Q: What is inflation?

It can actually be defined in a couple of different ways:

Definition 1: The price of goods and services inflates... meaning, prices go up and up and up over time.

Or...

Definition 2: The supply of money inflates... causing more and more dollars to chase the same (or, like nowadays, a lesser) amount of goods and services.

Two definitions, same end result:

As inflation occurs, it takes more and more dollars to live your life.

There's a lot of psychology loaded into that previous sentence.

It's a sneaky thing.

I mean, a dollar from my birth year of 1972 (below) looks remarkably like a dollar from today.

But looks aside, they are two very, very different units of value.

Q: What is the current rate of inflation?

If you Google that question right now, you'll get the answer of 7%.Logically, you'd deduce that an apple that cost one dollar a year ago, will now cost you $1.07.Not the end of the world, right? Small change.

Except, that innocent-looking 7% is the HIGHEST INFLATION HAS BEEN IN 40 YEARS!

The "target rate of inflation", which we'll discuss later, set by the Federal Reserve ("the Fed"), is 2%.So, actually, our current rate of 7% inflation is 350% HIGHER than the target rate of 2%.And another thing...7%? Seriously?

Have you SEEN the price tags on things lately?

Q: Where does the 7% figure come from?

That's just an "index".Suggesting that everything has conveniently increased by 7% is like is kind of like asking, "How's the weather in America?"You *could*, I suppose, add up the temperature in every 1-square-mile of land that makes up the entire country, divide that by 3,797,000 (roughly the number of U.S. square miles), and state THAT as the "Temperature in America."You might call that the ATI -- the American Temperature Index.It *sort of* answers the "How's the weather?" question... such as whether the overall national temperature has been rising.

To you, though, the person looking to plan a picnic on Saturday, it leaves off a lot of important details, like what the weather's doing at the park where you picnic.

That's the only weather important to you, and monetary inflation is similarly subjective to each of us.

But the Fed needs an index to shape monetary policy, so we have what is called the Consumer Price Index or CPI.The CPI is a list of various prices of consumer goods and services in a number of various areas, compiled by the Bureau of Labor Statistics (BLS).Like any index, the CPI's function is to simplify and smooth out an otherwise all-over-the-map set of curves if you were to map all the items' prices in different areas on their own.

Here, let's look at those together and compare.

First, here's the everything-grouped-together-into-one-convenient-number CPI graph over 20 years.

Note the range, on the left side, from -5 to +10... so a range of 15%.

Now, let's lay the graphs of all the various categories that create that index over one another, onto the same graph:

You instantly notice the abundance of notable highs and lows, and be sure to peak at the range on that left column: From -50 to +75, or 125% total potential swing.

See that purple peak on the far right? That's the price of gasoline, the inflation of which hit 58.1% year-over-year two months ago.

Q: What is the role of inflation?

Inflation, as frustrating (and controversial) as it is, is actually on purpose.

Recall that the Fed, also known as the "central bank", states that they generally target a 2% annual inflation.

The Fed creates inflation by tweaking interest rates or by pumping more money into the economy like they've been doing, rather significantly, since Covid-19 began.

That 2% yearly price hike is supposed to keep the economy strong by inspiring consumers to keep buying goods and services today before they're more expensive tomorrow.

Here, let me put a line at the 2% mark to show that, averaged out, inflation has actually been pretty close to the target.

Q: What's a simple example of how to create inflation?

Oooh, now we're getting to the juicy part.Remember back to the first thing we covered, the different definitions of inflation.Prices going up, yes, but also the money supply going up.Consider this scenario:Imagine a village of 100 people, each with 100 dollars given to them by the "central bank" on the day they're born.That $100 per person, or $10,000 total, constitutes the entire supply of money in the village.*Important note: The quantity of money in a system or "village" is irrelevant, as long as that money and its assigned value are sufficiently divisible into smaller parts as needed to function within that economy.

What IS important, is the "hardness" of that money, meaning how easy or "hard" it is for the overall supply to increase which would diminish its value.

Hard money doesn't easily expand in supply, and so it holds its value. (If you want to get technical, hard money has a high "stock-to-flow" ratio.)Historically, if two "equal" villages with two different monies meet and begin to transact with one another, ultimately the harder money will always win.

This is because, historically, every form of "soft" or "easy" money, money that can be easily created and its supply expanded thereby diminishing its value -- a type of money incidentally known as "fiat currency" -- goes to zero.

Let me repeat that:

Every fiat currency in history has ultimately failed and gone to zero.

Therefore, the cost of food, homes, entertainment, services... all those prices throughout the village are adjusted as needed to reflect the true supply and demand that exists for the people in the village and their money supply.

Each person subjectively decides where to spend based on what's valuable to them, and they pursue income-earning activities ("work") that match their need to re-supply their financial stores.

What's more, if a person would rather SAVE their money for a larger purchase or just to prepare for uncertain times ahead, they can do so without fear that that money is going to lose its value over time -- because it's a hard money, with an "inelastic" supply.

In the village, a dollar saved today is a dollar to spend one year or ten years from now.

The movement of money among the villagers for various goods and services, we'll call it "the market", works for years and years, decades and decades.

But then, one day, because, let's say the village's apple harvest wasn't so good and the apple farmers are hurting, the central bank decides to introduce more money into the village's supply.

The central bank prints another $5000 in currency and pumps it into circulation, increasing the supply by 50%.

And they distribute it unevenly, meaning they give an extra $100 to each of the 50 villagers who happen to work in the apple industry, and nothing to the other 50 villagers.

Those 50 chosen villagers' bank balances just shot up, and because they have more dollars, they can afford to pay more for the things they want.

When the merchants of those desirable goods and services see the increase in demand, they naturally raise their prices.

Voila! In our fictitious village, the supply of money went up, the prices of things went up, and inflation has occurred!

Q: So, did America's Central Bank pump a bunch of money into the economy?

Umm... yeah. In a big, big, BIG way.

When Covid hit in March 2020, we all figured it would trigger a major recession.

Businesses, schools, ports, jobsites, warehouses, social gatherings... everything locked down.

So, to head off hard times, the central bank began "Quantitative Easing" -- a term often translated to "printing money" -- and also related to the Fed buying copious amounts of debt securities from banks, increasing those banks' lending capacities.

Just like our village in the example above, so began a cash infusion into the US economy.

• Stimulus checks

• Increased & prolonged unemployment benefits

• Child care stipends

• Tax credits

• Rent relief

• PPP for businesses

• Student loan relief

• Health care relief

• Medicaid expansion

• Uninsured coverage

• Massive purchases of long-term treasury bonds & mortgage-backed securities

• And much, much more.

How much did the US money supply grow since Covid?Well, in early March 2020, M1 (basically the supply of "cash" or "liquid portion of the money supply") was $4.3 trillion.

Today, less than two years later......please swallow that coffee.....and sit down......today, it is $20.6 trillion -- an increase of 479% in less than two years.

Here's a graph showing the last 20 years of M1. Note the vertical wall on the right.

Fun Fact: How much is a trillion?

Allow me to use time to illustrate it.

A million seconds ago was 12 days ago.

A trillion seconds ago was 32,000 years ago.

Q: Wait, is adding to the money supply all the Fed did?

No no, there was more.The Fed also, simultaneously, lowered interest rates to never-seen-before levels.

Things generally purchased with loans -- like real estate, for example -- became much more attractive, affordable, and attainable, because the low interest rates equate to increased purchasing power.

The loan amount a buyer could previously qualify for began going up and up...

and borrowers/buyers could buy real estate for a notably higher purchase price but for the same monthly payment.

Rates are currently at about 3.5%, half that of CPI inflation, and -- keep in mind -- remain fixed for 30 years when someone takes out a homeloan.

Here's the graph of interest rates going back to 1982 -- the previous year of highest US inflation prior to 2021.

Q: Wait, so was THAT all that caused inflation?

Oh no, that's not all.

On top of the massively expanded supply of money, and the lower-than-ever-in-history interest rates, both of which caused more DEMAND for goods and services (those that survived the lockdowns)......the SUPPLY became squeezed like nothing we had previously seen.

Shipping ports, warehouses, building contractors, maintenance companies, manufacturers, assembly plants, shippers, not to mention coffee shops, daycare centers, schools, and on and on......they (naturally) laid people off expecting recession-era slow-downs or had staff-members get Covid and have to quarantine, and ultimately became short-staffed.

Many of them found they couldn't get raw materials or ingredients even if they did have the staff to assemble, service, or ship product.

Economy-wide, throughput and output was frequently found to have tanked.

So now *VASTLY* more money is chasing not the same amount of goods as before, but *VASTLY* less available goods.

Demand was skyrocketing while supply was plummeting.

Thusly, inflation soared.

Q: So why is it important to know about inflation right now?

Because, unlike our fictitious village before the cash infusion, where you could stick a dollar in the mattress and pull it out a decade from now to find it still buys what it once bought, that is not the case with US dollars.

The Fed's quantitative easing kept a lot of people out of poverty and a lot of businesses' doors open, but it simultaneously pushed a huge amount of goods and services out of the realm of affordability, through inflating prices.

It also significantly devalued any "savings" someone might have.

If you'd been saving up cash for a used car and finally hit that $10K mark, congratulations, but in 2021 used car prices inflated an average of 35%.So your $10K, over one year, came to have the buying power of more like $7K.Did you get a 35% raise at work? Maybe a few people did, but not most of society.

I think the most important thing to know about inflation is that it's not going to end.

I'm not suggesting that it's going to stay at 7% per the current CPI.

It will taper, or what is known as disinflation.

But the Fed is not going to call back all those trillions and trillions of dollars, nor are they going to suddenly spike interest rates to jam on the breaks of our extreme price hikes everywhere.

Interest rates are predicted to experience 4 increases during 2022, each of them 1/4%.If it all happened too fast, people would stop borrowing, stop hiring, stop buying, and recession would follow -- the exact scenario this was all meant to avoid.

In an inflationary environment like ours, it's important to have some sense of how to protect your money from becoming excessively devalued over time.

The mattress, or any savings vehicle with too low a yield, is going to "leak" value over time.

There is no perfect, single investment to hedge against inflation.

People point to:

• Gold

• TIPS

• Bonds

• Commodities

• Bitcoin

There are a lot of educational articles out there to help you develop your understanding, and a strategy.

Here's a good overview on Investopedia -- a website I end up on quite frequently.

As you can imagine, I personally like real estate as a way of riding the inflationary wave.

Let's take a quick look at how that has fared, in the context of our topic of inflation.

Q: What was Bellingham Real Estate's inflation rate in recent years?

During recent pre-Covid years, while the CPI inflation rate basically behaved itself and stayed closer to that 2% target rate, Bellingham real estate has averaged many multiples of that.To track real estate inflation rates year over year, I simply compile all Bellingham sales for each full year and calculate the median price of the median 3-bedroom, 2-bath, 1800-ish square foot home.

Although your property taxes, insurance, utilities, and other operating costs like maintenance will have risen with inflation, your largest expense (by several multiples) tied to real estate ownership -- the principal and interest (P&I) payment -- is fixed for three decades and therefore protected from -- and a hedge against -- inflation.

If your money is leaking value at a rate between 2% and 7% per year, on average, and you can store value in an asset that historically does measurably better than that, you should perhaps consider moving some money into that asset.

That's my proposal to you.

Q: Will real estate prices experience disinflation, aka a reduced rate of inflation or appreciation?

They most certainly will.

We're not going to see 20% forever -- that would be catastrophic and is the subject of another blog post.

But if Bellingham real estate were a currency, it would be considered extremely "hard" money.

The scarcity of buildable land and available contractors...

The extreme level of zoning and permitting regulation...

The required time and expense to even get a project off the ground here...

...keeps the "stock-to-flow" ratio -- and therefore the stability of values -- very high, all things considered.