As labor and supply shortages hasten the demise of globalization, there’s a giant sucking sound circulating through the world economy. People in both developed and emerging economies are watching their purchasing power shrink before their very eyes.
To get a read on what’s happening, Financial Advisor checked in with Tom Connelly, the president and chief investment officer of Versant Capital Management.
Financial advisors might think their typical clients, affluent Americans, are largely immune from the decline in global living standards. Connelly disagrees. Having spent nearly nine years chairing the investment committee of the $40 billion Arizona State Retirement System, the Phoenix-based advisor is an expert at matching financial assets and liabilities.
These days, ordinary Americans are forced to make difficult spending choices, so concern about the problems of the 3% or 4% of people with assets in the vicinity of $5 million sounds downright impolitic and irrelevant. Nonetheless, Connelly thinks many well-heeled clients are facing a higher level of lifestyle risk than they or most advisors realize. Clients should be “worried about having enough money even if they have $5 million,” depending, of course, on their lifestyle.
If inflation turns out to be more intractable than conventional wisdom holds, even those retirees living on portfolios with growing dividends plus fixed-income securities (and who don’t need to consume much principal) may “not necessarily” be secure if they lack the flexibility to cut personal spending. The problem is compounded by the fact that once-in-40-years price instability is striking at precisely the same moment that a global wave of baby boomers are turning 65.
Connelly sees his clients reacting in two different ways to the recent bout of inflation.
Those old enough to have lived through the hyperinflation of the 1970s in early adulthood or even as children recognize that their lifestyles may be impaired.
Younger clients, however, are far less likely to see any real threat. Conditioned by the last 15 years, many in this group believe that renewed Federal Reserve magic will ride to the rescue and salvage their portfolios while defenestrating inflation.
Connelly isn’t convinced. He isn’t the only one to perceive a deterioration in living standards unfolding as the world emerges from the pandemic. Allianz senior economic advisor Mohamed El-Erian and former U.S. Treasury Secretary Larry Summers have called it a global challenge.
Rising food and fuel costs will hit other nations much harder, but Americans have enough problems of their own. In Arizona, Connelly has watched housing prices surge at a faster pace than most other markets, increasing home equity for older residents while hurting affordability for younger people.
While the rate of inflation may moderate in the coming months, some price increases are likely to be permanent. Connelly believes that pressures on prices in sectors like housing, labor and food aren’t going away.
There is also a worrisome directional shift in national priorities. In contrast to the period following the Great Recession in 2008 and 2009, when both fiscal and monetary policy in the form of bank bailouts and quantitative easing received sharp criticism, “nobody [in either political party] is championing any kind of budget restraint,” Connelly notes.
This despite pandemic government spending that dwarfed the financial crisis relief more than a decade ago. “We’ll probably have to print money in the next recession. People and politicians aren’t willing to pay the price,” he says.
In 2010, federal debt of $13.6 trillion translated into about 90% of the $15 trillion (GDP) U.S. economy. Today, the debt figure is approaching $30 trillion, or more than 130% of a $22 trillion economy. “Inflation shouldn’t be a surprise,” Connelly says.
And the powerful inflationary undertow is likely worse. In June, Summers, along with IMF economist Marijn Bolhuis and Harvard lecturer Judd Cramer, wrote a paper for the National Bureau of Economic Research arguing “current inflation [rates] are much closer to past inflation peaks than the official [statistical] series would suggest.”