one in short order).

Consumer spending increased on average, however. This spending was unevenly distributed across industries, however. Some, such as retail and beauty, thrived. The demand for products pressed on, COVID be damned. But when the world’s factories and suppliers are shuttered, keeping up with demand becomes a considerable problem. Consumers spending in the retail space, combined with logistics issues, have now created a situation in which products are scarce and buyers are willing to pay higher prices to get them.

Lingering Supply Chain Woes and Supply-Side Issues

Though spending didn’t drop off quite like the markets predicted, supply for goods certainly did. And in 2021, signs point to a supply of workers getting smaller too.

The pandemic’s roots in China severely curtailed the global manufacturing sector (on top of the simmering trade war with the United States). Aluminum and steel tariffs had already impacted Chinese production, and lockdowns only furthered manufacturing woes. Other industrial nations experienced their own setback as employees were unable to work in factories due to public health policies.

As Asian factories ramped back up, problems with the global supply chain persist. American ports are full—some of the larger ones, like the Port of Los Angeles, are working 24/7 just to process the backlog of containers and ships. Similar problems exist in ports throughout the country.

When products can’t get made or shipped—or both—the demand for goods outweighs supply. This, in turn, makes most goods more expensive due to their scarcity. This is true even if there’s ample supply but goods can’t hit shelves. The result is higher prices and goods that are harder to come by, both phenomena that drive inflation.

Prolonged Labor Issues and Shortages

Workers in key economic sectors are also looking for significant wage increases after years without a meaningful rise in take-home pay. COVID-related unemployment payments, specifically supplemental increases to help cope with prolonged employment furloughs, have left major segments of the economy with workers making more staying home than returning to work.

In other sectors, labor unions have walked off the job for similar reasons. Some unions are on strike for better work conditions, while others are demanding higher wages and better benefits after years of austerity. This has exacerbated supply chain woes as workers walk off the job at John Deere factories and Kellogg plants, among others. Employees in professional sectors are more inclined to push back against management — or merely leave for a new job instead of fighting in the first place. This so-called Great Resignation may also put a squeeze on employers and, in turn, potentially drive up inflation.

Wage increases have expressed a correlation with inflation in the past, but this connection has become more tenuous in recent years. Yet despite efforts for higher wages, inflation created a 2% pay cut in terms of real wages—even if the average hourly wage grew 3.6% in 2021 versus 2020. Whether or not labor struggles will play a role in current inflation challenges, or if inflation will merely offset pay increases, has yet to be determined.

CPI

The Consumer Price Index is one of the biggest indicators of incoming inflation. As the CPI goes, so too goes consumer sentiment. If the CPI grows by more than a few percentage points, that translates into significantly higher prices for consumer products. That, in turn, can dampen spending and signal that a dollar doesn’t go as far as it did in the past.

The CPI has, on average, continued to climb from 2011 through the present as demonstrated below:

Source: BLS

The size of recent increases, however, signals that an inflationary period is either on its way or already here. Here’s the CPI from 2019 to the present, for reference.

Source: BLS

Consumer prices are expanding at a greater pace than seen prior to the pandemic. This provides another, and perhaps one of the loudest, alarms that inflation is on its way. When goods become more expensive and real wages don’t keep pace, consumers rein in spending. This can make it tough to keep economies growing in turn.

How to Hedge Against Inflation

Inflation does not affect all investments equally. Although some may lose value, particularly those in consumer goods, there are many that may even benefit from inflation. Stocks, for example, tend to suffer the worst when inflation is on the rise. A less-valuable dollar means that share prices don’t convert into as much purchasing power as they did before inflation rose. Other stock-heavy investments, such as equities-driven index funds, may see a loss in value as well—at least in terms of the purchasing power behind the investment.

On the other hand, several investments actually benefit from inflation. These take the form of commodities in particular. Gold, silver, and agricultural commodities typically increase in value as prices go up. If you invest in commodities, either directly or indirectly (through farmland, for example), your investment sum may rise alongside increased prices.

Alternative investments may also resist some of the financial challenges inflation brings. This depends, of course, on the underlying asset you’ve chosen. Real estate can resist inflation, but residential and commercial real estate may have less demand if buyers can’t afford to enter the market. Other real estate options, such as farmland, tend to be even more inflation-proof. They’re always in demand and are a scarce commodity. This is why farmland has such a robust history of maintaining its value, and can make for a strong long-term investment when inflation is on the rise.

How Farmland Hedges Against Inflation

Farmland investing proves itself to be uniquely suited to give investors a bulwark against inflation. The asset’s proven status as a long-term growth opportunity means it has resisted other inflationary pressures of the past with demonstrable increases in value. At the same time, its underlying crops themselves increase in value as inflation makes everyday staples more expensive. That, and the lack of new farmland in the United States means there’s only so much supply (with built-in demand to boot).

It was difficult for individual investors to break into farmland in the past. The size of the investment necessary was often steep, and so too was the financial commitment that came with it. Fractional ownership has changed this, however—opening up this real estate sector to individuals who can make a smaller overall commitment. This makes it easier to fit farmland investing into your broader portfolio, serving the role of an asset that’s able to withstand inflation more easily than many others.