A discussion of purchasing power risk, including defining purchasing power risk and factors that feed it, such as inflation, interest rates and the US Dollar.
What is purchasing power?
“Purchasing power is the value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing power is important because, all else being equal, inflation decreases the amount of goods or services you would be able to purchase.”–Investopedia
Thus, purchasing power risk is the risk an investor assumes because of the weakening of money.
Factors That Affect Purchasing Power Risk
One thing that significantly affects inflation and purchasing power risk is money printing. When the US Treasury and the Federal Reserve Bank coordinate to print large amounts of the US Dollar, it causes inflation. Inflation is simply an increase in the money supply. The bigger the money supply, the less the money in your wallet is worth. Moreover, inflation is a hidden tax. As a result, money you have in your bank account loses purchasing power when money is printed by the government. At its core, this is purchasing power risk.
On March 23, 2020, it was announced that the US Government would be giving out stimulus checks to Americans. In addition, they planned to give dollars and loans to businesses hurt by the COVID-19 epidemic. Almost overnight, approximately $2 Trillion in loans and grants were printed out of thin air. This is a huge red flag and a big purchasing power risk. As a result, the internet went viral in creating money printing memes. One of those memes was the now infamous “money printer go brrrr” meme.
Consumer Price Index
According to the US Bureau of Labor Statistics, the consumer price index has increased 1.3% in the past 12 months (before seasonal adjustment).
“The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Indexes are available for the U.S. and various geographic areas. Average price data for select utility, automotive fuel, and food items are also available.”-The US Bureau of Labor Statistics, Definition of Consumer Price Index (CPI)
A consumer price index value of 1.3% seems reasonable for 2019-2020. If inflation or the CPI were only 1% per year, that means that in 100 years one US Dollar would lose about half its purchasing power. For example, $100 in 1920 would only purchase $50 worth of goods in 2020. However, real inflation for items we buy every day is much higher. In addition, we’ll soon see what the real inflation values are, and they are not pretty. All these factors affect purchasing power risk.
Current Economic Crisis in the United States
Debt and Unemployment are High, Interest Rates Low and COVID-19 Strikes; The Stock Market is Soaring – Something is Wrong!
According to Experian data, consumer debt has grown to around $14 Trillion in 2019. Debt for Americans has been increasing steadily since at least 2009. This debt includes things like credit cards, home loans, vehicle loans and student loans.
In addition, Americans are struggling financially right now because of COVID-19 shutdowns. Many people live paycheck-to-paycheck and have no savings. As a result, a sudden loss of employment caused them to face economic ruin or bankruptcy.
According to the Bureau of Labor Statistics, 13% of Americans were unemployed in May 2020. In addition, 30 Million Americans filed for unemployment benefits in June 2020, approximately 10% of the entire US population (Source: CNBC News).
The coronavirus outbreak of 2020 has had big impacts on the US economy. Big layoffs and job losses have occurred continuously in 2020. For example, Disney and MGM have laid off thousands of workers. These layoffs mean that these former employees will be struggling to make ends meet and won’t be buying new homes.
In the past, crises hit the United States, but we recovered. However, this time it may be different.
In 2000, Investors Lost 50% of Investments When the Dot Com Bubble Burst
The Dot Com Bubble that began in March 2000 caused the S&P 500 Index to drop almost 50%. This bubble bursting lasted until 2007. That means that if you were planning to retire in 2000, and many of your investments were locked into a Wall Street 401(k) that fell 50%, you couldn’t retire. Many people at this time were forced to return to work because they couldn’t afford to retire.
Currently, Wall Street stock prices are at record-breaking levels. Prices are high, interest rates are low, and everyone is cheering the mania. Many are questioning whether this will end badly like in 2000 and 2008. Clearly purchasing power risk is a big factor when markets are at all-time highs.
The Subprime Mortgage Crisis of 2007-2008
“The United States subprime mortgage crisis was a nationwide financial crisis that occurred between 2007 and 2010 and contributed to the U.S. financial crisis. It was triggered by a large decline in home prices after the collapse of a housing bubble, leading to mortgage delinquencies, foreclosures, and the devaluation of housing-related securities.”-Wikipedia.com
The subprime mortgage crisis led to the Great Recession of 2007-2009. This crisis resulted in a huge purchasing power risk for everyday consumers. Although some people lost jobs, the effects were mostly felt by lower housing prices in the real estate market. The markets quickly recovered within a few years.
2020: Another Economic Crisis
Debt, Mortgages and Home Foreclosures in the United States
- Total Debt to GDP for the United states is over 150%
- The Federal Reserve currently owns approximately 30% of all mortgages in the U.S. today (over $2 Trillion)
- US National Debt is now over $26 Trillion
- Home foreclosures are beginning to increase
Alarming Trends at the Federal Reserve and Debt-to-GDP Ratio
Two alarming trends are that the debt to GDP ratio is at 150% and that the Federal Reserve Bank owns 30% of US mortgage securities. First, most experts agree that when the debt-to-GDP ratio climbs higher than 100%, you are in the economic danger zone. Historically, high debt-to-GDP ratios have ended badly.
Unfortunately, this is bad news for the United States economy. As a result, people’s investments and retirements could be badly damaged. Moreover, purchasing power risk will be astronomical if the US economy descends into hyperinflation. Prices of goods and services may go much higher as wages stay the same. For example, hyperinflation has occurred recently in places like Venezuela, Zimbabwe and Argentina. Furthermore, it could easily happen in the USA.
Future Purchasing Power Risk Predictions
The past is never a good indicator for what may occur in the future. However, in this case there are clues that point to where we may be headed economically. We can expect more inflation in the United States and expect the US Dollar to be weaker in purchasing power over time.
What we know is that real estate and the US stock market has been in a bubble for years because of low interest rates. Money printing by the Federal Reserve Bank has also contributed to the problem. Prices have gone too high, too fast. As a result, what goes up, must come down. This purchasing power risk will work itself out as an economic crisis. The question is how long it will last.
Purchasing Power Risk Summary
A great Black Swan event occurred in 2020, which threw a wrench into the worldwide economy. COVID-19, and the reaction by governments worldwide is unprecedented. It will have lasting economic results for years to come. Real estate prices will suffer, the stock market will likely correct itself to lower prices. In addition, the United States will probably enter a depression for several years, beginning in 2021. We may see both deflation and inflation, which will significantly affect purchasing power risk for average Americans.
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