Getting ready for inflation

Massive government spending appropriations with looming multi-trillion dollar fiscal deficits, combined with the Federal Reserve Bank’s determination to blow up the money supply by issuing a trillion dollars in the repurchase of government bonds and mortgages, presents a somber picture for those hoping for signs of economic prudence.

There are indications that the Obama administration is becoming much less popular — not entirely, not yet, but alarmingly so for a President who should be in his “honeymoon” phase. This casts doubt on the President’s ability to follow through for long on his New Deal policies of populist spending and taxes on capitalists and entrepreneurs — policies which, as with FDR in the Great Depression, are likely to be deflationary.

A poll in March 2009 indicated that for the first time in years, the majority of Americans said they would vote for a Republican for Congress. Congress has turned into a populist mob, fearing the elections of 2010, forgetting the spirit of the Constitution and voting what was almost a Bill of Attainder to mask their complicity in the AIG bonus scandal.

Time magazine, for the first time, put out an issue distinctly critical of President Obama’s competence.

More and more Americans are having “buyers remorse”, now realizing that the charismatic figure they had put in the White House has no executive experience. It seems increasingly unlikely that Obama will to be able to charm the masses for much longer — there are too many educated people in the country and almost half the population voted against him just last November.

The President seems anxious to get far away from the toils of executive duty and decision making, preferring what he knows best — inciting chanting crowds in carefully chosen “town hall” settings and appearing on late night comedy shows.

Meanwhile, President Obama, having joined the outcry in calling for action against “Wall Street Greed”, has compared his Secretary of Treasury to Alexander Hamilton — perhaps confident that many of those who voted for him don’t know anything about Alexander Hamilton, much less Secretary Geithner (whose betting odds of staying in office are rapidly deteriorating).

So, as Obama’s popularity wanes, so does the outlook for his deflationary measures over the longer term, leaving the country exposed to the now seemingly inevitable inflationary results of extraordinary wasteful government spending and a trillion dollar pumping up of the money supply.

Time to buy real estate and get a mortgage

The worse effects of inflation fall on those who don’t understand how it works or on those who, even if they see what is coming, can’t get out of the way.

In the long span of history, the Brazilians have lived through inflation for many, many years — usually never less than 20%, including the fifteen years of the “Brazilian Miracle” — an outstanding period of rapid industrialization and economic good times. The Brazilians survived inflation of 1000% during the populist governments of the 1980s and 1990s. The lesson is that people can put up with a lot, if they know what to expect and have time to be prepared.

Prolonged, high rates of inflation usually produce predictable effects:

  • long-term life insurance becomes worthless.
  • long-term bonds, without the protection of monetary correction or a link to gold, disappear from circulation.
  • fixed annuities or pension plans fail to provide economic support for the elderly
  • debtors gain a huge windfall by being able to pay off debts in devalued currency
  • the price of real estate (like everything else) goes up
  • wage earners whose salaries are not adjusted frequently, suffer a decline in living standards
  • the self-employed (who are able to raise prices daily and who factor inflation into their business plans) can do well
  • short-term interest rates rise to match or exceed inflation, so that creditors who roll over short-term obligations can survive.
  • governments that depend upon current sales taxes, rather than backward-looking real estate and income taxes, can survive, while government employees without monthly salary adjustments, have a hard time.
  • governments lie more the usual about the rate of inflation and cost of living.
  • price-earning ratios, reflecting high short-term interest rates, fall sharply. However, stocks, once adjusted downwards for inflation, and once business learns to live with the new reality, can be a reasonable investment, although not a safe as real estate.

Most Americans today work for a salary or fixed wage or depend upon social security that is adjusted for inflation only yearly. American society is not set up to withstand inflation at rates of 20% a year or more. Brazilians during the decades of high inflation, were able to get by because defenses against inflation had been built into the system, based on long experience.

The first casualty of high inflation in the United States will be the political party and the politicians who are in office at the time. This looks like it will be the Democrats. This is what brought down Jimmy Carter.

Inflationary economies still have business cycles

The business cycle doesn’t go away with inflation. Sales and production still rise and fall. There are good years and bad years. Monetary values are just adjusted daily and, if this goes on long enough, people get used to it.

The main reason that inflation is difficult to stop once it gets started is that it is based upon government spending that is endemic — baked into the political cake. There are just too many government employees, too many entitlements, too many special programs and no politician has the guts or ability to do anything about it. It is easier to adjust to inflation, that to stop it.

I lived in Brazil during the sixties and seventies, years of high inflation, never less than 20%. I was able to successfully run various businesses and raise a family, without ever feeling that inflation was really that much of a problem. Certain things didn’t exist, like life insurance, but you adjusted to it and soon forget about it. Almost everyone had government employees in their family. Some of my staff also had government “jobs” on the side, alhough they never had to show up other than to collect a paycheck.

The Obama administration is laying the groundwork for a rate of inflation that the American public is not prepared to accept. Some future administration will have to clean up the mess.

Meanwhile, if you can get a thirty-year fixed mortgage at 4.5%, even if your home is “under water” today, the odds seem very favorable that, in the long run, you’ll be a winner.

If inflation is indeed coming, its time to be prepared. Run your own business, hold real estate, borrow long-term at low fixed rates of interest in amounts you can afford to pay. Once inflation hits, sources of attractive long term loans will dry up.

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2 comments on the article “Getting ready for inflation
  1. It is nice to read your article. But I didn`t find any data of Capital Flow from FED in this paper. It seems to me only “expectation” for future. Is there any data from Capital Flow to support your view? Thanks

  2. The most recent Fed Z.1 release shows figures for Q4 2008. However, the basis on which to predict inflation relates to government spending approved by Congress in Q1 2009, which, in fact, will only occur at some later date.

    The Fed flow of funds accounts are most useful to describe long-term, embedded trends, such as the stock buyback movement which has dominated equity market since the mid 1980s. However, these statistics are also useful in putting current debates into perspective.

    The flow of funds accounts as of Q4 2008, shows Federal spending exceeding income by $513 billion. The current deficit for 2009, based on White House budget projections (which some consider over optimistic), shows a deficit of $1.7 trillion — three times as great.

    Additional “stimulus” proposals, now under consideration, will increase this deficit even more.

    What will turn the current White House plan from a temporary stimulus measure into a recipe for built-in endemic inflation is whether the money being spent becomes a permanent “entitlement”.

    Since most of the people receiving this extra government spending have a vote, history has shown repeatedly, in various countries, that it becomes extremely difficult for politicians to turn off the spigot, depriving the electorate of income on which they have come to depend, even if this is inflationary.

    Of course, this article is only an “expectation” and, in fact, an expectation that I hope does not come to pass.


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