If the Fed is printing so much, why aren't we seeing higher inflation? How will inflation affect our investments and personal finances?
What is inflation? Inflation is the rate of increase of prices. Normally, the Fed measures inflation by looking at the price of a basket of goods. In that basket of goods, we have essential products and services that the average household uses. If the price of that basket of goods increases by 4% a year, it means inflation is 4%.
There are normally 3 types of inflation, monetary inflation (very important for investors), simple inflation and core inflation. Core inflation doesn't look at energy and food prices.
Inflation is caused by spending. The more people spend, the higher inflation will be. Therefore, in a healthy economy, inflation of 1-2% a year is good. Low unemployment rate also creates inflation. When people are working, they have more money to spend and prices go up. Creating more money can also cause higher inflation as it lowers the value of money. Therefore, the interest rate also affects inflation. Lower interest rate means higher inflation.
The Federal Reserve System has a dual mandate: Keep unemployment low and keep inflation low and they do that by controlling the interest rate.
In the past years, we had a lot of money in the system but where's inflation? Innovation kept it down. Fed Chairman Jay Powell said that companies such as Amazon $AMZN is one of the reasons why we don't see inflation. A strong US Dollar also meant that inflation was absent.
This recession is different from others. Oil $OIL prices have crashed, which lowered inflation. People cannot go out to spend money, which also lowers inflation. Therefore, for the average citizen, what we're seeing is deflation but for the investor, there's monetary inflation. Cash is trash for an investor right now. The S&P 500 $SPX500 is near ATH, Gold $GOLD is at ATH, so is the TLT ETF $TLT . Why keep cash?
But inflation will eventually come too for the average citizen too as when things get back to normal, they will be spending money that they are currently saving.
As an investor, the best thing to do is to stay invested but to be careful with your investments. It is not because it is easy to invest in a random company to make money that you should do it. Now, it is more important than ever to look at fundamentals.
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