Inflation, high prices, price gouging, record profits, corporate greed, this is just some of the jargon we are hearing this election season.  One side focuses more on the first two terms and the other focuses more on the last three.

Imagine you come into some money.  Make it $1,000, $10,000, or $100,000, whatever would be a significant amount to you, to which you would want to retain.  Let’s further say you are like me and don’t trust yourself to keep it in your bank account where you could spend it on a whim, and want to put this money some place to work for you.  Additionally, you of course know there has been some inflation recently and if you just hold cash its value will be somewhat eroded.

What do you do with this money?  In 2019, when there had been decades of little inflation, the situation might have been clearer. In 2019 the safest thing to do with your money, buy U.S. Treasury Bills, paid about a 2% per year return.  If you were a bit more of a risk taker, you could have bought stocks and in the 15 years through 2019, stocks as measured by the S&P 500 index went up and down, but averaged about a 10% per year return.  Whether Treasury Bills or stocks were right for you depends on what is called risk tolerance.  That is how much risk you are willing to assume.

That was 2019 and we are in 2024.  Since 2021, the U.S. has had a bit of inflation.  That has to affect interest rates.  If you look around the world, low inflation countries like Japan and Switzerland have among the lowest interest rates, and high inflation countries like Venezuela and Zimbabwe have among the highest interest rates, even though interest rates are often artificially controlled in high inflation countries.

When you lend your money to anyone, including the U.S. government by buying a Treasury Bill, the first thing you want is your money back.  The next thing you want is compensation for any inflation during the time someone has your money, and of course you must consider any taxes that you will pay.  Only after that are you getting a return on lending your money.  Because of the inflation since 2021, Treasury Bill rate is now about 5% as I type this.  That might seem pretty good if you are that type of person who would put that money in a very safe place.

What if you are the type of person willing to take on more risk?  Well a possible 10% per year return on stocks might have looked pretty good compared to a surer 2% per year on Treasury Bills in 2019.  With the return on Treasury Bills now 5% per year, perhaps that is enough return to convince some people, including you, that it is not worth accepting the extra risk for only possibly 10% per year on stocks compared to that surer 5%. The market is unlikely to accept this narrowing of the difference between the two rates of return.

So not only will inflation cause interest rates to rise, but stock returns must rise too.  There are two ways stock returns can go up.  If company earnings stay the same the stock price must go down, or companies must find a way to make more money (profits) to make the return on stocks rise, keeping people from selling off its stock.  We would expect this to drive up the expected stock return to something around 13%, to make stocks similarly attractive as in 2019.

If you run a publicly traded company and want to continue to run a publicly traded company, there is really only one option. This is because if you as a CEO let your company’s stock price fall, you have a high probability of being out of a job.  So, you must find a way to earn higher profits. Perhaps a CEO wanting to keep his job might be described as greedy, but more profits when interest rates rise is a move by the CEO to remain CEO.  And so higher interest rates usually mean higher profits.

Think how this works politically.  A central bank (an arm of the government in many countries) adopts bad policies printing excess money, maybe at the behest of the government that is outspending its revenue.  This leads to inflation.  Inflation leads to higher interest rates. Those politicians causing the inflation then often start complaining about price gouging and demanding price controls. The higher interest rates then lead to high profits to maintain stock prices.  Then the calls for price controls against price gouging are buttressed by pointing toward rising corporate profits and calling it corporate greed.  The higher interest rates and profit are natural results of the inflation a government created, and ironically and sadly those who caused the inflation may benefit politically from it due to their claims of price gouging and corporate greed.

James L. Swofford is a Professor of Economics in the Department of Economics, Finance and Real Estate at the University of South Alabama.

Image: Free image, Pixabay license.