The Truth Behind Inflation

It comes as no surprise that ever since the pandemic in 2020 the cost of goods and services consumers like you and I use everyday are rapidly increasing, you notice it in everything you purchase on a day-to-day basis such as food and fuel to even utilities and rent, so what caused this seemingly sudden increase prices?

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To answer this question correctly there are three concepts you need to understand, Number one is excess speculation, number two is risk, and number three is inflation.  

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Let’s start with the excess speculation, what causes excess speculation? Simply put excess speculation is a by product of monetary policy put in place by the federal reserve central bank. When an economy is in put in undesirable circumstances (most recent example being the 2020 pandemic) the federal reserve is forced to rescue the collapsing economy by using quantitative easing programs. What this means is they lower interest rates to near zero allowing companies to borrow money essentially risk free. The federal reserve also administers purchasing programs for various assets including bonds and mortgage-backed securities, the goal from these purchases is to support the equities and real estate markets. By buying billions of dollars worth of bonds the value of these bonds increase driving the bond yields lower as they have an inverse relationship. This process props up the equites and real estate markets as more people liquidate their bonds to buy stocks and real estate fueling excessive speculation as more and more people chase the rising value of risk assets.

To understand the relationship between risk and inflation you first need to understand money supply. Risk is a by product of excess money supply, when the federal reserve increases the money supply by printing money, they induce a mass amount of liquidity into our system. When this happens it encourages consumers to buy goods and services which in turn funnels its way into the hands of corporations. Likewise, this excess cash is also used by institutions and retail investors to invest in the equities and real estate market causing further increased prices and even pushing the current valuations beyond the further valuations hence the risk.

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Inflation is by product of risk, think of inflation as a natural remedy to the excess risk in the economy. As investors start to speculate more buying stocks, real estate, goods, and services prices naturally increase due to the excess demand and risk within the economy. Inflation acts a remedy as prices go higher due to naturally reducing the temptation of risk and excess demand, as prices go higher fewer people can afford to buy stocks, real estate, good and services resulting in lower prices.

In summary now that we understand what caused the Inflation we are seeing in our economy today, what can we do about it to get it back under control? There only two ways to truly reduce inflation, the first being let inflation run its course and eventually it will bring prices and valuations down as people cannot afford to take on excess risk due to highly elevated prices, this is extremely dangerous because there is no way of telling when inflation will start to come down. The second only realistic way to calm down inflation is to go to the source of the inflation to begin with, this being the monetary policy.

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The federal reserve can cut money supply or raise interest rates higher or perhaps both, resulting in lower prices and valuations, this also raises bond yields as investors and institutions are encouraged to position themselves in lower risk assets, by doing so this eliminates excess speculation and risk helping to reverse the inflationary cycle.

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