What Financial Institutions Should Know About Inflation Now

What Financial Institutions Should Know About Inflation Now

Banker Tracy Bacon, COO and previously CFO at FirstCapital Bank of Texas, remembers those days — though not as a banker. She entered banking in 1989, after college. But she was old enough to have a sense of what was going on in the household when her parents periodically discussed their mortgage rate, which was in double digits. At the same time, six-month CDs, one of the few savings vehicles not subject to now-extinct federal deposit interest rate controls of the day (Regulation Q), were likewise in double digits.
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Though today’s mortgage rates remain quite low, Bacon is already having a taste of inflationary times. She moved to the Austin area recently and hopes to buy a home. However, she says, this has grown harder than it once was because prices have been driven up — sometimes doubling.

A Key Definition:
Inflation is a complex subject. Simply stated, it is a time when too many dollars are chasing too few goods, raising prices at a pace that few working adults recall. The price of money typically rises too, in part due to market forces and in part as central banks attempt to tamp down inflation by rationing money. In the worst scenarios, the stage is being set for a period of high inflation that would be accompanied by much higher interest rates and potentially then by recession as governmental over-reaction slams the brakes on the economy. Experts indicate that this trend could be global, as the causes go far beyond U.S. borders.

Over time, multiple causes have triggered periods of inflation. The generation of financial executives that did business in the 1970s and early 1980s lived through what was described as “runaway inflation.” It was the time of the dreaded “wage/price spiral.” In 1979, new Fed Chairman Paul Volcker announced a draconian new policy of letting previously fixed interest rates float freely. It wreaked havoc especially with borrowers as rates rose higher and higher, but the policy eventually, painfully, helped tame inflation. It’s the outlook for high inflation that has the potential to upend almost everything that today’s bank and credit union executives have come to regard as “normal.”

— Deutsche Bank report The report goes on to say that: “An explosive growth in debt financed largely by central banks is likely to lead to higher inflation. We worry that the painful lessons of an inflationary past are being ignored by central bankers, either because they really believe that this time is different, or they have bought into a new paradigm that low interest rates are here to stay, or they are protecting their institutions by not trying to hold back a political steam roller.” “We worry that inflation will make a comeback. Few still remember how our societies and economies were threatened by high inflation 50 years ago. The most basic laws of economics, the ones that have stood the test of time over a millennium, have not been suspended.

Though the Fed and some economists believe the pain of the past can be avoided, other voices have much less confidence. Consider this from economists at Deutsche Bank in a report “Inflation: The Defining Macro Story of This Decade”: Bacon says FirstCapital management has been concerned about the return of inflation for some time, and has been developing strategies and cutting costs where they can.

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