Share your thoughts on inflation…

[hipmatt]

I am no expert on inflation by any means. But I keep hearing how the inflation rate that the fed keeps on quoting us is wrong, and that it is too low, and that inflation is really much higher.

When I try and think about the cost of living increasing over the last 5-10 years, it seems as though it would be very hard to be quoting numbers less that 4%.

We all know how much housing and mortgages have risen lately, a common mortgage now can be well over $2500, it seems to me that less than 10 years a go, that the common man would be spending $1500 or maybe less.

We all know that gasoline has doubled or tripled in price since just before 9-11-01.

Energy costs are all much higher than 10 years ago or less. I’d say that nat. gas, water, and electricity have all more than doubled since 1997.

Health Care, has risen sharply as well. Co pays, deductibles, and insurance premiums have all seen to have gone way higher, while coverage might have been reduced for some people, making out of pocket expenses even higher.

Cars haven’t gotten way more expensive, but they do seem to be on the up and up, especially trendy ones.

Electronics, some may say that they have stayed constant, in that you get more for the same amount of $$, like with computers, I agree. A nice computer will cost you about a grand now in 2007 and even in 1997, however they are much nicer now, but… TV’s of today are way more expensive. In 1997 most people had a basic 27″ or maybe a 36″ heavy CRT, I would say these might cost about 200-500, for the average house. Now we don’t even really have these anymore, example Costco, only sells Plasmas and LCDs, the average size is 42″ and the average price is about $1000. A household today with 3 tvs, a 42″ $1200, a 37″ for the master..$800, and one kid gets a 20″ LCD..$400. Thats $2400, for 3 TVs, vs say $1000 200+300+500 for a 19″, 27″, 36″ tv of 1997.

I would have to say that HD programming and high speed internet, PVR’s DVR’s, high tech dish boxes will also be about 2x the cost that they were 10 years ago.

Personally, I didn’t have a cell phone in 1997, but almost all of us do now, and that isn’t a cheap addition to the expenses for an average family household.

Food: Food has gone up, eating out and groceries both, especially lately. I know that lately oranges, orange juice, eggs, corn, corn tortillas, milk, and others including agriculture and produce have all been affected with supply and demand problems, causing an increase in their prices.

So what has stayed the same? Am I missing anything? It seems to me that over the last 10 years, the cost of living has doubled? I may be wrong, and please help me if I am. Please also help me if I forgot other things that have gone up in costs.

When you take the common man jobs, have the wages doubled in the last 10 years, I don’t think so? I am thinking, retail, fire, police, teachers, labor, customer service, truckers, non-doctor medical, food, tourism, etc. These types of careers have had modest wage increases in the last 10 years, certainly not doubling.

I know there have been larger wage increases in corporate America, the tech sector, RE of coarse, construction, and I am sure others too, but for most jobs, no.

Anyways, sorry for rambling, I just want to hear your thoughts on inflation, is it as bad as I make it sound, worse, or is the gov. right and inflation is creeping along at slightly higher than desirable levels? How are people making it, besides easy credit?

[CostaMesa]

I think you’re onto something. Problem is, how do the plebes get to the truth.

As a data point – my income has stayed nearly constant since ’97. It’s within $500 annualized. I often wonder why I stay in the manufacturing industry…which is *supposed* to be one of the only true value creation engines that any economy has available to it.

Feel free to flame away…I’ve obviously got it coming.

[NeetaT]

I’m glad you brought this topic up. I can sum it all up in one statement that expresses my feelings regarding my financial situation. Most would think that I’m in a good postion. I have in excess of $500,000.00 in cash and feel as though I have nothing thanks to inflation, especially the cost of housing. I guess I will keep working until I’m 70yrs old. I’m 44 by the way.

[rseiser]

Inflation is one of the most difficult things to understand and forecast, although most crucial to allocate one’s investments.

First, forget looking at the price of items alone, especially mass manufactured goods. They have nothing to do with inflation. If we had no inflation at all, prices of most things would go way down since we always get more efficient through productivity.

I am using here the Austrian definition of inflation, i.e. “the supply of money and credit”. It tells you how much more prices go up compared to if there was no inflation. So if we have inflation of 7%, and some widgets are now dropping 10% per year, they would otherwise drop 17%! It therefore tells you clearly how much purchasing power your money loses “compared to a fixed asset”. You wouldn’t declare that if you keep cash under your mattress, and you can buy 10% more widgets next year, that your money has gained in purchasing power, when in reality there are 7% more dollars, and you are 7% behind compared to the government’s expenditures (with new dollars) or 7% behind your neighbor who has no cash but fixed assets.

The problem is, there are really no fixed assets, since everything is consumed or produced at some rate, and also fluctuates during bubbles and busts, see real-estate, oil, and gold. But in the long-run these three have worked out well to rise fairly well with inflation. I would say that a “working hour” should also be fairly fixed over long periods of time. I mean you hope that if you worked 30 years ago for one day, that you could now get someone else work for you for one day in exchange (despite him using some advanced machinery).

Ok, now that we got this out of the way, the more difficult questions still remain:

[rseiser]

What is the rate of inflation, and what will it be in the future?
The inflation today is easy to determine by looking at the money supply. It is about 10%. The problem is, that not all of that is issuance of permanent new dollars, but a big part of it is credit. The credit temporarily adds more dollars into the economy and drives up prices, such as stocks, real-estate, commodities, precious metals, your gardener’s daily wage, etc. But there is always a chance that credit goes away, e.g. if people default on their debt or if they had enough of speculation and rather want to pay it back to have a peaceful mind.
Both components of inflation are hard to predict and can vary in a wide range.

a) The credit component could vary from a huge negative number (in a credit collapse) to a moderately positive number (if speculators continue to borrow dollars to invest in assets).
The upper boundary will be somehow restrained by the ability of servicing the debt and by the margin requirements. We are at quite high levels of debt, and most people couldn’t afford to take on much more, since their monthly interest would eat up all their income. But if interest rates go down to 1% again or say to 0%, you could service an infinitely large debt. But you also have margin risk, e.g. if the asset you bought drops by the amount of money you put down. So you probably don’t want to take credit in the amount of 1000% of your assets, since if prices drop 10%, you are bankrupt. But some people do it anyways.
The lower boundary can be defended by the governments and banks to keep the party going. They will just prevent you from paying back your loan or defaulting on your house, simply by lowering interest rates again and convince you that you can ride it out.

b) The money component will always be positive as long as we are in a fiat money system, and as long as we have a government that likes to spend and citizens that are pleased with it. The government can so easily issue new dollars, e.g. by purchasing their own bonds, that the possibilties are unlimited. They can pay their salaries, their lobbying groups, the military, old, poor, and sick citizens. They can just deficit spend (on and off-balance sheet) as long as nobody complains. They can spend little, when credit and the economy grow by themselves and when people get wary of the rising prices. They can also spend a lot, especially if times are bad or credit is contracting, under the umbrella of helping the economy out. One thing is for sure, they will spend, and it will be paid for by new money. They won’t raise taxes to 60% to pay for social-security and medicare, they will just create new dollars every year to pay the recipients.

Add up the two components and you get the total inflation.

[rseiser]

What can I do to protect myself or to profit from it?
Are you dissapointed that I didn’t tell you the exact rate of inflation for the next years? It is exactly because it is unknowable, and even more so, we have come to such extremes that it can go either way. If one learns one thing, that is that coming inflation might not be between +8% and +12%, but could possibly be between -10% and +30%. That’s the all important conclusion: to be very careful. Note, that I still estimate the mid-point of +10%, which is basically the “status quo”, and what the government probably likes to continue. But there is no guarantee that we couldn’t see -10% where stocks and houses get crushed (1973-1974), or +30% where oil and gold soar and cash becomes worthless (1979).

Clearly, I believe we are similar to the 1970s, where deficits came home to roost, and where we were on a fiat currency. Something like the 1930s is out of the question since the dollar is not backed by gold anymore.

So overall, the best way to invest is probably cautiously diversified towards continued inflation. Avoid bonds and stay low in cash, but also don’t take too much credit to speculate on rising prices. Try to diversify into the hard assets that are historically cheap. Some precious metals for sure, oil and gas companies since they have low P/Es. Avoid historically expensive assets such as stocks and real estate. But they might make sense in other countries, or away from the mainstream speculation.

Next, let’s keep monitoring what the government does in the next years. If we get a time like the late 1970s where rates of inflation accelerate, will a Paul Volcker come along to realize the mistakes and cause a recession, or will it turn into a Weimar Republic?
Here are the clues:

– Will the government lower interest rates so that savers will again get screwed? In this case, take your money and run, like most people will probably do next time. Interest rates would have to be 5% higher anyways to compensate me for inflation, and a widening of this gap will want me to hold even less cash. Just short-term liquidity.

– Watch the government’s rhetoric regarding prices catching up. The more people realize inflation, the more they anticipate it by buying fixed assets. If the government starts to blame someone else for rising prices and wants to hand out money to alleviate the problem, things are going to get worse fast. Remember, giving the government control will also result in less production, and then prices will rise even more. Like in the Weimar Republic we could quickly go from 10% to 11%, 13%, 17%, 23%, 35%… if the government plays catch-up.

– A falling dollar might also make things worse. Not just because imports get more expensive, but also because a lot of dollars will come back to the U.S. The past acceptance of dollars world-wide as reserve currency has benefited the U.S. greatly. We could expand the money supply, which is essentially free, to get real products from abroad, while foreigners more and more stored our dollars. This has kept price increases low, but if foreigners decide to send all these dollars back in exchange for products, it will work in reverse.

– Also, watch the public. Most people have been so brain-washed by the government that they are really happy the way things are. Just the fact that people allow the government to print money to erode all the productivity that would otherwise lead to much lower prices. Count electronics together with oil and you get a 2% CPI, something most people are still happy about. In reality such a CPI should show -5%. The difference of course the 7%, that the government can pay to everyone in their reach who now doesn’t need to work to produce anything. It will only be the citizens who can eventually prevent the government from inflating. No signs of that though.

So in summary, things like gold still have their purpose. Even in the unlikely event that inflation stops and gold drops somewhat, other assets will drop so much more, so you will still be able to buy a lot with it.
And try to bet on inflation in a tax efficient way. IRAs and foreign accounts might be the way to go, but it is getting more and more difficult to avoid the tax paid on phony capital gains.

[NeetaT]

rseiser,

You seem to be an erudite person. So here’s the $64,000.00 question; where do I invest my $500,000.00? Please be specific.

Thanks, NeetaT

[rseiser]

Give it to Rich. We agree on most things, and as far as I know, he manages money very similar to me and my colleagues at Liberty Valley. We have used a diversified approach, and I hope it will continue to beat inflation. Here is our track record. Login with guest/guest to view the 2007 holdings. It is a non-profit investment club, so make sure you read the disclaimer.

[farbet]

Stagflation not Inflation is the problem
ETF is the best way to go. Emerging markets will weather the coming crises.

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