Friends, readers, and consumers, save me your jeers. I come to praise inflation, not to bury it.
Hey, I think inflation is getting a bum rap.
In the U.S. anyway.
Sure, run-away inflation in China and Brazil and India looks like it’s going to cause a lot of pain to consumers—a 70% rise in the price of onions in India?—and to investors—a 20% correction in Chinese stocks?
But back here in the United States? Bring it on. We need inflation. We should open our arms and hug it to our chest like a long-lost friend. Remember that just a few months ago we (well, the Federal Reserve mostly) were begging for the return of inflation to save us from that ol’ economy-wrecker deflation. And now we want to crush it, stomp on it like a bug? What kind of welcome back is that to our old friend?
So, in an effort to save one of our country’s longest and most important relationships I offer this reminder: Ten reasons why we—in the United States—should love inflation.
By the way, inflation in 2010 measured by the headline Consumer Price Index ran at a 1.5% annual rate. Core inflation, which omits increases in energy and fuel costs, came in at just 0.8%. That’s the lowest core rate since the beginning of the index. These are, of course, the government official numbers, which many folks, including yours truly, believe understate inflation. But let’s not get sidetracked, okay?
- Inflation keeps deflation from the door. Deflation can kill an economy. (Just ask the Japanese.) With prices going lower every day, consumers have constant pressure to put off purchases because “It will be cheaper tomorrow.” This is no way to run a modern consumer economy. Even the Chinese know it’s a bad idea to discourage consumer spending. That’s why savings accounts in China pay a negative real interest rate. Every yuan you save today is worth less tomorrow.
- Inflation gives us the illusion that we’re making progress in our work lives. And that illusion provides critical grease for the economic wheels. Wouldn’t a 5% raise feel good in 2011? Wouldn’t it make you feel appreciated at work? That tomorrow you might be able to afford ________ (fill in the blank)? Even if that 5% raise was, once you subtracted inflation, equal to 0%, it sure would feel better than the honest-to-goodness 0% raises that many workers have received in the last few years. And workers that feel better—even if as a result of an illusion—are more productive (and less likely to throw a spanner at the servers.)
- Inflation makes consumers feel richer—so they’ll buy more. We’re still trying to get the U.S. economy revving so that it produces more jobs, right? Waking up each morning knowing that your biggest asset—your house—is worth less doesn’t make you want to strap on that American Express Card and drive to the mall. (Don’t give me this stuff about nominal versus real prices. We all live in a nominal world.)
- Inflation makes consumers feel that saving is worthwhile. I’ve been trying to teach my kids to save. Do you know how impossible that is when banks pay 1% or less on the traditional passbook account? If it weren’t for the free lollypop, there would be no way to get them to put a buck in at all. And we need inflation’s help not just in building a future generation of savers but also in making the buy now/save-to-buy later decision tougher. Think there’s any real incentive to save instead of just charging it when interest rates are so low? We need the whiff of inflation to push them higher.
- By eroding the value of money, inflation reinforces the value of concrete assets. That’s important in a world that needs to do a lot of investing in finding and developing new supplies of commodities such as oil and copper. Anything that works to lower the relative cost of capital for these projects is a plus in industries with current supply/demand imbalances.
- Inflation is essential to ending the slump in the housing markets. Cheap mortgage money isn’t enough to get buyers into the market when they’re afraid that the price of the asset is about to slump. We need inflation’s help to get us back to the good old days when homeowners could count on their houses being worth more (in nominal dollars, I know) every year. Inflation can make home ownership a no-lose investment again.
- And while we’re at it, we need inflation to make debt loads more affordable by shrinking the real value of that debt every year. Owing $450,000 on a mortgage is much easier if inflation is eroding the value of that debt every year by 3% or so. (Yes, inflation pushes up the price of credit, but as long as your own debt carries a fixed interest rate, you don’t really care about the higher rates that future debtors will pay.)
- Without inflation we have no hope of containing the U.S. national debt short of disaster. The U.S. government needs inflation to reduce the real value of the government’s debt even more than strapped homeowners do. As of January 20, according to the very frightening U.S. debt clock (http://www.usdebtclock.org/index.html), the U.S. national debt was $14.1 trillion. That’s roughly $45,000 in debt for every U.S. citizen. (Which is almost as big a burden as the $52,000 in personal debt per citizen.) And that doesn’t count the unfunded liabilities for programs such as Medicare. Think there’s much chance that burden will be sustainable in the long-term without some help from our friend inflation in reducing its real dimensions?
- I don’t want to make it seem like inflation is like the friend who convinces us to spend more than we have. Inflation is also crucial to restoring our personal and national financial discipline. At current interest rates, money is simply too cheap for the federal government and Congress to pay much attention. At current interest rates the interest on the U.S. national debt comes to just $414 billion a year. (Not the $3.5 trillion I mistakenly noted in an earlier version of this story. That’s was the interest paid on all debt in the United States including consumer and corporate debt.) That’s a ton of cash but it’s not enough to crowd out spending on crucial government programs. Inflation pushes up interest rates so that we can’t afford to build that lame weapon system in some Congress person’s district, and, whammo, a crisis. And we all know we’re not going to fix this problem without a crisis.
- And inflation makes it easier to tell stories that begin “When I was your age, I used to pick beans in the hot sun for a whole day to earn just $1.” At least until your kids are old enough to figure out that a $1 in 1958 would be worth about $7.60 today. (Here’s a calculator they could use. Don’t let them near it http://www.dollartimes.com/calculators/inflation.htm )
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/.