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Tue June 21, 2011
Inflation can be good for you
A rising Consumer Price Index (CPI) has caused more doom and gloom on Wall Street. But on this week's Money Matters, financial commentator Greg Heberlein tells KPLU's Dave Meyer it's nothing to worry about. A bane for Wall Street can actually be a boon for Main Street.
Why is a rising CPI seen as a bad thing? Persistent CPI increases prompt higher interest rates. That makes it more expensive for businesses to borrow. It also affects investors who buy stocks with borrowed money.
But it's different for consumers. Higher interest rates mean better returns for certificates of deposit, savings accounts, bonds, money-market funds and other forms of fixed incomes.
One of the big complaints in recent years is the beating savers have experience from those accounts. Seniors dependent on those accounts have suffered dearly. Money-market accounts have shown returns of only a small fraction of one percent. One-year CDs have been in record-low territory below 1 percent. One-year Treasury bonds at their worst have collected an extremely low rate under 3 percent.
CPI increases will change all that. Besides conventional savings, millions who have tried to offset inflation by buying Treasury Inflation Protection Securities directly or through a mutual fund will prosper.
So what’s the fuss? Some extrapolate a mild CPI increase to forecast extremely high inflation numbers down the road. Economists and other market analysts are infamous for taking the past six months of data and projecting it years down the road. True, inflation approaching double digits or more can debilitate the economy; such rates could propel prices to levels consumers no longer can afford. That was never more evident than the period in and around 1980, when some interest rates reached 20 percent.
But inflation today is only half of 7 percent. The rate for the most recent 12 months is 3.6 percent. That’s for an index that moves in tenths of a point. And as inflation rises, the Federal Reserve, which governs the interest-rate environment, has a variety of tools to stem inflation.
The stock market looks after itself. It realizes that higher interest rates could siphon money away from stocks and into fixed income. That’s a negative for stocks. It also knows that higher borrowing costs can affect corporate profits, making stocks less attractive.
A condition known as stagflation – when the economy falls as inflation increases – becomes more of a fear. But that takes years to develop amid repeated economic missteps.
Consumers should not be misled by fears that may never materialize. Moderately higher interest rates will enrich their bank accounts. In fact, even stock-market investors should avoid such knee-jerk reactions as last week’s mid-session 200-point drop. Studies show that inflation of 5-7 percent is the best environment for stocks, too. So calm down and look forward to better returns.