Inflation, winners and losers

[airdale]

re. I-bonds, we max out the $25k per year that’s allowed for a couple.* Over 10 years that will be $250k. Trivial for some, perhaps, but meaningful for most, as an allocation of retirement savings.

* we are each buying the maximum allowed $10k per year from TreasuryDirect (which they hold online) so that’s $20k per year as a couple. Plus we buy the maximum allowed $5k per year of paper I-bonds using our tax refund. Those are the only possible ways of buying.

We’re about age 60. Much younger people probably wouldn’t want to own I-bonds.

I-bonds are definitely worth a look for people where that kind of numbers work. Our view is that the biggest threat in retirement is inflation and that the last two or three decades are not representative of history, even just looking at the late 70s/ early 80s. Accordingly we took a very large position in TIPS as we were going into retirement. We hold them in IRAs so the tax aspect is not a negative compared to I-bonds. I just never think of I-bonds as investments because we have never been in a position where the small annual limits worked for us. Obviously YMMV.

 

[ebetancourt]

In the end, everyone loses with inflation. Some are better offsetting it than others.

Not the top 20% and especially the top 5%. From 1989 to 2019 they gained 11% and 22% of total income. Everyone else lost.

Historical Income Tables: Households (census.gov)

 

[Sac Arrow]

Not the top 20% and especially the top 5%. From 1989 to 2019 they gained 11% and 22% of total income. Everyone else lost.

Historical Income Tables: Households (census.gov)

Assuming your math is correct, I would say they lost too. Just not much.

 

[David Megginson]

If inflation becomes an issue, What should I buy now while it is cheap? What should I hold off on until later?

Obligatory 'No politics'

It's relative — is inflation inflating your personal wealth and income faster or slower than it's inflating used-airplane prices?

 

[David Megginson]

In the end, everyone loses with inflation. Some are better offsetting it than others.

Mild inflation (e.g. 2% per year) allows employers to reduce real wages in sectors that aren't doing well just by "freezing" them, without changing the number on people's paycheques. It allows for adjustment with less labour unrest.

 

[Morgan3820]

Mild inflation (e.g. 2% per year) allows employers to reduce real wages in sectors that aren't doing well just by "freezing" them, without changing the number on people's paycheques. It allows for adjustment with less labour unrest.

Which then will motivate employees to improve their skill set and market themselves to increase their real wages. I had a minimum Wage job in high school which motivated me to finish my degree at university. Now I have a more marketable skill set which leads to greatly increased wages. Allowing me to more fully involve myself in the economy. Isn’t that neat how that works. Give it a try.

 

[GRG55]

Mild inflation (e.g. 2% per year) allows employers to reduce real wages in sectors that aren't doing well just by "freezing" them, without changing the number on people's paycheques. It allows for adjustment with less labour unrest.

Actually, mild inflation allows for nominal increases in wages without increases in real wage costs. It's one of the major reasons Central Banks pursue that policy.

 

[ebetancourt]

Assuming your math is correct, I would say they lost too. Just not much.

They increased their share of total income 11% and 22%. I did not check the growth of income against inflation. So it's possible your statement is correct. At minimum, the wealth disparity increased substantially. The share of income of all other quintiles shrunk. The lowest by 18%.

 

[Bob Noel]

I would be more interested if the "rich got richer" claim tracked individuals. That is, once people are rich, are they always rich for the rest of their lives (life?)? or is there movement between groups (e.g., some rich people become poor and some poor people become rich)?

 

[Deelee]

I would be more interested if the "rich got richer" claim tracked individuals. That is, once people are rich, are they always rich for the rest of their lives (life?)? or is there movement between groups (e.g., some rich people become poor and some poor people become rich)?

That would be interesting to see. Would be interesting to see the percentage of people that, once above a certain rich-ness level, stay above that level. Honest question - what defines somebody as rich?

 

[Morgan3820]

The definition of rich will change as it is found that the 1% don't as much money as was perceived. Then it will be the top 5%, 10%...

 

[Deelee]

Yeah... is rich defined as people with the top x% of net worth? Or is it something like - those with a net worth of over $xxxx?

 

[GRG55]

I would be more interested if the "rich got richer" claim tracked individuals. That is, once people are rich, are they always rich for the rest of their lives (life?)? or is there movement between groups (e.g., some rich people become poor and some poor people become rich)?

Once they become rich it depends if they buy an airplane, or resist the urge.

 

[Chip Sylverne]

I was looking at the money supply, which looks like it is going asymptotic.

Lots of money out there if you look at M1. Very little of it changing hands if you look at velocity. Velocity has been in the toilet for quite some time, which to me is the more worrying factor. Inflation really isn't a major factor if people aren't buying stuff.

 

[David Megginson]

Actually, mild inflation allows for nominal increases in wages without increases in real wage costs. It's one of the major reasons Central Banks pursue that policy.

Different side of the same coin, depending on how well the economy's doing at the time. When a sector's moribund, 2% inflation lets you "freeze" wages (actually cutting them by 2%/year); when it's doing adequately, it lets you give a 2% "raise" (actually just freezing wages); if it's doing so well that you're having trouble hiring people, then you might have to give a real raise (> inflation).

 

[David Megginson]

Lots of money out there if you look at M1. Very little of it changing hands if you look at velocity. Velocity has been in the toilet for quite some time, which to me is the more worrying factor. Inflation really isn't a major factor if people aren't buying stuff.

As others have mentioned, high inflation hits lower-income people worst, especially those on fixed incomes (like many retired people), because they're forced to spend everything they make. Most of us who can afford to fly airplanes, even if we don't consider ourselves affluent, probably have the capacity to save a chunk of our income instead of spending it, at which point the impact of inflation is much lower (it might even be a positive impact, if the inflation is causing your savings to appreciate).

 

[David Megginson]

Yeah... is rich defined as people with the top x% of net worth? Or is it something like - those with a net worth of over $xxxx?

Depends on your perspective. If we want to talk about the "one percent", then you're in the U.S. one percent with a family income of about $450-500K/year, but we're probably all in the global one percent (last I looked — a few years ago, admittedly — you needed about $35K/year to make the cut).

 

[FastEddieB]

Depends on your perspective. If we want to talk about the "one percent", then you're in the U.S. one percent with a family income of about $450-500K/year, but we're probably all in the global one percent (last I looked — a few years ago, admittedly — you needed about $35K/year to make the cut).

I’d think “wealth” is better defined by net worth rather than income.

 

[GRG55]

Lots of money out there if you look at M1. Very little of it changing hands if you look at velocity. Velocity has been in the toilet for quite some time, which to me is the more worrying factor. Inflation really isn't a major factor if people aren't buying stuff.

Savings rates are up as mobility is constrained due to COVID. But people are buying stuff. At these rock bottom interest rates housing and consumer durable such as RVs, snowmobiles and the like have been moving off the floor pretty fast. This at the time component and goods supply chains are being disrupted by COVID.

"...We gotta install microwave ovens
Custom kitchen deliveries
We gotta move these refrigerators
We gotta move these colour TV's..."
--Dire Straits--​

But what most people don't realize is that goods trade is a small part of developed economy capital flows.

Right now one of the things I am watching is the US$ exchange rate. If the $ strengthens (and most are not expecting that) it will mean safe haven global capital is flowing into the perceived safety of USTs and the $, in part because US sovereign bond interest rates are higher than other developed economy alternatives (gilts, bunds, etc.). That'll be an indicator the virus is sending us into another deflationary spike in the economy, and velocity will continue to plummet.

 

[David Megginson]

I’d think “wealth” is better defined by net worth rather than income.

Yes, people use either, but it's hard to move back and forth between them. For example, I'd consider a Wall St trader earning $1m/year to be rich, even if the person had zero (or negative) net savings. I wouldn't consider a farmer owning land with a nominal value of $3M (if zoning laws permitted subdivision) but barely scraping $30K/year net income in a good year to be rich. Those are edge cases, of course; most of us fall somewhere into the messy middle.

 

[FastEddieB]

Good point and good examples.

 

[Sac Arrow]

As others have mentioned, high inflation hits lower-income people worst, especially those on fixed incomes (like many retired people), because they're forced to spend everything they make. Most of us who can afford to fly airplanes, even if we don't consider ourselves affluent, probably have the capacity to save a chunk of our income instead of spending it, at which point the impact of inflation is much lower (it might even be a positive impact, if the inflation is causing your savings to appreciate).

See that is the problem. I don't know about 'right now' but for the last twenty years, bank interest and bond yields has been for all intents and purposes zero, forcing people to take risky investments to avoid having their savings depleted through inflation.

 

[Chip Sylverne]

You're right, "buying stuff" was not the correct term, though last I looked C was still about 70% of GDP. Let call it liquidity preference instead. With interest rates as low as they are, the next best alternative to cash and equivalents isn't compelling. But until velocity increases, I think the risk of inflation is low. Demand pull and all that.

Which exchange rates are you most interested in vs. dollar?

 

[PaulS]

I’d think “wealth” is better defined by net worth rather than income.

I think you are correct, income can be fleeting and is punitively taxed. Wealth, if managed correctly, endures, and you have to look no further than Warren Buffet, to understand that in his mind, income is for losers.

There are many people out there who look wealthy, but are leveraged to the max, like a house of cards ready to collapse with the slightest upset.

Live within your means, save money and you can build wealth. There are quicker ways, but you need to have the skills to get there.

 

[David Megginson]

See that is the problem. I don't know about 'right now' but for the last twenty years, bank interest and bond yields has been for all intents and purposes zero, forcing people to take risky investments to avoid having their savings depleted through inflation.

True. If you're young enough, you can buy equities, because you can afford for them to have 5-10 bad years and wait for the recovery (you'll still end up far ahead). But if you're, say, 65 or 70, a "slump" could last a significant percentage of your remaining health/active life, so it's not a great option. Buying low-fee SPDRs tracking "value" stock indexes helps to limit the risk by spreading it around and avoiding fund-manager egos and volatile stocks — mine were never down more than 10% or so, even in 2008 — but still, not perfect.

A while back, there was an elderly lady who'd hold court in our local coffee shop. Her voice carried very well, and she wasn't shy about stating her opinions. I remember once hearing her instruct one of her friends: "You just tell that financial advisor of yours to stop talking about 10 years. Tell him 'I'll be DEAD in 10 years!'"

 

[GRG55]

You're right, "buying stuff" was not the correct term, though last I looked C was still about 70% of GDP. Let call it liquidity preference instead. With interest rates as low as they are, the next best alternative to cash and equivalents isn't compelling. But until velocity increases, I think the risk of inflation is low. Demand pull and all that.

Which exchange rates are you most interested in vs. dollar?

70% of USA GDP is consumption, but only a portion involves goods trade. A large part is consumption of services - your doctor, dentist, accountant, lawyer, barber, etc. However, the major capital flow financial transactions don't show up in GDP at all - and compared to say the 1940s these financial flows now completely overwhelm trade flows globally. As everyone knows there's a massive amount of US$ held outside the USA (including official sector currency reserves). We'll know there's the potential for inflation if we start to see a tidal wave of offshore US$ arriving on the beaches looking to buy physical assets (such as property) and productive capacity (US businesses and assets such as mining/mineral rights), instead of financial assets such as USTs.

I own and run two companies in the USA and one in Canada, all interrelated in the same economic sector, so we are keenly aware of the greenback-Loonie exchange rate for business purposes.

For macro investing purposes I just watch the DXY. During those periods things get "exciting" I will spend a bit more time tracking the Pound. Euro and Yen rates, but for the way I invest (I don't trade, I'm a macro investor looking for the major changes in the cyclical and secular trends) the DXY is good enough.

 

[David Megginson]

I own and run two companies in the USA and one in Canada, all interrelated in the same economic sector, so we are keenly aware of the greenback-Loonie exchange rate for business purposes.

I hear you. My consulting business is based in Canada, but since 1998, it has received most of its revenue in USD, EUR, GBP, and even DKK. Exchange rates are on my mind as constantly as a growing red blob ahead of your plane in the NEXRAD imagery.

 

[Chip Sylverne]

I came across this graphic which shows GDP growth below trend for an extended period, as well as inflation expectations as reflected in TIPS real yields. The Fed has indicated it expects to keep interest rates at current levels for the next 2 years, so they are more concerned with the lack of growth than inflation. It doesn't look like we ar e at the start of a period of rampant inflation. Quite the opposite, it would take a period of significantly above trend growth for us to even get back to historical baseline levels. Your idea that the reshoring of capital in search of assets could be a triggering event is interesting. Stagflation anyone?

 

[David Megginson]

I don't have it in front of me, but after doing a huge study of historial economic trends, the French economist Thomas PIketty concluded that a fully-developed economy can't grow faster than 2%/year (or something close to that) over the long term. When a year's GDP growth is higher than that, it's either because a fully-developed economy is catching up after a war or recession or something similar, or because an underdeveloped economy (e.g. Brazil, India, China) is catching up with the fully-developed ones.

 

[Half Fast]

Not saying it’s ever a good thing, but some do win big - to wit, debtors, who can pay off their debt with smaller dollars. Or marks.

Which I mention because of a biography I read. The writer lived through the German hyperinflation of the 1930’s. He had sold a house and held the note. One day he received in the mail a single postage stamp, whose inflated value was equal to the balance of the mortgage he was owed. German courts had ruled “A mark is a mark”, so that was that. Of course, during “normal” inflation the effect is much smaller, but still there. Debtors win while creditors lose.

One takeaway is that if you really think inflation is going to rear its ugly head, take out the biggest fixed-rate mortgage you can find. Maybe one day you can pay it off with a postage stamp!

Yep.

Back in the 60s my parents bought a home with a 30 year mortgage. Thanks to the hyper inflation of the Jimmy Carter years they paid it off in about half the time.

 

[FastEddieB]

Yep.

Back in the 60s my parents bought a home with a 30 year mortgage. Thanks to the hyper inflation of the Jimmy Carter years they paid it off in about half the time.

We bought a house in Miami Lakes FL for $40,000 in the late 1970’s. It had been built in 1962, and the assumable first mortgage was for $14,000. We assumed it and paid the last several year’s mortgage payments, which I recall were around $94/month.

In the past, we’ve always structured our mortgage payments to include additional principal so as to pay them off sooner. With today’s interest rates, I don’t think that makes sense. Rather than apply an extra $200 to the principal, let’s say, I think it would make more sense to invest regularly in a mutual fund investing in dividend/income equities, or the sector of one’s choice. Or diversified over several sectors. I think over any reasonable time frame you’d be likely to come out way ahead.

 

[Chip Sylverne]

I don't have it in front of me, but after doing a huge study of historial economic trends, the French economist Thomas PIketty concluded that a fully-developed economy can't grow faster than 2%/year (or something close to that) over the long term. When a year's GDP growth is higher than that, it's either because a fully-developed economy is catching up after a war or recession or something similar, or because an underdeveloped economy (e.g. Brazil, India, China) is catching up with the fully-developed ones.

I am admittedly unfamiliar with Piketty, but I think he places the blame for limited growth not on structural barriers inherent in a large economy, but the limiting factor being to the small group to whom most of the capital flows. Most of his work is based on inequitable distributions of wealth.

 

[Half Fast]

In the past, we’ve always structured our mortgage payments to include additional principal so as to pay them off sooner. With today’s interest rates, I don’t think that makes sense. Rather than apply an extra $200 to the principal, let’s say, I think it would make more sense to invest regularly in a mutual fund investing in dividend/income equities, or the sector of one’s choice. Or diversified over several sectors. I think over any reasonable time frame you’d be likely to come out way ahead.

Probably true. But I do like the security of owning my home and having zero debt. Takes away quite a bit of worry. As long as I can pay the power bill and buy groceries we'll be okay. (I suffer from an engineer's paranoia. Every good engineer I know is always thinking of what could possibly go wrong and looking for ways to mitigate the risk.)

When we bought this place, we took out a 30 year mortgage but paid lots of extra principal and cleared it in about 12 years. I decided not to do a 15 year because I wanted the smaller monthly obligation, even though we paid well beyond it. That gave me flexibility to make a smaller monthly payment if an emergency came up. For instance, when we had a slab leak and needed to repipe, rather than taking money out of investments we paid the plumber 90 days same as cash and reduced the mortgage payment a bit for 3 months. Our monthly outlay remained nearly constant.

Seemed to work out okay.

 

[David Megginson]

I am admittedly unfamiliar with Piketty, but I think he places the blame for limited growth not on structural barriers inherent in a large economy, but the limiting factor being to the small group to whom most of the capital flows. Most of his work is based on inequitable distributions of wealth.

I think they're separate points. IIRC (and it's been a few years), the opening chapters talk about a hard limit on GDP growth in a fully developed economy, and the later chapters talk about his concern that excessive wealth concentration (which, he claims, happens just periodically) is economically and socially harmful. It was the latter that got the most press.

 

[DesertNomad]

Not every country is wildly printing money. We own our home in the Czech Republic and have rented it out for the past several years while we are living in the US again. The rent, being denominated in Czech Crowns, is a good hedge against the falling dollar. When we moved there in 2002, a dollar bought about 35 CZK, while today is only buys 22 CZK.

 

[David Megginson]

Not every country is wildly printing money. We own our home in the Czech Republic and have rented it out for the past several years while we are living in the US again. The rent, being denominated in Czech Crowns, is a good hedge against the falling dollar. When we moved there in 2002, a dollar bought about 35 CZK, while today is only buys 22 CZK.

The Czech Republic's neighbours in the Euro zone have had the opposite problem from wildly printing money. Over the past few years, some countries have dipped a toe into deflation, which is a really bad place to be. It's hard to manage the money supply to control inflation in prosperous countries like Germany or the Netherlands without overly constraining struggling countries like Spain and Italy. The U.S. likely has the same problem — controlling inflation in prosperous states like California or Massachusets must harm struggling states like Mississippi or West Virginia, but since the FED focuses mainly on the national number, the problem gets glossed over.