Taming a Demanding Monster

Frankly Speaking

Taming a Demanding Monster

You may have heard someone refer to the law of supply and demand. It's one of those things that normally works on autopilot. I say that with caution since for two years using the word normal has been dangerous. Understanding supply and demand helps explain today's economic turmoil including inflation, supply chain disruptions, labor shortages, and bad hair days (well maybe not the hair).

The law, really a theory, goes something like this: companies will try to maximize profits by selling  their stuff at higher prices if they can, while consumers normally (there's that dangerous word) react to higher prices by buying less of the stuff in order to save money. This tension makes it hard for companies to arbitrarily push through price hikes, thus keeping prices and inflation relatively stable.

Like any theory, this one is based on some underlying assumptions. One major assumption is  consumers' buying decisions are free from government influence. That assumption became road kill in early 2020 when the government embarked on a bold new COVID-induced economic experiment. They started handing out checks specifically intended to influence/stimulate consumer spending. It was a huge success with spending quickly recovering, but like a Frankenstein monster the experiment took on a life of its own. Over the course of 2021 consumer spending grew an out of control 13.2%.

This monstrous consumer demand for ever more stuff soon outstripped the pace at which companies were able to supply stuff. When companies weren't able to make 13% more stuff, we called that a shortage or a kink in the supply chain. The reality is the demand monster had strained the supply chain to the breaking point. This is a major factor in the continued shortages we see in certain products.

While the demand monster rampaged, companies were able to raise prices 6%-8%. According to the law of supply and demand, as they raised prices consumers would start buying less of the more expensive stuff. That didn't happen. The government fed the monster stimulus money for so long that consumers were now unfazed. Companies were able to make higher prices stick. That's called inflation.

Having created the monster, the government is now trying to tame it. The Fed's plan is to raise interest rates, causing higher monthly payments on things like new mortgage and new car loans. As consumers feel their budgets getting squeezed, they will have less to spend feeding the demand monster. Can the Fed slow the economy enough to control inflation, but not so much as to cause a recession? That's a tall order. My concern is the Fed's current plan to raise rates to 3% by mid 2023 seems too little, too late. Whatever happens, there's no escaping some level of monster induced economic damage.

                                                Frank Rizzo, CERTIFIED FINANCIAL PLANNER ^TM

The opinions in this material are for general information only and not intended to provide specific advice or recommendations for any individual. The economics and market forecasts set forth in this material may or may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Inveting includes risk, including fluctuating prices and loss of principal.