I agree that 1.5-2.5% is very low inflation. But even under those circumstances from 2000 to 2007 the end result was 16%. (That’s not accounting for food and energy… how much was gas in 2000 ?).
Your rule of thumb for long interest rates of 5% plus inflation is probably pretty close to reality for moderate ranges of interest rates (e.g. 6-10%). But I don’t believe the market is reflecting what inflation is currently. It reflects anticipated inflation over the course of the term of the bond looking forward, not current or past inflation.
My real point regarding inflation is that I think people forget that even a little inflation does a lot of damage. That’s why I have not bought in to the belief of a 40-50% decline in nomimal house prices. 40% in real terms, sure, but not nominal. If this occurs over 8 years of relatively low inflation that’s 20-30% in nominal prices and 20% due to inflation. If inflation is higher maybe its 25% due to inflation and 20% due to nominal price declines.
Inflation happens.
{Clarification: I started at 2000 with an amount of 100, so I only accounted for 7 years of inflation in my example: 2001-2007. If I start at 1999 and take year 2000 inflation of 2.7% into account I get 19% cumulative over 8 years. IN either case a bit over 2% on average over that period}
