Warnings in the News

Warnings in the News

The Great Recession has lasted so long that people do not remember inflation.  But, three recent statements, one from the meeting of the world’s central bankers, and two from the G20 Summit in China, ring the alarm bells warning us that inflation is on the way:

August 28, 2016 – JACKSON HOLE, Wyo. (Reuters) – Central bankers in charge of the vast bulk of the world’s economy delved deep into the weeds of money markets and interest rates over a three-day conference here, and emerged with a common plea to their colleagues in the rest of government: please help.

 In a lunch address by Princeton University economist Christopher Sims, policymakers were told that it may take a massive program, large enough even to shock taxpayers into a different, inflationary view of the future.

“Fiscal expansion can replace ineffective monetary policy at the zero lower bound,” Sims said. “It requires deficits aimed at, and conditioned on, generating inflation. The deficits must be seen as financed by future inflation, not future taxes or spending cuts.”

Translation:  We are going to spend our way to prosperity with inflation.

 September 4, 2016: U.S. President Barack Obama and Chinese President Xi Jinping agreed that both countries would “refrain from competitive devaluations and not target exchange rates for competitive purposes. at the G20 Summit held at the Hangzhou International Expo Center.

Translation:  We are going to lower the value of our currencies through inflation.

September 6, 2016: Leaders of the Group of 20 economies meeting at the Hangzhou International Expo Center pledged to use spending to improve infrastructure and the global economy.

Translation:  We are going to spend our way to prosperity with inflation.

In plain language, global economies are weak and weakening.  Governments can no longer stimulate their economies with lower interest rates, because they at or near zero.  They cannot afford to raise interest rates for fear of pushing us back into recession.  What can they do?

Inflation.  They are going to make money out of thin air and spend it to mollify their people.  At the same time, we will wiggle out of our mounting debts & Social Security obligations because inflation will let us pay in cheaper and cheaper dollars.

How will they do that?  Borrow money from themselves and spend it under the guise of “rebuilding infrastructure,” “investing in our future,” and “making America great again.”  So what if prices go up a year from now, and the year after that, etc.

Tax Reform will be like Robin Hood; tax the rich, give to the poor; “equality” and redistribution.  But it will not tax enough, or cut spending enough to balance the budget, or reduce the national debt.

Globally, it will be about which countries can inflate their currency faster to gain trade advantages, and reduce any debts they have from other nations.

Domestic inflation example:  You earn $100,000 per year and a house costs $250,000.  You borrow $200,000 to buy the house, and pay 25% of your income ($25,000) per year for your mortgage.

Suppose inflation doubles prices and wages.  Your salary might have to increase to $200,000 just to buy the same amount of food, gasoline, clothes etc. because prices have doubled.  You would be no better off in lifestyle, but your $250,000 house would be valued at $500,000.

However, your mortgage would still be $200,000.  You used to pay 25% of your $100,000 salary to cover the mortgage ($25,000 per year).  Now, $25,000 is only 12.5% of your $200,000 salary.  Inflation has cut your debt in half, as a percentage of your income.  And just look at the $300,000 of equity you have in your house!

Inflation would also lighten the government’s $1 trillion annual deficit s and $19 trillion national debt load and allow government to continue to borrow even more.

Think it cannot happen?  When I came to Texas in 1977, house prices were going up so fast that people were “flipping” homes like pancakes.  Of course, mortgage interest rates were double digit, and CD’s rates were too.  And federal debt jumped 17% that year.

Just look at the inflation we have experienced in the past.

The chart below shows 100 years of history.  The Consumer Price index (CPI-U) for January 1913 was 9.8.  The CPI-U for September 2013 was 234.149.  This means that something that cost $9.80 in January of 1913 would cost $234.15 today!

http://inflationdata.com/Inflation/Inflation/Cumulative_Inflation_by_Decade.asp

The average annual inflation rate in the 1940’s was 4.86% in the 1970’s it was 6.5% and the 1980’s was 13.5%. Each of those decades were especially hard economically for people trying to make ends meet while prices increased and wages didn’t keep up.

Perspective on Inflation

Inflation Unemployment Average Income Average House Multiple of Income 4yr College Multiple of Income
1960 1.4% 5.50% 5,200 16,500 3.17 8,000 1.5
1970 6.5% 3.50% 7,700 23,400 3.04 16,000 2.08
1980 13.5% 6.00% 16,700 64,600 3.87 30,000 1.80
1990 5.4% 5.60% 28,700 122,900 4.28 38,000 1.32
2000 3.4% 4.00% 41,500 169,000 4.07 47,000 1.13
2010 1.6% 9.60% 48,700 221,800 4.55 69,000 1.42
2015 0.5% 5.30% 53,700 296,200 5.52 78,000 1.45

 

This time, it looks like inflation could really hurt most people because wage increases and inflation adjustments for fixed income Social Security retirees probably will not keep up with rising prices.  That will make buying a home even more difficult, in that prices are already a bigger multiple of income than they have ever been.

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False Hope Is Far Worse Than No Hope

What is wrong with hope?  We know that in an impossible situation where the outcome is unknowable, hope can keep us in that situation long enough to triumph or despair.  The problem comes when hope is not accompanied by action.  When things look hopeless, we either give up or fight on with everything we have.  When we are given false hope, assurances that all will be well, despite the looming crisis, we either relax in the happy notion that it will work out, or we fight on, but not with everything we have, rather with the idea that fate or miracles will save us.

It seems that the past few years in America, we have operated on the false hope that the federal government has the ability to control economic and world events.  Our hopes were elevated after 9/11 by the war on terrorism, including military interventions in Iraq and Afghanistan.  The results have been weak to poor.  We have burdened the future taxpayers with four to six TRILLION dollars of future obligations, and for what?

We have exhausted our volunteer military with short turnarounds and multiple tours.  We have aggravated and elevated the importance of the leaders and citizens of the region with our misunderstandings, ignorance, and arrogance.  No one has ever been able to extract the minds of the people from the secular feuds, endemic poverty, and warlord mentality since before the birth of Christ.

Everyone else on the planet sees our hubris and disrespect for other cultures, yet we continue our Crusades.

What if we had recognized the damage and pain inflicted on our national psyche by the 9/11 attacks?  What if we had reconsidered our smug attitudes toward the rest of the world?  What if we had just revised our approach of insisting that democracy is the best form of governance for everyone regardless of their history, culture, economy, and philosophy?

Instead, we embarked on a path of attack and appeasement.  We attacked anyone who remotely seemed to be a threat with no idea what to do and whom to do it with or to.  We were ready to believe that the vast expenditures and capabilities of our military could subdue the culprits and liberate the subjects of our perceptions of tyranny.  We took no heed of the clear indications that the religious and cultural context these people were born and raised, they see as absolute truth.

What made us think that pouring billions of dollars into the hands of a culture that values corruption and cheating as an art to respect would buy us anything but hate and deceit?  Where else have we bought victory or power with our Niagara of free money?

We fooled ourselves that the impact of the attacks on world confidence and finances was easily healed.  We proceeded to go on a spending spree of unheard of proportions, borrowing as much as our credit could bear, and more, when politics made buying a home hysterically important and easy for virtually anyone.

Our false hopes led us down a path of self-destructive thinking and acting.  In the midst of an unmitigated world financial crisis, governments took on the bad debts of citizens using the creditworthiness of nations.  Now that that burden has become untenable, we see financial strategies that verge on desperation and still try to maintain the illusion that the solution is at hand.

I wonder what paths we might have taken without the false notions and optimism on which we proceeded to get where we are today.

The Twin Towers – Catalyst & Metaphor

A friend on facebook posted an opinion article from the NY Times blaming “the elite” for our current woes in America. I read the article; the author laid the blame on G. Bush’s tax cuts for the wealthy, wars in Iraq & Afghanistan, greedy Wall Streeters, and the aloof elite.

I agreed with the time frame for the problems, and I agreed that the symptoms and reactions to the apparent problems contributed to the economic issues we face. Then something clicked.

Americans have not noticed that the twin towers attack of 9/11 was both catalyst & metaphor for the problems of the past decade. After the planes hit the towers, fires ensued. As the fires expanded, the buildings’ structures weakened. After the fires weakened the structures enough, the weight of the upper stories was too much, bringing down the buildings.

After 9/11, America’s fears were on fire. We were wounded, and scattered. The wars, in part, were attempts to get our strength, and courage back. However, the fires of fear continued to burn. The stock market declined, new businesses could not get funding. We languished for years.

Meanwhile, a trend, set by FNMA and GNMA with US Government encouragement, of lowering lending standards for less-qualified homebuyers went viral. Commercial financial institutions copied the government model: Package a pool of mortgages, get big insurance companies to guarantee them, and sell them to investors.

World investors, hungry for safe investments, created an insatiable demand for these mortgage-backed securities. The huge volume of money that had escaped from the stock market, and other “risky” investments, went looking for a new home. What could be safer than home mortgages, backed by property values, and insured by the US government, or other insurers? Unable to satisfy the demand, mortgage companies made everybody and their brothers mortgage brokers.

The buying frenzy put immense pressure on the homebuilders to keep up with the demand for new homes. Hiring all those construction workers, buying all those materials pumped up the economy, and the demand for everything. Home values rose rapidly. Spending for appliances, carpets, furniture, etc. mushroomed. Suppliers, transporters, retailers took on more staff. Employment was easy. We built a surplus inventory of 5-7 years of new homes at sky-high prices.

Refinancing went crazy. Credit-stretched Americans turned to home equity loans to expand their buying power. When the fallacies of this financial structure finally weakened enough, the weight of the bad loan investments brought down the financial institutions, collapsing the economy.

In other words, we got Osama bin Laden, but he got us first. The best part, from his standpoint, was that we blamed each other; we further weakened our nation by political in fighting, and vicious personal attacks on ourselves. How he must have laughed at us as we divided our house against itself, emulating the twin towers.