Throughout the COVID-19 era, comparisons to the 1918 influenza pandemic have often been drawn. From a fiscal standpoint, though, World War II bears a stronger resemblance. The massive defense expenditures of the mid-1940s are equivalent to today’s stimulus checks and Paycheck Protection Program (PPP) loans. According to the Federal Reserve Bank of St. Louis, today’s federal debt (as a percentage of GDP) sits just below its post-WWII peak.
The monetary parallels to the 1940s are also striking. In order to reduce borrowing costs, the Federal Reserve created money to purchase Treasury bonds to keep interest rates down. Consequently, the Consumer Price Index rose by nearly 60% from 1942-1948, meaning that holders of cash lost almost 40% of their purchasing power. By 1951, the situation had become untenable. In March of that year, the Treasury and the Fed issued a statement which committed to “minimize monetization of the public debt.”
Since then, various U.S. presidents leaned on Fed officials to keep monetary conditions easy—favoring inflation risks over unemployment risks—particularly during election years. But since the early 1980’s, the Fed’s stated policy (if not always its actual one) has generally been to get in front of rising inflation while it’s still brewing.
As Fed Chairman Jerome Powell has made clear in recent addresses, however, that four-decades-long approach has officially ended. In an April 28 press conference, Powell stated his intention to let inflation run hot (well above 2%) while it keeps stoking the fire with low interest rates and bond purchases.
Investors seem to have grasped the implications of the Fed’s rhetoric. Bond markets are now forecasting the highest anticipated five-year inflation rate (2.6%) since before the Global Financial Crisis. Stock prices have risen markedly in the expectation that more dollars in circulation will translate into higher corporate profits. Commodity prices have likewise gone on a tear. And while digital coins and non-fungible tokens may bear many of the classic bubble hallmarks, most of them have one thing that the U.S. dollar does not—scarcity.
Skeptics may decry the recent inflation concerns as the mere continuation of fearmongering that began with the Fed’s bond buying during the Global Financial Crisis period. What’s different this time around: the new reserves that the Fed created aren’t just sitting idly on bank balance sheets as they did in 2009. Today, the new dollars have gone directly into individuals’ and businesses’ bank accounts, and they are getting into the economy. The Labor Department reported a 4.2% rise in the Consumer Price Index in April 2021 over last year.
Because the demand for cash has risen so dramatically since the Crisis era, money creation has not (yet) generated the high level of consumer price inflation that it would have historically. However, monetary policy operates with a long lag, so it’s very difficult to forecast how much inflation will eventually show up.
While we may be fighting a virus, rather than a war, the economic collateral damage—inflation—remains the same today as it did two generations ago. Now, just as then, holders of cash and bonds will absorb the hits as their purchasing power erodes. As the inflation risks spike, investors should seriously reconsider whether bonds and cash are truly “low risk” after all.
About James Adams, CFA, CFP® and BSSF Wealth
BSSF Wealth is a fee-only financial planning firm headquartered in Camp Hill, Pennsylvania, with additional office locations in Hanover and Lancaster, as well as Frederick and Westminster, Maryland. BSSF Wealth is a Member of Advisory Services Network, LLC.
James Adams (“Jimmy”) is a Private Wealth Advisor at BSSF Wealth, which he co-founded in partnership with Brown Schultz Sheridan & Fritz (BSSF). He has two decades of financial services experience with expertise in asset allocation, portfolio analytics, financial planning, and investment manager selection. He is also the author of Waffle Street, a memoir of his time spent at a Waffle House in 2009 after the market collapse in the Global Financial Crisis. The book was later adapted into a feature film of the same name, starring James Lafferty and Danny Glover.
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