Social Inflation

In March of 2020 the world fell apart.

Markets were in turmoil, policy makers were scrambling, and citizens of the entire globe watched in fear as COVID-19 began to spread. The effects of the virus weren’t clear. No one knew if it was spread through physical contact, shared air, or even common water sources. Nor did they know its true mortality rate once the pathogen was contracted. While COVID spread through the world, so too did fear.

The stock market mirrored this global sentiment, crashing 34% from its peak in February 2020 to its trough in March 2020. 

To combat the international economic pessimism, the Federal Reserve took action by lowering interest rates at a pace rarely seen before in the history of markets. And markets listened.

Stock prices roared to life, M&A volumes boomed, speculative assets like crypto soared, and new vehicles of speculation such as SPACs were birthed. If you were judging the wellbeing of the world by stock ticker prices, you would have thought the global economy was healthier than Andrew Huberman and Brian Johnson combined.

So this all begs the question, why doesn’t the Fed always lower interest rates? One word - inflation.

When the Fed lowers rates, the cost to borrow money becomes cheaper. And when the cost to borrow money becomes cheaper, spending goes up. And when you have larger amounts of spending chasing the same amount of products and services, prices go up, and inflation ensues.

If you spent any time reading financial news over the past four years, you’ve heard about inflation. Inflation is the phenomenon that’s made the price of eggs astronomically high, caused CostCo to raise the price of their legendary Chicken Bake from $2.99 to $3.99, and notoriously caused many of your favorite products, like bottles of coke and bars of soap, to shrink in size yet remain the same price.

But there is another type of inflation that you can’t directly measure with something like the Consumer Price Index. This type of inflation is impossible to record on financial statements yet it has a huge impact on the way we spend our money. I call it social inflation. While inflation erodes the purchasing power of your dollars, social inflation erodes the perceived value of your assets. 

Social inflation is going on your dream vacation to Yellowstone only to grow jealous when you see your best friend post pictures from their trip to Saint Tropez. Social inflation is buying a great home that will serve as a wonderful place to raise your family only to feel envious of the neighbor across the street who has a few more bedrooms and a couple more bathrooms. Social inflation is building a profitable business only to feel discontented as you read about someone in Forbes magazine with a larger bottom-line. Nothing about your possessions or experiences changed, but the measuring stick you compare yourself to grew and as the saying goes, “everything is relative”.

While inflation erodes the amount of goods and services your dollars are able to purchase, social inflation erodes the satisfaction your dollars are able to purchase.

In the past our ability to compare our lives and possessions to one another was constrained by geographic distance, lack of social encounters, and lack of media in any form. 

100 years ago the person to whom you may have compared yourself was the richest person in your town, your nearest neighbor, or the richest person in your church congregation. 70 years ago the person to whom you may have compared yourself was the richest person you read about in magazines or saw on TV. 25 years ago the person to whom you may have compared yourself to was the richest person you saw online. 

Today, we compare ourselves to people on social media, a medium that is a performative warped image of reality where hundreds of millions of people spend time. The great irony of this is that not only do we compare ourselves to the greatest statistical outliers of wealth, beauty, and intelligence on social media, we compare ourselves to versions of these people that aren’t even real and are therefore impossible to achieve! And just as the Fed's decision to lower rates caused inflation to run rampant, the advent of social media caused social inflation to soar.

Charlie Munger has a great line that says “It’s not greed that runs the world, it’s envy.” The basic idea is that it’s not enough for humans to live lives of material abundance. We are only satisfied when we have more possessions than those we compare ourselves to. 

This phenomenon can be seen at the extreme end with someone like Tony Robbins. As I wrote previously in response to a piece by Nick Maggiulli, “Robbins may be worth $600M but he hangs out with billionaires. His friends include Ray Dalio ($15.4B), Oprah Winfrey ($2.8B), Robert Smith ($9.2B), and Marc Benioff ($10.3B). His fortune pales in comparison to those of his friends. So Robbins, who is rich by any metric other than the one he is likely using, decided to employ this scheme to boost his net worth into the billionaire echelon.”

It’s not enough for Robbins to be enormously wealthy because the social inflation he contends with is so high that it completely erodes his perceived value of the assets he owns. While this degree of social inflation will never be captured on a balance sheet, it certainly affects the way Robbins chooses to spend his time, money, and reputation. 

There are a couple of lines about wealth and happiness that I love:

“A wealthy man is one who earns $100 more per year than his wife’s, sister’s, husband.” - H.L. Mencken

“Happiness equals reality minus expectations.” - Tom Magliozzi

These quotes perfectly capture the relativity of the human condition. You only feel wealthy if the net worth you’re comparing yourself to is lower than your own. You only feel happy if the life you live exceeds the life you expected. 

The Fed will never mention it, nor will any banker, or economist but when social inflation is high, perceived wealth plummets because the net worth you compare to your own is so impossibly high and the life you expect to live is so impossibly grand that it completely erodes your surplus of satisfaction. And though it's hard to measure, it will undoubtedly have an effect on the economy in the future. As Jason Zweig says “Finance is not about math. It’s about how people behave with money,” and much of human behavior is driven by emotion. And social inflation certainly affects the emotions of millions.