Our American partners shared with us a presentation about inflation, and I took some notes. I'm not an expert in economics, so my notes may not be very professional. The main purpose is to help myself learn and understand, so everyone can take a look as a reference.
Inflation plays a very important role in macroeconomics. The most significant calculation of inflation is the CPI - Consumer Price Index.
This number doesn't have much significance for ordinary people; either they don't believe it (why is it only 5%), or they do believe it, understanding that the purchasing power of $100 last year has changed this year. However, for investors and financial institutions, the CPI is very important, such as the Federal Reserve using it to understand whether the economy is overheating or cooling down, thus allowing for macroeconomic regulation.
On the website https://www.bls.gov/news.release/cpi.toc.htm, the U.S. Bureau of Labor Statistics calls a sample representing 87% of the U.S. population to inquire about their spending proportions on healthcare, education, clothing, food, housing, and transportation. Then, through statistical calculations, they determine the CPI. For example, on May 1st, the CPI index for April was just updated.
In the various tables on this website, the first one is a comprehensive table: it shows that from May of last year to the end of April this year, the CPI increased by 8.3%. After the announcement of 8.3%, the stock market reacted immediately at the opening (economists had estimated 8.2%).
However, the m/m (month-over-month) ratio is also important. The CPI for April increased by 0.3% month-over-month, which has decreased compared to the previous few months; however, the Core CPI, excluding food and energy, was 0.6%. (The reason for excluding food and energy is that these two factors have too much volatility.)
When conducting surveys for estimation, a sample of over 90,000 different goods or services is taken. In the U.S., the proportion of goods to services is 6:4; after excluding food, the proportion of goods to services becomes 3:7. We can also see the weightings, such as housing accounting for 32.452%. Over the past 10 years in the U.S., rent fluctuations have been relatively small, playing an important role in stabilizing the CPI; however, during the pandemic, the Federal Reserve injected liquidity not only by purchasing U.S. Treasury bonds but also by buying a large amount of real estate debt securities (MBS), around 40-50%. This has led to significant increases in housing prices over the past two years.
If we take a look at the historical curve of the CPI:
The chart represents respectively:
Red line - Inflation
Black line - one-year rate
Blue line - real interest rate (rate minus inflation)
If the blue line is positive, cash is not losing value. Regarding cash:
Cash is Trash - when inflation is too high
Cash is King - when stocks are collapsing
At the same time, we compare the price of crude oil:
The ideal situation for CPI is to stabilize and then achieve a soft landing. However, historically, adjustments have often not been done well, such as two major inflations in the 70s-80s:
In 1973, members of the Arab Petroleum Exporting Countries organization, led by Saudi Arabia, announced an oil embargo on countries that supported Israel during the Yom Kippur War. Global oil prices surged nearly 300%. The U.S. negotiated with Arab countries to restore normal oil supply.
In 1979, the Iranian regime collapsed, followed by the Iraq War, leading to the second oil crisis. By 1980, inflation reached 14%, and interest rates also hit 14% or even 16%. However, three months later, by May, interest rates dropped to 8%, while cash devaluation was too high. President Reagan appointed a new Federal Reserve Chairman, Paul Volcker, who significantly increased interest rates, cooling down the market and controlling inflation. Reagan's conservative economic philosophy also laid a good foundation for the next 20 years.
If we look at the CPI over the past 15 years:
In 2008, the subprime mortgage crisis occurred, and the Federal Reserve cut interest rates to 0.
Following that, there was over a decade of economic prosperity starting from 2000, with low unemployment rates but no significant rise in inflation, which was maintained at around 2%. The supply chain in Asia-Pacific contributed significantly (goods accounted for 10-15%), and this was also highly related to technological development, which greatly improved production efficiency. The Federal Reserve was able to maintain low interest rates.
Then came the pandemic, and its impact over these two years has been immense. In 2017, due to the development of shale oil technology, U.S. exports exceeded imports, lowering oil prices. In 2019, oil prices were maintained at around $40-$60 per barrel. Due to lockdowns caused by the pandemic, people stayed home, production halted, and there was no demand for crude oil. In May, crude oil prices fell below $20 per barrel, higher than the production cost. Before the invention of vaccines, infection and mortality rates were high. There was no demand for clothing and services; states provided $600/week in unemployment benefits; the federal government provided an additional $600-$700/week in unemployment benefits, even exceeding the wages of blue-collar workers ($1000/week). With no demand for services, tangible goods (Goods) were in short supply.
In Q1 of 2021, vaccines were developed. India lost control completely at the beginning of last year, so they quickly started local vaccine production. By March-April, the epidemic was under control; Europe and America also controlled the epidemic by mid-year. Globally, work resumed, energy demand increased, prices surged, and CPI began to rise to 8%, partly due to excessive liquidity injection by the Federal Reserve last year and excessive relief funds distribution. Especially in CPI, rent is structurally rising. GDP is negative, job opportunities are abundant, but still hard to find people, and the economy is still overheating.
The current expectation is to reduce CPI to 2-3% by the end of 2022 through various adjustments. The Federal Reserve also said it would take measures, and interest rates will rise twice more, from 0% to 2%, which may lead to many companies going bankrupt and many people losing their jobs.