Riding the I-train

Higher inflation is already here, but how long will it last?

Inflation has been called the invisible tax because there’s no congressional legislation, no start or end date, and no splashy headlines to, frankly, tick people off.

As the pandemic lockdown ends, millions of consumers are emerging from their homes feeling somewhat bullish. They’ve survived a pandemic and likely received stimulus checks; some are getting enhanced unemployment benefits; and after a year of not spending on restaurants, entertainment, or travel, they may be anxious to make up for lost pandemic time.

This pent-up demand is the perfect setup for inflation using the basic rules of supply and demand. Nearly everything, it seems, is going up in price.

Warren Buffett acknowledged the trend during Berkshire Hathaway’s annual shareholder meeting. “We are raising prices. People are raising prices to us, and it’s being accepted.”

The consumer price index jumped 5% in May, the highest 12-month level since the summer of 2008. Jobs are coming back, although not as quickly as forecasts indicated. The 559,000 jobs added in May doubled April’s adjusted 278,000 jobs but fell short of the projected 650,000 jobs, while the unemployment rate fell to 5.8%.

What does this all mean for the local economy? To offer some wisdom, we put that and other questions to Steven Rick, chief economist at CUNA Mutual Group and senior lecturer in the Department of Economics at UW–Madison; Jim Tubbs, president and CEO at State Bank of Cross Plains; Brandon Scholz, president and CEO of the Wisconsin Grocers Association; and Arlyn Steffenson, executive vice president and chief lending officer at Monona Bank.

Two sides

Whether or not inflation is good or bad depends on the situation, notes CUNA Mutual’s Rick. “Inflation can be a good thing if you have a lot of debt because it erodes away the value of the dollars you borrowed. So, debtors like inflation. Creditors do not like inflation because they don’t like getting paid back in dollars that are worth less.”

The same applies to the federal government, he says. “We’re running massive deficits, which runs up our debt, but you can erode the value of that debt with inflation. From that perspective, the feds may not mind having it a little bit of inflation.”

While the Federal Reserve tries to keep inflation under 2%, the market is increasing prices. The price of steel is up about 200%, and corn and commodity prices are up as well. In early 2020, lumber mills shut down fearing the pandemic would halt construction but then were caught flat-footed when the housing market took off due to low interest rates. Still trying to catch up, the price of lumber is up about 400%.

“We could actually see a correction,” Rick suggests. “Lumber prices could come tumbling down once the mills start cranking up production again. What goes up always comes down, so things will correct and adjust.”

Rick agrees with Federal Reserve Chair Jerome Powell’s assessment: Price-levels will continue to rise, albeit temporarily. Economists, he explains, describe inflation as a continuous rise in the price level, not just a one-time jump. “We’re seeing a jump in the price level, but it may flatten out,” Rick says. “For that reason, we don’t expect prices to continue rising year after year.

“It’s easier for the Fed to stop inflation than to revive it.”

One tool the Fed has to tame inflation is to raise interest rates through its Federal Open Market Committee, which meets eight times each year. At each meeting, the FOMC sets a target for the federal funds rate, which indirectly influences short-term interest rates for credit cards and consumer and commercial loans.

So far, the Fed is holding the federal funds rate low, but other factors are putting upward pressure on interest rates. Ten-year U.S. Treasury bills jumped almost a full percentage point between the summer of 2020 and today. Now at 1.6%, the increase impacted the 30-year home mortgage rate dramatically and slowed refinancing.

“Interest rates hit their lowest point in the first week of January and they’ve gone up since then,” Rick says. “I am forecasting treasury rates to rise another point, to 2.6% by the end of 2022,” which will affect borrowing costs, business loans, or home equity lines of credit.

Small businesses should take heed, he advises, because “as inflation goes up, interest rates will rise, and the cost of capital will get dearer.”

Meanwhile, economists are forecasting the nation’s economic boon to be over 6% this year and probably 4% in 2022 based on pent-up demand and bulging savings accounts. “It’s a funny thing,” Rick says. “Everyone likes the cause of inflation [a robust economy], but they don’t like seeing the effect [increased prices] of inflation.”

Staying the course

At State Bank of Cross Plains, Jim Tubbs is keeping a close watch on interest rates. Rising rates could prove significant for business owners looking to expand their facilities, purchase new equipment, or improve their operations, just as banks and credit unions are flush with liquidity and willing to lend.

If rates rise, consumers could decide to hold off on automobile or home loans as they become more costly. Tubbs is particularly concerned with the lack of inventory in the real estate market, where demand outweighs supply and is driving up home prices; in some cases, $30,000–$40,000 over the list price.

Meanwhile, the average 30-year fixed rate for a mortgage is still around 3%, which is remarkably low compared to the 1970s and 1980s, when they hovered around an economically crippling 18–20%.

“The good news is that rates have not increased thus far,” Tubbs says. For that reason, State Bank of Cross Plains is staying the course on rates, confident that the Federal Reserve has deemed any interest rate spike temporary.

“There won’t be a knee-jerk reaction that will start changing monetary policy and interest rates, so it’s a short-term blip.”

But printing more and more money to keep the economy afloat isn’t the answer, either. “If the administration’s monetary policy is to just keep pumping trillions of dollars into the economy by printing money to provide for all this stimulus, it will keep the economy going and provide tremendous resources to be able to buy things, but there’s a ripple effect,” Tubbs cautions.

“It puts millions of people in a position to spend money when there’s very little out there to buy. Add to that a supply chain issue and a strained labor market and you have an impact that we’re dealing with right now.”

Brandon Scholz (Wisconsin Grocers Association) hears a lot from his constituency about that strained labor market. He blames the government’s stimulus package. “[Workers] could be making as much as $15 to $20 an hour not working, which is a huge disincentive,” he says. “The intentions were great, but now we’re going into the second year of this.”

The extra $300 per week federal unemployment bump is scheduled to end in September, but it also creates a double-edged sword. “You don’t want people who need those benefits to have them taken away, but they were never meant to be permanent. We have an economy that needs a workforce. If people don’t go back to work, what are we going to do?”

It’s not a matter of not paying employees enough, Scholz argues, but the industry’s razor-thin margins. “If the government mandates a $15 per hour wage, I can guarantee you that some people will get $15, and others will lose their jobs, so we’d have to further reduce the workforce and put people on unemployment.”

The other option is to raise prices.

Forecast: Lumpy and sticky

Arlyn Steffenson (Monona Bank) agrees the workforce is the number one concern. One business owner he knows contemplated closing one day a week just to prevent employee burnout, but that affects the business’ bottom line.

“Business owners have gone from no demand during the pandemic to falling revenues to now, when the economy finally opens up and sales are up but they can’t fulfill demand.”

Looking ahead, Steffenson expects the  the economy to be lumpy for a while.

“The Fed’s bias has been to let inflation run over 2% to make sure the economy is getting back on track,” he notes, “but at some point, you wonder if the market will force their hand and that if they see inflation getting out of control, they’ll have to raise interest rates to counteract that.”

To date, the U.S. government has kept short-term rates low, which is a good sign because that’s where more commercial businesses borrow, Steffenson explains. “They also buy securities in the open market to keep longer-term rates down.

“That’s why predicting interest rates right now is nearly impossible, but we do need to keep an eye on inflation to see whether it’s sustained or comes back in balance as all of these issues begin to resolve themselves.”

Steffenson confirms that Monona Bank has seen “decent” loan demand driven by customer demand. “As long as there is economic growth, there will be loan demand,” he notes, “but if businesses can’t increase their revenues due to constraints on labor or the supply chain, that will put a ceiling on how much they can grow.”

Most banks, he adds, are experiencing a deposit surge and historically high deposits. “If these dollars get spent, it will definitely trigger more inflation, but that’s a hard prediction to make.”

Rick describes that money in the bank as sticky. “Now that people understand that the government can shut things down at will, will they keep a cushion of savings — the old nest egg of three to six months of expenses?” he wonders.

Economists will be closely watching consumer behavior, he adds. “Will people keep their money in their banks or credit unions, or will they go back to pre-pandemic conditions, living paycheck to paycheck, blowing their windfall to buy new toys all at a higher interest rate?”

The events of 2020 were a normal reaction to an abnormal and external set of circumstances, Rick explains.

“We always wondered what a pandemic would do, and now we know. The gross domestic product in the U.S. fell by 3.5%. That’s now a data point we can use to compare against future crises.

“We shut down car dealerships and nonessential businesses, which tanked the economy and in hindsight wasn’t necessary,” he suggests.

“We probably won’t do that again because we’ve learned. Next time, we’ll mask up and social distance but we’re not going to shut businesses down like we did in 2020, so the GDP won’t crash.”