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/.
Get a grip people. Jim’s article is dead on and insightful.
It seems that many people are entranced by the cabdriver’s narrative that “inflation” means your buying power will be meaningfully diminished. Mr. Jubak has set himself up for criticism by beginning his discussion at a high level instead of walking amateur investors through this garden.
A separate segment should have preemptively explained that wage increases offset manageable inflation. I know that this was part of the main body, but this is not clear enough for the reactive “buzzwords” group.
I agree with you 90% of the time, Jim, but not on this one. Gmcguire has it right; the American public and the entire world is sick of the Fed manipulating the value of our money. It’s the world reserve currency, clearly it needs to be stable and not treated capriciously. Inflation can stop a recovery as quickly as it started it. We need to remember history and not repeat the lesson of the 70s. People won’t be as receptive to Volker’s measures to end inflation this time around.
Just what an unemployed and foreclosed upon public needs: higher prices. Great.
gmcguire, 1% long-term inflation is a bad record, you say? In comparison to what? If you look at the U.S. nineteenth century, pre-Fed, the record shows huge swings in prices, largely depending on the boom and bust of the business cycle and the state of global commodity supply. Commodity prices as a whole fell for 33 years to 1897 because the world was seeing a massive expansion of commodity production (Australia and Argentine wheat, for example.) Gold and silver supply increased during the period but not enough to match global increase in economic activity in all periods and for all sectors of the economy. We finished the century with hard currency scarcity alternating with hard currency abundance and frequent financial crises. That’s the situation that led to the creation of the Fed. All I see suggests that the world is headed into a period of where increasing gold production gets harder and gold mining gets more expensive. It’s a lousy time to think about gold as currency.
Jacques, my error and now corrected. The $3.5 trillion is the interest paid on all U.S. debt–government, consumer, and corporate. U.S. government interest payments were $414 billion according to the U.S.Treasury.
comparing 3% US inflation to zimbabwe is like a farmer facing a drought not wishing for rain because he’s afraid of a flood. INflation is not the same as hyper-inflation.
Guys, good grief. You need to read the entire rationale, not single sentences.
Reasons 8&9:
“the U.S. national debt was $14.1 trillion”…
“.. the interest on the U.S. national debt comes to just $3.5 trillion a year.”
That makes for a 25% interest rate, isn’t it ?
A digit must be wrong, or did I miss something ?
Also, how would react the foreign creditors who own a big chunck of that debt (half of it?), when they see that the country tries to deflate its debt on their back ? Wouldn’t they want higher yields ? Would they stop lending alltogether and precipitate some crisis already seen elsewhere ?
If inflation is good, why isn’t Zimbabwe the richest country in the world? Do its citizens “feel richer”?
I always admire your insights, Mr. Jubek, but inflation is a actual tax that even the least who can afford the tax must pay. In the 98 years since the Federal Reserve was foisted upon a financially unenlightened populace this country has seen massive inflation — funny enough it is about 98% since 1913, averaging about 1% for each year the Federal Reserve has manipulated our fiat currency.
So I have to argue that inflation has NO merits, nor does deflation. This country needs sound money based on a real value not under the control of a privately held bank that operates by hiding behind non-accountability and non-access to its secretive manipulations, i. e. The Federal Reserve.
The Federal Reserve’s contrived inflation makes no one “feel richer”; to the contrary it causes higher wages to match the higher costs of goods and services which in turn increases income taxes. BUT INFLATION IS JUST FUNNY MONEY used for a game in which no one wins.
We need to demand the game be changed to have an accountable sound money system if this country and its citizens are to prosper. Then people might be able to “feel richer”.
I’m SHOCKED that such uniform misconstruction would result. SHOCKED.
The obvious point of the article was that, relative to deflation (the primary boogyman the last 2.5 years), inflation is preferred. Perhaps Jim could have (and maybe should have) stressed that fact a little more, though frankly it seemed pretty clear to me. And it is obvious that he’s not talking about 1979 style hyper inflation, he’s talking about 3-4% annual inflation, the kind that has been around the last ten or 20 years.
Yes, many of the decisions we make as economic actors are not entirely rational- they’re based on a distorted perception of our unique personal circumstances, such as a 3% raise (that everyone appreciates) in a 4% inlationary economy (which many of us don’t recognize) feels better than a 0 raise in a 0% inflationary economy. What is indisputable is both feel better than a lost job in a 3% deflationary economy, as demand drops, capacity outraces demand, and gets whacked as a result. Duh.
And the reality is we are a nation of debtors, like it or not. Note the uniform cheers when the “tax-cut compromise” ladled another trillion of debt onto the pile. If we’re going to be controlled by the free lunch crowd, might as well acknowledge the need for inflation, even if the coupon clippers get clipped.
I’ve been coming to this site every day for a while now to read Jim’s insightful articles. Unless this one was an early April Fool’s joke, I don’t think I’ll be doing that any more. Jim, the longer this article stays up, the less credibility you’re going to have.
1. ok
2. Are wages increasing at the real rate of inflation? My worry is that the raise minus inflation is negative, not zero.
3. ok
4. This one is the exact opposite of the truth. Why would I save $1 if I can buy less with it tomorrow than I can today? You just said in point 1 that deflation discourages consumer spending, and now you’re saying that there is an incentive to save with inflation?
5. Who are you trying to fool with this one? How is the relative cost of capital lower when the commodities you’re trying to buy are more expensive as a direct result of the inflation?
6. Are we trying to strive toward “no-lose investments”? It’s this kind of thinking that leads to a bubble in the first place. Is the goal to just continue running a bubble economy based on artificially high housing prices? The “slump” will end when prices reach a point where demand returns.
7&8. True! Inflation is a debtor’s best friend. Too bad the wealth of savers will be wiped out in the process, but I suppose that doesn’t matter when the entire nation is in debt.
9. We’re certainly going to learn some financial discipline, but I think that how you describe it is misleading. Interest rates spike to fight inflation, not to embrace it.
10. I’ll give you this one. I do love those stories.
I’m sorry if my comment sounds too harsh, but I kept waiting for you to post a “just kidding” comment and it never came.
Reason #4: “Inflation makes consumers feel that saving is worthwhile.”
Say what? Inflation means you’ll pay more for goods tomorrow, so buy them today. I think kids and adults appreciate that considerably more than seeing their savings accounts increment up a little faster than now. Jim, you can’t serve a peeled apple while singing the praises of the peel foregone.
I couldn’t disagree with this more.
Name one thing that you wouldn’t buy today if you knew it was going to be 1% cheaper a year from now? Food, new running shoes when your old ones wear out, repaired roof to stop the leak, replace the broken refrigerator? And another thing, Japan has deflation because of their crappy economy, they don’t have a crappy economy because of deflation.
Jim – I get the “careful what you wish for” tongue in cheek here, and the need to correct baby boomers who fear inflation today will look anything like it did 40 years ago – but gotta take exception to this thought:
(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.)
Actually, you should care about the higher rates that future neighbors will pay. Most people are buying a neighborhood to accompany their house. If future debtors are in significantly worse conditions than you are, it’ll show up pretty soon on the block.