Today, on April 12, the monthly US consumer inflation figures were released for March 2022. 

They were high — the overall figure was 8.5% year-over-year. In March, average prices rose 1.2% over the prior month. In February, prices rose 0.8%. In other words, inflation is high and even accelerated in March.

The numbers were so high that White House Press Secretary Jen Psaki commented on it the day before the report was released to the public. This was apparently done in an attempt to prepare the public or to shift the blame.

“We expect March CPI headline inflation to be extraordinarily elevated due to Putin’s price hike,” Psaki told reporters.

Let’s Get Real

Okay let’s get real. This government official is desperate to find somewhere to shift the blame for this disaster, which appears to be out of control. 

Yes, it’s true that Russian President Vladimir Putin invaded Ukraine on February 24, 2022 and has been conducting a brutal war of aggression. The main action taken by the US, NATO and their allies against Russia was economic sanctions. Russia is a major exporter of commodities that affect the entire world such as oil & natural gas, nickel, fertilizer, wheat, etc. Ukraine itself is also a major commodities producer.

So yes, it is making things worse. However, US and global inflation was already rising to record levels before February 24. 

So how did we really get here? 

The Numbers

These figures are year-over-year, meaning that prices in March 2022 are compared to prices in March 2021. 

Core inflation includes everything other than food and energy.

Here are the broad strokes (compared to February 2022 report):

• Energy inflation: 32% (25.6%)
• Food inflation: 8.8% (7.9%)
• Core inflation: 6.5% (6.4%)

What is Inflation Caused By?

M2 Money Supply, courtesy of FRED.

The above graphic shows the M2 money supply, which refers to cash and checking deposits as well as savings deposits, money market securities and other deposits such as CDs that are considered nearly liquid. 

The gray lines in the above graphic indicate a recession. 

Inflation refers to the average of the price of all goods and services over time. The first cause of inflation is the ratio of goods and services to money.

If there is a ton of money in circulation compared to the goods/services that can be bought, their price tends to go up. Sellers think that their goods/services are more valuable than the money. This creates increasing inflation.

On the flip side, if there is very little money in circulation, the buyers think that their money is more valuable than the goods/services and so they are more likely to hold onto their money and the price of the goods/services goes down. This is known as a recession.

The Federal Reserve or Fed, the US central bank, has the aim to keep these factors in balance, and some time ago decided 2% was the inflation target. 

If inflation and economic growth is too low, they usually seek to loosen their monetary policy through actions like lowering interest rates and quantitative easing, or as we say on Twitter, money printing. 

If inflation gets too high, the Fed usually seeks to tighten monetary policy by increasing interest rates, and taking money out of the economy. 

Almost 30% of the M2 money supply was created in the past two years. This is also tied to Federal government spending, but I will keep it simple. It is reasonable to assert that the Fed went too far, and has created this current inflation monster.

A Second Force in Inflation

Extreme shortages of supply and extreme spikes in demand can also send the prices of goods and services skyrocketing. 

Since the production of oil and gas affects almost every other part of the economy, energy inflation has an outsized effect on overall inflation. 

Prior to the Russian invasion of Ukraine, the Biden administration took a series of actions to limit the production of the US oil & gas industry. Started in January 2020, they launch:

• The Keystone Pipeline was canceled.
• The leasing of federal land for drilling of new oil and gas was suspended.
• Existing leases in Alaska for drilling oil and gas were suspended.
• Specific offshore lease sales in the Gulf of Mexico were canceled.

The target was to decrease the negative effects on the environment caused by drilling for more oil and gas. However, these actions also affected the long-term ability of the U.S. to produce its own energy, driving the nation to import its energy.

It is reasonable to assert that these actions by the US government made the economic impact of the Russia-Ukraine War worse.

Where Do We Go from Here?

I see four potential outcomes:

1. In the perfect (and least likely) scenario, the Fed gradually gets inflation under control and the US government manages not to mess it up through massive borrowing. Inflation slows, the economy and employment rate continue to improve. The stock market and crypto have a mildly negative year or two with no major shocks. Then markets continue their sharply upward trajectory. 
2. The inflation bubble will pop in the next few months and the US economy collapses in the near term. The Fed’s tightening actions drive the economy into a recession. Prices will drop and unemployment will increase. The stock market, real estate market and crypto markets will drop sharply. Assets considered recession-proof, or less risky, will outperform other assets. I expect Bitcoin to drop but altcoins will sell off far more sharply in this scenario.
3. The Fed’s actions fail to get inflation under control for some time. Due to government spending and other factors, inflation will reach double digits and politicians will continue to point fingers. The stock market, real estate market and crypto markets will continue to skyrocket with massive valuations completely disconnected from the economy. Those who invest will continue to grow their wealth and those living paycheck to paycheck will be driven into poverty. This will eventually end with either point #2 above happening or point #4 below.
4. The Fed continues to raise interest rates but inflation does not drop and instead transforms into high inflation, high unemployment and slow economic growth. This happened to the US in the late 1970s and is known as stagflation. In this scenario, commodities will likely outperform assets considered risky. 

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This content is for educational purposes only. It does not constitute trading advice. Past performance does not indicate future results. Do not invest more than you can afford to lose. The author of this article may hold assets mentioned in the piece.