Posted on 06/13/2010 9:14:20 AM PDT by SeekAndFind
The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds. -- John Maynard Keynes
Much of the western world is mired in debt. American consumers are walking away from their suffocating mortgage payments in droves, and consumer credit outstanding has barely declined. To make matters worse, the US is suffering from the highest level of unemployment since the Great Depression.
Many economists, market gurus, and television talking heads are waiting for the moment inflation strikes. Here's the conventional wisdom: Hopelessly indebted, the country, aided and abetted by the Federal Reserve, is expected to aggressively monetize (print money) its debt, wreaking havoc on the exchange rate. Bond prices are anticipated to fall, while commodity prices and interest rates are expected to rise. Under this scenario, inflation, as measured by CPI, is expected to climb faster than the “goldilocks” rate of 2% of the last few years (1% currently), and standards of living are expected to suffer as general prices rise faster than incomes.
While we agree with the "inflation" thesis expressed in the preceding paragraph, we also see a world that's more nuanced than do most market commentators. While the above-mentioned scenario may play out over the next few years, we see inflation as a current reality, and with significant consequences.
The most common measure of inflation uses a price index, like the CPI. Even the Fed has tunnel vision when it comes to inflation, looking at it only through the narrow prism of indexes that measure the nominal changes in final prices. We, on the other hand, believe that the idea of inflation encompasses both the nominal prices of goods and services as well as the levels of consumer incomes. So, in our view, stable prices, as measured by the various indexes, may actually represent inflation if incomes are falling. Our view, then, looks at the level of "living standards," which encompasses both income and price levels.
According to the CPI, we've experienced low and stable inflation over the last few decades. But, one only needs to look up the prices of cars, jeans, college tuition, health care, rent, and many other day to day items to realize that the average American's expenditures have grown at a much higher rate than the reported inflation number (see shadowstats.com for an eye-opening education on "changes" (perhaps, manipulation) of this calculation). At the same time, the average American's pre-tax income has remained stagnant for the last decade. Rising prices versus stagnant incomes is, by our definition, inflation because the purchasing power of the average American has decreased over the last decade. While our definition may be relative, the result has the same deleterious impact on those it affects as does the tunnel vision definition of inflation.
When one thinks about inflation in terms of living standards, one realizes that inflation can occur in different ways and have different impacts on demographic or social segments.
* Currency Devaluation: In a currency devaluation, the immediate impact is on the cost and prices of imported goods. Eventually, the prices of domestic goods will rise as input sources, especially if they're foreign, drive up production costs. In April 1933, FDR called in all the gold coins then in circulation, prohibited US citizens from owning gold (not repealed until 1972), and paid the official price of $20.67 per ounce for the coins. Nine months later, FDR devalued the dollar by raising the dollar price of gold to $35/oz, a 69% devaluation in terms of gold. In our current experience, since 2002, the trade-weighted dollar index has fallen 30% from 111 to 78, clearly a slow devaluation process. And while the dollar has recently shown strength on investor concerns over the value of the euro, the long-term trend is clearly down. In fact, the Obama Administration's goal is a higher level of exports, something that they plan to accomplish with a weaker currency. Unfortunately, in a world where demand is falling, every industrial country wishes to increase its domestic output (and therefore domestic jobs) via more exports, and we are witnessing a "race to the bottom" in terms of currency values. This is evident in investor increase in demand for gold as a monetary substitute and its consequent increase in value in terms of fiat currencies. We suspect that the Obama Administration's frustration with the peg of the Chinese RMB to the dollar has to do with the fact that the dollar can't be depreciated against it.
* Artificially Low Interest Rates: In the US, we have a rapidly aging population. Many of these baby boomers are at or near retirement age. As they have aged, many have shifted a larger portion of their liquid assets into fixed-income securities. It's also true that many of the ultra-wealthy, having already made their fortunes, have a significant portion of their assets tied up in fixed income. Comparing today's yield curves with the yield curve of 2007 makes it clear that fixed-income investors are taking a haircut on yield. Three years ago, a bond portfolio of similar duration would have earned an investor between two and 4.5 percentage points more in interest return. On a million dollars, today's fixed-income investors are earning $20,000 to $45,000 less per year, pretax. For many fixed-income investors, this has meant a 40%-75% reduction in income, depending on the duration of the portfolio. A similar reduction in income can be seen for corporate bonds. This represents a significant fall in consumer income. With the price indexes continuing to rise (although slowly), living standards have been impacted, and, as a result, these segments have endured the equivalent of a virulent inflation.
It's clear that the Shadow Bailout (artificially low interest rates) has helped the banks repair their toxic balance sheets. It's also clear that the manipulation of interest rates through the Fed Funds rate, the provision of near zero rate loans by the Fed to the large banks, and the resulting near zero deposit rates to consumers has drastically lowered the incomes, and hence purchasing power, of a large portion of American savers. These reduced rates have also lowered the returns of pensions and endowments, further exacerbating their funding gaps, and putting future payouts in serious jeopardy. It's a tragedy that many hard-working, trusting Americans will be forced to face a future with lower incomes and less purchasing power, which will reduce consumption, the bedrock of American GDP. Lower incomes for the wealthy will also leave less money for investment (as will high taxes, currency issues, and regulation), helping to ensure slower economic growth.
* Rising Debt Loads: When interest on debt, especially public debt, grows faster than income, the required interest payments must eventually come from the dwindling income pool. If interest rates rise, the problem becomes more acute and more immediate. This means higher tax rates, which reduce discretionary income and thus reduce living standards.
When viewed through a non-traditional lens, it's clear that slow devaluation, low interest rate policies, and endless debt have already created the equivalent of more traditionally defined inflation. Bond prices are “inflated” in much the same way that real estate and housing were in the last two bubbles. With heavy supplies looming large over the next few years, there must surely, eventually, be a mismatch between bond supply and investment demand, at least at today's anemic yields. Living standards, for many, have already been reduced.
While we agree that our massive debts will eventually be monetized, and that a general inflation will more than likely be part of our future, we believe that a type of inflation is already manifesting its ugly head.
What can an investor do? Stay out of debt, keep some dry powder, and stick to the highest quality assets. Mind your margin of safety and own a gold hedge if you can stomach the potential volatility.
Many of the products we import -- especially those we import from a country like China that has a very low standard of living and pegs its currency to ours -- are artificially cheaper than they would be if they were produced here in the U.S.
So whatever our lickass gov't says is Inflation, is not necessarily your inflation. YMMV.
I’d also point out that the examples of “inflation” cited in this article aren’t really accurate. For many people who pay rent for their housing, the rents have been restrained by the economic troubles we face as a nation. Apartment vacancies are very high these days, which probably explains why my lease renewal notice for 2010 included NO escalation in my rent at all — for the first time ever.
We have been inflating since the advent of GWB when he announced “devaluation.” The government folks in charge of economic propaganda have been rejiggering the “basket of goods” since probably the inception of that particular measure of inflation to minimize the actuality. I watch the prices I pay for food and especially the prices in the convenience stores. Those prices seem to be more sensitive to immediate inflation. It is up and going upper.
People can complain, for example, about how college education costs have been rising faster than the rate of inflation for years . . . but those costs only affect those who are in college at any given time (which isn't necessarily a large portion of our population).
The article mentions rent as going up. It has been going down for a while now. In the Seattle area, I know several renters. Without exception, their rents have gone down 28% to 41%, and most without moving.
Even there, as I reflect on paying Tuition + R&B for 3 kids, I note that my costs declined, on average over time, as I refused to pay the big bucks after the first one.
One day, on Free Republic, we’re going into catastrophic deflation, and then the next day, we’re going into catastrophic inflation ... I wish someone would make up their minds ... LOL ...
Of course, I expect to hear next — we’re going to have inflation and deflation, both at the very same time ... :-) [someone will definitely try that one out on us, soon...]
Right. One of the reasons why college costs have risen faster than inflation over the years is that college education is one of those things that people seem willing to pay for, regardless of how much it costs.
Maytag just had a recall on dishwashers. Options were a cost-free repair or a rebate on a replacement purchase. So I checked the purchase price of my 4 year old appliance - $519. Replacement cost $724 (with upgrade to stainless steel lining) I make that 30% over 4 years.
Debt loads are dropping, real estate values dropped hugely, ditto stock markets, autos and computers and clothing all got way cheaper. This article is BS.
...many companies have kept the price the same - but no longer is there one pound of pasta in the box!
We always have inflation, or else a movie would still cost a nickel.
All one has to do is to buy something that you have bought before, say roofing shingles, a gallon of gasoline (I remember 20 cents/gal), lumber, car batteries, auto parts, steel, and so on. Inflation is here chewing our guts out and the CPI doesn’t pick it up properly. Older folks on fixed incomes are being squeezed by taxes an rising product costs. And the Federal government spends money like there is no tomorrow and state governments prove incapable of reducing spending. It truly is dog eat dog and the ones with the most power extract the wealth from the weaker. Where have we seen this system before?
Automation and other increases in efficiency in manufacturing without a similar increase in efficiency in services cause changes in the ratio of prices between goods and services. Education is probably the worst example of a service which in recent years has not merely been holding in efficiency, it could be said to be decreasing in efficiency. It takes more teachers, teachers’ aides, and administrators to teach a given number of students today than it took 20 or 40 years ago. If the quality education was going up to match the increase in labor then you could say that efficiency was stable, but I don’t think anyone can say that more is being taught at the elementary, high school or college levels. Given the disparity of changes in efficiency, it is no surprise that the relative cost of education goes up. Other services are similar.
bump
Pretty well covers it.
Almost as if demand is what drives the market.
: )
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