Board: Real Estate Investment Trusts
TMFWysocki posted a piece written by Morgan Housel.
A few quotes: There's something funny about inflation: how one-sided the criticism is.
Inflation, of course, raises prices, which is bad -- and that's usually where the criticism ends.
But there's another side of inflation: the impact it has on wages and assets. If prices go up 10%, but wages and net worth also rise 10% (or more), are you worse off?
I have a very different perspective on inflation than Morgan. I am often wrong and might be this time. We will have to look back 5 or 10 years from now to see how it works out. A few points:
1) Nowhere is it written in stone that wages will have a 1 for 1 rise relative to inflation. Years ago, when union membership was a larger fraction of the work force, I used to make future inflation judgments based on new union contracts. When they negotiated X% per year raises, you could count on inflation coming in close to those numbers. This is no longer true for two reasons. First reason is that union membership is dramatically lower in the US than it used to be. Second reason is an extension of the first, in that a large swath of the American workforce does NOT have pricing power. Globalization has flattened the earth and American workers are increasingly competing with the lowest wage countries in the world.
2) Totally missing is the effect inflation has on the fixed income component that many people have. Yes, it is less than it used to be, because Social Security is indexed to inflation. However, there are still literally tens of million American’s that have fixed pension and/or annuity payouts. These folks flat out lose dramatically when inflation picks up.
3) There is an assumption that “inflation” as measured by the Bureau of Labor Statistics CPI-U is a fair representation. So if BLS shows a 2.0% annual CPI-U, some percent of the population will experience nominally the same personal inflation. I AND MANY OTHERS DON’T BELIEVE THIS FOR ONE SECOND! John Williams at Shadowstats.com has covered this in great detail. I am not going to rehash all of the arguments, but suffice to say Williams tracks how inflation would be reported before the BLS changed their methodology. He currently shows inflation running at about 10% annually, versus the about 2% that BLS reports.
You might say, why would the BLS change their methodology to report lower inflation?
Two simple reasons, GDP and government payments. GDP is always reported as a “real” after inflation number. If you raise the inflation number, you lower the reported GDP. The fastest and best way to “grow” GDP is to somehow lower inflation. Do you think anyone in Washington has any incentive to show a higher GDP number?
Secondly, since Social Security and some government pensions are indexed to inflation, the lower the number, the lower the payout. Do you think anyone in Washington has any incentive to pay out less in Social Security and pensions?
The problem is about to get worse as Social Security will likely start using the “chained CPI.” I will not go into detail, but suffice to say, it will lower the inflation number, thus lowering the payouts. The primary change is due to hedonic substitution. If steak gets too expensive, you switch to chicken. If chicken gets too expensive, you switch to beans, etc.
4) Inflation has a very negative effect on stock prices. Anybody that tells you otherwise needs to explain this one data point.
In 1966 the Dow hit 1000.
In 1982, the Dow hit 1,000 again, but due to inflation was only worth ~ 333 1966 dollars. So investors nominally broke even, while losing 2/3rds of their money over those 16 years.
People that tell you that stocks are a good inflation hedge base that on the assumption that earnings will track inflation. Even if we stipulate that to be true, what they are missing is that P/E’s DECREASE with increasing inflation. My friend Ed Easterling at crestmontresearch.com has done an outstanding job explaining how this works. About 95% of the people that talk about inflation and stocks get this fact wrong. They have flunked “financial physics.”
5) To this point, I have only discussed “traditional” inflation of the mild variety, say up to 10%. The possibility of hyperinflation or“Weimar” type inflation is NOT off the table. Rob Arnott of Research Affiliates publicly stated the odds of Weimarization are 10% to 20% in his opinion. If this occurs, all bets are off. This is the Armageddon scenario with much worse outcomes for average Americans. Once again, I will not go into great detail, but just look up Zimbabwe or Weimar hyperinflation to get a feel for how life would be.
I did NOT see Morgan comment on this, but IMO, the future course of inflation is probably the single most important macroeconomic factor we have going forward. As Ed Easterling describes in his outstanding book “Probable Outcomes”, inflation tends to drive everything else financial. So it is an important topic. I spend a considerable amount of time working on inflation. Does not mean that I correct.
Inflation expectations are the primary focus I use in my portfolio management. Whether the account owner is 8 years old or 88 years old, inflation still dominates the allocation I use.