Inflation + the Supply Chain
For the past few months, we have, like many people interested in financial topics, talked a lot about inflation. We discussed how to hedge against inflation on the NEST Edge, where we get insight into Sean’s investment management process. We discussed inflation in relation to recent policy changes, and how they may affect retirement plans and accounts such as traditional IRAs and Roth IRAs. And we even discussed the relationship between inflation and Baby Boomers entering retirement, and the importance of factoring inflation into your retirement planning along with other considerations such as health insurance and caregiver costs. But all of these conversations focus on the consumer’s experience of inflation, so we thought we’d flip the perspective and consider inflation from another angle: production. As consumers prepare for Thanksgiving dinner this week, heading into grocery stores with long shopping lists to fulfill, many have noticed a startling rise in the cost of food items. Anyone who has been actively involved in financial planning before knows that inflation happens every year, but this year it has been particularly steep, with the cost of groceries jumping 5.4% since 2020. This marks one of the biggest increases in the past two decades, according to the Consumer Price Index. By contrast, grocery prices did not increase at all in the five years before the pandemic.At the cornerstone of rising inflation is simple supply and demand. Simply put, “inflation is most likely to occur whenever there are too many dollars chasing too few goods,” explains Forbes senior contributor Mike Patton. So while a consumer rightfully bugs out at a price tag that reflects a 28% increase in the cost of bacon since last year, the unseen supplier on the other end of that exchange is also experiencing startling changes that trigger this increase in cost.
Shifting Demand
If you’re like most consumers, you probably didn’t think about the supply chain much, if at all, before the pandemic. In 2019 (which seems like a lifetime ago) most consumers and suppliers would order things with the expectation that they’d arrive immediately. Because consumers wouldn't purchase more than what they needed in the immediate future, suppliers and producers would not purchase more inventory or materials than what they'd expect consumers to absorb in the immediate future, lest they acquire surpluses that they couldn’t sell. Everything was operating on an “as-needed” basis, hinging on the certainty that items would be available and arrive in a timely fashion once ordered. Cue that record-scratching sound effect - all of that changed in 2020 with the pandemic lockdowns. 2020 reshaped the needs and logistical demands of consumers, which sent a ripple effect of change down the supply chain. It might be more accurate to describe it as a "tidal wave" instead of a ripple, since the supply chain is still adjusting. Instead of purchasing things "as-needed," consumers began to stock up. Everyone remembers the early days of the quarantine, when we all thought we’d be at home for a few weeks and so everyone bought out all of the frozen foods, Clorox wipes, and toilet paper. Well, this didn’t just affect your local grocery store - it affected the entire supply chain, which now had to catch up to that unexpected surge of demand. Beyond those early days, though, the pandemic altered the entire dynamic of “supply-and-demand” in ways that are still being felt today, in 2021, as we continue to recover from the pandemic. Rather than spending money at events, restaurants, and other industries, consumers were forced to stay at home, and the demand for goods and services shifted to reflect that. Goods that could be consumed and used at home continued to be purchased at higher rates than before, and since the supplies for these goods suddenly had a much higher demand that their industries weren’t prepared for, this bogged down production and delivery of these supplies to manufacturers.
Production & Distribution vs. Demand
The relief efforts in the form of stimulus checks and other Federal programs also continued to provide Americans with money to spend even though employees were not working, meaning that there was a disproportionate amount of demand compared to the rate of production. Production rates were already slowed down by restrictions on operations and labor shortages, and this mismatch between supplies available, production rates, and demand for products means prices increase. A good example of this issue is seen in the shortage of computer chips, which had negative effects on many industries including the used car industry. The labor shortages persist today and are still affecting the supply chain, driving production rates down further while consumer demand remains high. Beyond changes in production capabilities and consumer demands, there are also ongoing challenges with the transport of goods to the suppliers. Container ships are still being held at ports, and rail freight is getting more expensive, both of which limit the amount of goods that companies are able to transport. Thus the "supply" for vehicles and means to distribute goods and materials does not match the increased demand, and this spikes the price of those goods. Finally, natural disasters such as Hurricane Ida continued to disrupt production and transportation of goods, which left many of key industries short on materials they needed to keep up with demand.
"Stocking Up" Drives Prices Up
All of this disruption has encouraged businesses to adopt the same “stock up” mentality that consumers have, rendering some items hard to find and make, driving prices up further as a result of scarcity. As you can see, the problems with the supply chain are layered and have a domino effect on each other which ultimately increases the prices of goods even further, beyond the other economic factors and events that are contributing to inflation. The pandemic has reshaped the dynamics of supply and demand, creating shortages and disruption in the supply chain that we will be adapting to for a long time. It’s hard to anticipate when these supply chain issues will work themselves out, and if a return to an economy similar to 2019 is feasible or possible. The Fed has talked about starting the tapering process for months now - and once that has actually begun, inflation might adjust. A gradual reduction in the stimulus purchases by the Fed may also decrease consumer spending, and thus demand, which will ease some of the pressure on the supply chain. In the meantime, though, know that the rising prices at your HEB aren’t just the bacon companies grubbing for money - it’s a much more complex, layered issue than that.
Financial Planning & Investment Management
If you’re interested in adjusting your financial planning strategy or investment management strategy to hedge against inflation, reach out to us at info@nestfinancial.net. That email goes directly to the inboxes of our financial planning mentor Gloria and investment management mastermind Sean, and they would love to help you with your financial goals. Send us an email and join the many other Austin families and individuals on the path to financial freedom!
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