Covid-19 can make the savings issue much worse for many people. Not only has the global pandemic caused a significant health crisis and excessive mortalities, it has also elicited a massive response from governments to curb it. One of the biggest effects of the response has been the shutdown of many important economic activities. Especially hard-hit are the catering and travel industries, close-contact services, oil production and processing and more. In an attempt to help businesses and employees in these industries, governments have also adopted numerous measures which will, in one way or another, significantly increase the money supply in the economy. Below we discuss what this may mean for your savings.
The shutdowns are inflationary
Consider what is bound to happen when fewer goods and services are produced while the amount of money in the economy stays the same. This means that the same amount of money is now chasing a smaller amount of goods and services. This is a recipe for inflation right there.
This is the situation we are now finding ourselves in. A lot of businesses are physically unable to render services to people but those people still have the money they would have spent on those services. Some of this will be mitigated as people will consume other things like new books or online streaming, but not all of it.
Another reason it will take time for this process to become evident is because a lot of people have lost their jobs or have been furloughed. This means that they have probably had to cut down their spending. But this does not reduce the total money supply in the economy and it will ultimately leak out into the open.
The signs of inflation may already be here
You may not yet see higher prices but that may be because inflation may initially manifest itself in less direct ways. Businesses know that customers do not like overtly rising prices, so instead of raising them, they may reduce quality and (or) the variety of products on offer. For instance, it generally costs supermarkets more to have a wide variety of products because they do not benefit as much from the economies of scale.
Economist and popular blogger Bryan Caplan recently suggested that the process of covert inflation has probably already started, citing his personal experience of buying groceries lately.
Government aid will amplify inflation
But the inflation caused by increasing scarcity is just the beginning. Monetary policy has recently rapidly become much more pro-inflationary than it already was. The US Federal Reserve has abruptly reversed its policy of slowly raising the basis rate and cut it to near zero. This means that banks can now borrow money from it almost for free.
Central banks are also turning to unprecedented approaches in their attempts to stimulate the tanking economy. For instance, the US Federal Reserve is about to launch the programme of direct lending to middle-sized firms starved of cash. The projected amount of lending is $600 billion.
The second prong of the Covid-19 economic stimulus plan is fiscal. Governments all over the world have been adopting emergency spending bills. For example, the US measure will result in giving every American with annual income below $75,000 a direct cash transfer of $1,200, and families will receive $500 for every child under age 17. But an even larger amount of newly-created money will be allocated to struggling businesses. Hundreds of billions of dollars are set to be loaned or invested directly into them. The total amount of projected additional spending in the US fiscal stimulus package is around $2 trillion.
The cash injections are already showing in the money supply figures. Between March 9 and April 11, the US money supply (M2) aggregate has grown from $15.9 to $16.7 trillion, a 5% jump in one month!
And it is not just the United States. Similarly if not more aggressive measures have been announced by the United Kingdom, Germany, Japan and others. It is difficult to predict how much these massive money injections will boost inflation in the coming years but the increase is bound to be unprecedented for the last few decades.
What that means for you
What does all this mean for someone like you who may be rightly concerned about your hard-earned savings? It is abundantly clear that if you just keep them in your bank account or under the pillow, their real purchasing power (what you will be able to buy with them) will fall a lot in the coming years. You may decide to spend them now, instead, before they depreciate, and it would be totally understandable. However, you may also want to consider other ways to protect them, of investing them in things whose value may not fall or may even rise significantly in the near future.
Our forthcoming articles will be dedicated to analysing just such potential opportunities. Stay tuned for them if you liked this article.