Moneybeat: The real inflation story

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MARY REICHARD, HOST: Coming up next on The World and Everything in It: The Monday Moneybeat.

NICK EICHER, HOST: Time now to talk business, markets, and the economy with financial analyst and adviser David Bahnsen. David heads up the wealth management firm The Bahnsen Group. He is here now. Good morning to you, David. It’s been too long, good to talk to you!

DAVID BAHNSEN: Good morning, Nick, good to be with you.

EICHER: Well, the July producer price index came in jumping almost a full percentage point. This, of course, the biggest in years. A lot of it looks tariff driven, but you've said in your Dividend Cafe devoted entirely to inflation, David, that inflation, “is politically convenient, but an economically sloppy way of looking at it.” So why do you say it's wrong to say that tariffs cause inflation, and what's a better way to think about tariff driven price changes like this?

BAHNSEN: What I first have to do to answer the question is encourage listeners to understand the definition of inflation. As long as we’re defining inflation the way a regular person would—if we’re just defining inflation as when a price goes up—then I certainly believe tariffs are very often going to be inflationary for a period. What happens is some prices that go up because of the new cost of tariffs then can go down because companies start to lose market share, and they have to compete, and it’s going to be different product by product.

I use the example of coffee, where there is really not a lot of options. People are going to drink coffee even if it’s 20 or 30% more, so that price tends to stay higher. But then there’s other things that can be easily substituted, easily competed for. Then what companies then have do is give up the price increase and take a cut in profits, which becomes a different economic problem. I don’t believe it is less of an economic problem. In fact, I think it leads to greater economic problems, because corporate profits serve as the bedrock for job creation, wage growth, new investment, and what we call the factors of production.

If inflation is meant to be when there’s real economic inflation—meaning the monetary phenomena of a broad and aggregate price level—well, if there’s a new tariff on coffee and coffee prices go up, but there’s no new money supply and no new production of goods and services, there’s just an increase in price on coffee, in theory that would mean something else in the economy went down in price. That’s why I say tariffs are in and of themselves not inflationary, but they do cause prices to rise for the thing being tariffed.

The issue, though, that nobody has wanted to really address is the fact that healthcare, higher education, and housing—that all conveniently start with the letter H—are the only three things that have had substantial price inflation above the level of broad inflation. CPI, consumer prices, have grown about two and a half percent over 25 years. It had been lower than that until the post-COVID boom that we had. Those things, to me, represent a really embedded, systemic, policy-error-driven problem impacting society, creating a rift in society that’s not being discussed.

So that’s the two-headed monster I’m trying to take on. Number one: understanding the data around tariffs and prices and economic growth with more than just “what prices went up this week.” Number two: looking at the deeper level of inflation that I think is more significant to our understanding of the economy.

EICHER: I'm glad you brought that up, because that was on my list of things to ask about, because I appreciated the fact that you had done that 25-year analysis and showing that inflation has been running along at about 2-1/2% a year, even with the COVID era spike. So that's interesting. You mentioned those three items: housing, health care, college costs, racing ahead of everything else, and they're all subsidized by government. So I think this is a good opportunity to talk about why government subsidies tend to cause those prices to go up.

BAHNSEN: If you want more of something, subsidize it. In other words, if something costs $5 and I’m going to put money into it, now the seller can charge $6. There is a very easy explanation. The way the price function works: prices are pockets of information, and humans respond to it. That’s intuitively understood with things like coupons and sales, right? You’re going to move more product when prices go lower, and then when people hear prices have gone lower, they respond. When they hear prices are going to go higher, they might respond quicker. That’s embedded in the way retail prices might work. All those things are just a basic, logical outflowing of the price mechanism.

When the government is making something more readily available and helping to pay for it—either through cheaper financing, through Fannie-Freddie mortgages, or an unlimited student loan market in higher education, or quite literally being the buyer in healthcare, particularly Medicare and Medicaid—then the price function has to respond accordingly.

EICHER: David, you also pointed out in the Dividend Cafe this week that wages have outpaced prices over that 25-year stretch, but then you zoom in on the things where people really feel it—food, shelter, utilities—that everyday basket of goods, wages are not keeping up with those. So how do we square rising wages over the long term with this middle class angst?

BAHNSEN: What I did is put two different charts in Dividend Cafe. One was 25 years, showing that wages had surpassed price increase other than in healthcare and higher education, but that in the last five years, basically since COVID, the study referred to it as a “common man basket”—utilities and food, shelter and energy, things like that, unavoidable expenditures—and that is where real wages have not kept up.

This was a data point that really played to the President’s advantage in his first term. President Trump saw a good period of real wage growth—meaning after inflation, wages had grown. I think this is likely the most practical element of how a society’s standard of living is growing. It’s kind of a disingenuous thing when people say, “Can you believe an ice cream cone used to cost five cents?” but they don’t ever mention that the average salary used to be $9,000. You have to take both to really get an understanding of how it has been applied to our quality of life.

The problem, of course, Nick, is averages are averages. There are always some people where the cost of living has grown more than their wages have. Yet all we can do at the macro is look at the overall big picture. You ask how these two things square? This is a really important point for WORLD listeners. You have a 25-year period where, in macro, for the most part wages had gone up more than prices. But those really significant areas of housing (big ticket items), college (big ticket items), they were growing more and more and leaving more people out, creating a little bit of this rift of there’s an outsider-insider divide in the economy.

There are people who can afford a house and go to a good university and send their kids to college, and there are people that can’t. The people that can’t—well, it’s true, their cost of a VCR became a cheaper DVD player, and then became a cheaper DVR, and then it became streaming. Their prices did not grow as much as wages, but there was still a part of the economy that was becoming more unaffordable.

I believe housing is the elephant in the room. It’s the subject I’ve probably talked about the most over the years.

It’s not a monetary inflation issue. It’s government subsidy on the loan side, pushing prices up, distorting ther market. You have politicians that want to go throw money at it by giving people a tax credit to buy a home or giving people the money for the down payment. Yet we have this massive supply problem where we haven’t built enough housing and too much regulation, impediment, and burden to do so. That’s the area where I think the common man angst has struggled.

The wage growth will come back, but not if corporate profits are being eroded. Real wages have to be able to grow through market forces in order for all quality of life to go up. That’s the area where I think there’s tension and a lot of misunderstanding as to what has really gone on.

EICHER: All right, David Bahnsen is founder, managing partner, and chief investment officer at The Bahnsen Group. He writes regularly for WORLD Opinions, and at dividend-cafe.com. David, thanks.

BAHNSEN: Thanks so much, Nick. See you next week.

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