It is hard not to notice the price increase. Food prices went through the roof. Rising gas prices don’t plan to stop. It is happening all over the world. The only question we have is, “What’s going on?“
Why is everything so expensive?
This is the question we will try to answer to the best of our ability. Hopefully, after reading this article, you will understand how we came to this point and how you should proceed from here.
The Phillips Curve, NAIRU, and Understanding Inflation
The Phillips Curve
The Phillips Curve is a graphical representation of the relationship between inflation and unemployment that was first introduced by A.W. Phillips in 1958.
The curve shows an inverse relationship between the two variables, suggesting that when unemployment is low, inflation is high, and when unemployment is high, inflation is low.
The reason why this is like that is that with lower unemployment, wages rise faster, whereas when fewer people are working, wage growth is weaker, and companies have to increase prices to compensate for it.
The best sentence that explains the Phillips Curve comes from one of the characters in Spike Lee’s movie The 25th Hour:
“More jobs means fewer people looking for work, means it’s harder to find good people to fill those jobs, means you got to raise wages to get them, means inflation goes up.”
The theory turned out to be incorrect and was replaced by NAIRU.
What is NAIRU?
NAIRU stands for “Non-Accelerating Inflation Rate of Unemployment.” It refers to the level of unemployment at which inflation is stable and not accelerating. In other words, it is the lowest level of unemployment that an economy can sustain without causing inflation to rise.
When unemployment is above the NAIRU, there is downward pressure on wages and prices, leading to lower inflation. However, when unemployment is below the NAIRU, there is upward pressure on wages and prices, which can lead to higher inflation.
This theory became irrelevant in 2020 when the FED stopped referring to it as it was not supported by data and nobody could determine how low unemployment could go without causing inflation. This is a changing factor as the economy itself progresses.
Why Is This Important?
We’ve used these financial theories and models for over 50 years, and they turned out to be false or unreliable. What’s important for you to understand for the sake of this article is that we tied employment to inflation. In fact, employment has always been one of the major factors determining the state of economic growth or decline. But, not the only one.
Just take a look at this and how everything changed in the last few years, proving these theories false:
What’s happened in the last three years, and last year in particular, is quite unusual and something we have never seen before.
Back to the original question, why is everything so expensive?
Covid-19 Is Responsible For Rising Prices
The Covid-19 pandemic is an obvious factor in inflation and rising prices. However, it was more the federal government’s response that triggered price hikes than the virus itself.
Let’s dissect this.
With the lockdown came layoffs, and a large number of companies were forced to close their doors. Uncertainty was in the air, and governments around the globe had to find a way to help people in need.
At this point, we were already in recession. Energy prices started to go up, but the higher prices were visible across the board. There was a surge in government spending programs in the US, and some of the things we did included:
- Sending $3,200 in stimulus checks per person
- Sending $600 a week as bonus unemployment insurance
- Boosting food stamp benefits
In 2020, there was an increase in checking account balances both in low-income families and in families at the top, by 65% and 30-30% respectively.
The Federal Reserve spent a total of $5 trillion to sustain families and businesses during this period while keeping interest rates at zero, making it easier to borrow money for investments such as buying a new home or car.
What’s noted is that people spent money steadily on goods rather than services. Instead of going to restaurants and getting out of the house to have fun, people bought things to decorate their homes as well as gadgets for work and entertainment. The increase in consumer spending wasn’t connected to employment.
Although the cash people received initially helped them, in the long run and on a national level, it accelerated inflation. The purchase of goods led to empty grocery store shelves (e.g., food costs increased), but there was also a shortage in the car market, with production unable to meet the demand.
All of this triggered a chain reaction. For example, oil producers expected price increases after Covid-19, which is why they slowed down production and struggled to keep up with the demand. This is when gas prices went up.
But all of this is connected to two other factors we will analyze:
Supply Chain Issues
The supply chain – two words we kept hearing constantly in the last three years.
When physical goods are stuck in place, prices rise.
The supply chain consists of five basic parts:
When there’s a problem in one of these areas, global supply chains get disrupted. You are not able to receive goods on time, which makes businesses increase the prices of the goods that they have in stock as they wait for the new shipments to come.
When the pandemic began, it caused a lot of countries to shut down their companies. Vietnam is one of the largest goods suppliers for the American people, and when they experienced problems in manufacturing, it disrupted the entire supply chain.
The ships would wait for weeks to unload their cargo. The Biden administration invested millions of dollars in accelerating the shipping process. While there’s still room for improvement, it seems that the biggest issues are in the past, and many Americans have consistent access to goods and groceries.
However, the rising prices never dropped. Once the food prices increased, they remained high despite some of the problems being addressed in the supply chains.
Unfortunately, there are other factors.
Trade War With China
China is the biggest exporter on the planet, and its the title they’ve been wearing with pride since 2009. Up until 2018, China increased the number of goods it sent to the US when the trade wars commenced, leading to tariffs on more than $300 billion worth of Chinese goods.
The trade wars continue today. U.S. imports of Chinese goods increased to $538.8 billion in 2022, slightly less than the record set in 2018. On the other hand, the US exported $153.8 billion worth of goods to China.
This gap is widening:
In dollar terms, the US is trading more than ever before, but the countries we are importing from have changed.
Either way, these tariffs additionally raise prices, and you can see how one deal can change the price of goods such as gas, groceries, technology, cars, etc. Whether this deal is good or bad for the US in the long term is something we’ll have to wait and see, but global politics does play a role, and we have to acknowledge it.
War in Ukraine
It has been a year since Russia invaded Ukraine, and this war illustrates a man-made disruption in the economy and how a war in Europe affects consumers around the globe.
Both Ukraine and Russia are major exporters of wheat and grain, but with the ongoing war and blocked ports, Ukraine was unable to export their products, while Russia needed to keep supplies for themselves.
Did you know that before the war, Ukraine was one of the biggest agricultural powerhouses?
- 5th in global wheat exports
- 3rd in barley exports
- 3rd in corn exports
- 1st in oilseed exports
Both Ukraine and Russia have a large percentage of Chernozem fields, or black-colored soil, which is the most fertile soil you can find.
Combined, Russia and Ukraine export 30% of globally traded wheat, 20% of globally traded corn, 75% of globally traded sunflower oil, and 1/8th of total calories!
A majority of importers are from northern African countries and Middle-Eastern states, including Turkey. These countries were hit the hardest, but other countries around the world also felt this, keeping their wheat prices at an all-time high with these supplies in demand.
Rising Gas Prices
The war caused an increase in energy prices, primarily for European consumers, but the US is not an exception. Russia is the major exporter of gas, and the sanctions imposed by the US and NATO countries riled global energy markets and caused the high cost of oil and gas.
In the US, the day before the invasion, prices jumped by $1.48 a gallon to $5.02, reaching a record-high on June 14.
Today, we have lower and steady prices no matter which gas station you decide to visit. However, there’s a discrepancy between states. For example, people in California need to pay more money and have higher gas prices compared to the residents of other states, such as Texas.
The market has leveled off, but the war definitely changed things, which is visible in Europe, where the demand for gas and oil is high, and there is an evident rise in price.
The war itself escalated in the same period as the pandemic and the supply chain issues. The past year has been pretty rough for the global economy.
Savings Fall Through During Inflation
It takes time to beat inflation, despite all the steps the FED and governments are taking regarding interest rates and employment. It will be some time before we see lower prices on products. There are still rough periods ahead, and it is hard to determine what will happen.
Are we going to pay more or less for basically everything next year? What can we expect? What can you do to make the most of this situation? Should you be putting your money aside?
Generally speaking, saving money and living below your means is a good thing. Most people can find themselves in a healthy financial situation as long as they track their spending and plan their budget. But with inflation, the money you save will only fall through. Its value degrades over time, which is why it is important to keep the money moving.
Solve This Problem with Lifestyle Banking
The idea behind this system is to pay your premiums and watch your cash value grow. In the meantime, you can take out loans from your insurance company and use that money to cover the costs of goods and services. What you will also do is pay yourself interest and grow your revenue by doing so.