In the midst of some recent investing research, I decided to take a look at the inflation experience of the United States in the 1940s and 1950s. Why the 1940s and 1950s? Simply because there are a lot of “not since WWII” references today (e.g. unemployment; debt-to-GDP %). I want It turns out that inflation averaged 3.8% from 1940 to 1960 with most of that coming in the 1940s (5.6% versus 2.1% for the 1950s)1. In other words, a dollar in 1940 was worth about 58 cents in 1950 and 47 cents in 1960.
Why am I talking about inflation? We're in the middle of a pandemic. Aggregate economic activity is well off the highs of 2019 despite a rebound in 2Q. Fiscal transfer payments, including for unemployment and the Payroll Protection Program, will soon end and it's unclear what additional measures might be enacted. Corporate bankruptcy filings continue and will likely accelerate in the second half of the year. Initial unemployment claims remain high, and 33 million Americans were drawing unemployment checks in June.
There's no question that a wide range of possible economic outcomes could play out over the next 12-18 months. Hopes could be dashed if it takes longer than expected to produce an effective vaccine at scale or uptake is inadequate. In the meantime, serious economic risks and challenges remain.
Still, if we look beyond the next 12-24 months, to a time when the pandemic is (likely) behind us, the effects of massive monetary and fiscal efforts may be more obvious. That's not to say that inflation is inevitable - it is not. Potential inflationary factors like money supply growth, de-globalization, and major under-investment in commodities production must be weighed against factors likely to be deflationary like massive debt levels, demographics (i.e. ageing), and the continued impact of technology on the supply curves of most industries. Not to mention the velocity of money has been in decline since the late 1990s.
But it just doesn’t take a lot of sustained inflation to erode the value of a dollar. Inflation of 3% over a decade reduces the value of a dollar to 74 cents. Even inflation of 2% turns a dollar into 82 cents over a decade.
Low inflation feels like it's not a problem because it happens slowly, subtly, over time. Only when the things we commonly buy start going up 5% or 6% per year every year do we take notice.
Even in difficult economic periods, when prices are more apt to decline than increase, we need to be thinking about purchasing power. Like all fiat currencies, dollars erode in value over time. The U.S. government is locked into a course of action for the next decade (and perhaps longer) to make sure this happens.
The enemy of the long-term investor is always inflation. That is as true today as ever.
1. https://www.in2013dollars.com/ based on data from the U.S. Bureau of Labor Statistics