Lighting the Inflation Time Bomb’s Fuse

We covered the idea of “monetary velocity” yesterday

That’s the speed at which money circulates through the economy. It’s a crucial part of the well-recognized link between the money supply and inflation.

But as we discussed, the eggheads have it wrong

You see, they thought monetary velocity was relatively stable.

But in reality, it has been trending downward since the mid-1990s. And when COVID-19 shut down the global economy in 2020… velocity fell off a cliff.

Now, the velocity trend line is flattening out.

If you’re lost, don’t worry. The takeaway is simple…

For years and years, the Federal Reserve pumped money into the economy to battle crises.

Every time a crisis occurred, the central bank would go to work with bags of proverbial “helicopter money.” And every time, falling velocity helped prevent inflation.

The Fed wound up pumping the economy full of money. But most of that money didn’t circulate quickly.

So we got lucky… We got the benefits of “easy money” without having to suffer with rising inflation.

But with the velocity line flattening out, we have a problem today… It means the Fed’s efforts are causing out-of-control inflation.

Falling velocity is no longer preventing the increased money supply from turning into inflation. That leads to some unavoidable consequences for investors.

Essentially, we’re now faced with a big dilemma…

Is the current velocity situation a temporary post-pandemic adjustment? Or are we about to enter a new era in which velocity stabilizes – or perhaps even trends upward?

You don’t need to look far to realize we’re entering a new economic era…

The majority of Baby Boomers are retiring. And the folks who aren’t old enough to do that yet are looking for alternatives to the kinds of jobs they previously had.

We hear constantly from companies about the challenges of finding workers today. Labor shortage is now a dominant theme in our society. And one way or another, companies will need to give more incentives to get the workers they need.

Regardless of how they do it, if companies want to get workers, they’re likely to pay higher wages. And in turn, they’ll pass the higher costs on to consumers through higher pricing.

It’s more than just higher wages being passed on to consumers, too. It’s also about how willing workers are to spend the money they earn. This idea can get complicated…

Economists talk in terms of “multipliers” to describe what appears to be “2 + 2 is greater than 4” to the average person. But we don’t need to get into the weeds here…

We simply need to know that increased velocity can lead to more inflation than you might assume by just looking at higher wages being passed on to customers.

That means elevated inflation is here to stay as long as these economic conditions hold true. It could last for a decade or more.

Simply put, we won’t be able to look at the stock market in the same way as before…

Companies, sectors, and industries vary in how they can cope with or be hurt by inflation. And after being dormant since the early 1980s, this issue is now back in the spotlight again.

The “everything bull market” is coming to a close. The stock market isn’t just a single entity. So instead, we need to think in terms of multiple markets.

We’ll see bull markets in industries and stocks capable of doing well in this environment. But at the same time, we could see prolonged bear markets for companies that can’t adjust.

In the end, as we’ve said before, it’s time to get serious about finding the right stocks.

Good investing,

Marc Gerstein

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