Inflation…how did we get here?

If you ask ChatGPT what causes inflation, it will list first the imbalance of supply and demand, the rise of production cost, monetary policies and then supply shocks, in that order. Each of these factors alone, can cause inflation.

Over the last 4 years, we had to deal with all 4 of them. Covid-19, or better, the reaction to it, caused a worldwide supply shock since whole factories were shut down for extended periods of time. That caused an imbalance of supply and demand. As a reaction to that, monetary policies were implemented to cushion the effect. These monetary policies meant lowering interest rates and printing money. Lower interest rates tend to be unattractive for foreign investment, which decreases the currency's relative value.

Printing money of course increases the supply of these fiat currencies that are not backed by anything, except governments promise. That increased supply of money caused many people to stay home and take the government assistance, in many cases equal to their income. Eventually employers had to offer incentives, meaning higher wages, to motivate employees to return to work and that caused an increased production cost. While that mainly effected lower income jobs first, there is a ‘trickle up’ effect to higher income earners. Higher wages are a good thing, but it also creates inflation and that always affects lower income earners the most and contributes to the wealth gap.

In a relatively brief period of time, governments around the world created a severe inflationary environment, called hyperinflation. After the mismanagement of COVID-19, central banks and governments continued to fail by raising interest rates in an unprecedented speed to fight this hyperinflation. That of course caused a whole slew of other problems. The current inflation was mostly caused by an extended period of very low interest rates which encouraged borrowing and spending, and supply issues through lockdowns. But the failed monetary policy was the main trigger for the acceleration into hyperinflation.

So how do we get out of it?

Unfortunately, hyperinflation will not be solved by summon the grocery retail chains and asking them to help fight inflation. These chains have taken us for a ride over the last 4 years while reporting record profits and are not going to stop as long as there is enough money out there, to support these prices. The same applies to the elimination of the carbon tax. The promise of eliminating this tax is a pure political play in my opinion, and I think even the politicians promising that, know very well that this price gap would be immediately filled by the companies offering the product or service.

Prices in a capitalist economy are set by supply and demand. During covid-19, governments reduced supply with shutdowns and increased demand by infusing tremendous amounts of money into the economy. Money that is not backed up by anything. Corporations will always take advantage of these kinds of environment and look for the highest possible profit, which is the definition of capitalism. While they have contributed to the hyperinflation, they did not create it. Higher interest rates discourage borrowing and therefore spending, the result is lower inflation. The problem is that higher interest rates also slow down the economy, increase government spending on servicing debt, discourage foreign investments and cause problems for many homeowners.

Quite often we see a recession as an event in between higher and lower interest rates. When elections are near, numbers are skewed, and money is thrown around to avoid a recession at any price to secure re-election. That is the period we are currently in south of the border, and very soon here as well. Recessions have plenty of negative consequences, but they have served as a reset for economies and markets and occur on average every 3 ½ years.

While the rate of inflation has come down significantly, the possibility of entering a deflationary period is on hold for now. It is still above the desired rate, and given the current circumstances, higher inflation could be here to stay for a while. The cold hart truth is that there is no straightforward way out of this. We have put governments in charge of fiat currencies, which is equivalent to have a fox guard the henhouse.

History is showing us that fiat currencies tend to fail, and the US and Canadian dollar might go the same path. However, the timing of this happening is unpredictable, and in the case of the US and Canadian dollar, they have much more staying power than most other currencies out there. The flaws of fiat currencies have been used by many to promote alternative assets, like gold, silver, real estate, bitcoin, and other things. While these are great investments, most of the online ads, interviews and videos, urging you to buy into something because the end is near, are biased, misleading and have been around for decades.