Thursday, December 20, 2007

Long-Term Inflation



This chart shows the average annual inflation rate over the previous five years. The shaded areas represent recessions.

The good news is that inflation isn't picking up as quickly as it did in the 1970s. Here's the bad news.

Has this type of upward trend ever been reversed quickly and painlessly? Trends are hard to stop sometimes. A body in motion so to speak. - MAB

The answer apears to be never.

Source Data:
St. Louis Fed: Consumer Price Index For All Urban Consumers: All Items
National Bureau of Economic Research, Inc.

This post inspired by MAB. He wished to see the long-term picture.

22 comments:

Anonymous said...

Stag,

Thanks for the chart. I've got to mull this over.

Stagflationary Mark said...

MAB,

For what it is worth, I did more Costco shopping this evening. The couple behind me asked if I was running a bed and breakfast, lol.

Jim Rogers: Cotton Is a Good Way to Buy Oil
http://seekingalpha.com/article/57914-jim-rogers-cotton-is-a-good-way-to-buy-oil
Cotton is a good way to buy oil-- hear me out. Much apparel has been made from synthetics. Synthetics come from oil. So many textile makers are converting back to natural fibers because oil is at an all-time high. So if you want to buy oil, buy sugar [because it is easy to turn into ethanol], or buy cotton. What I'm buying right now is agriculture.

Over the past few weeks I've been buying sheets (five flannel sets at Macy's on sale, five regular sets at Costco today). I figure there's not much of a downside. I'll use them eventually no matter what happens. It is hardly going to make a dent in my long-term financial picture one way or another, but perhaps the sheets will help me sleep better at least (some pun intended).

Anonymous said...

Stag,

I have to admit, since Volcker, cpi inflation has declined dramatically and remained reasonably well controlled. When I get time I'll try to look into when the geometric, hedonic and owners equivalent rent changes were made. These keep nagging me, but maybe its just because I haven't taken the time to understand them.

In any event, inflation appears to have bottomed. Its creeping higher, but nothing alarming yet.


With OER, measured inflation is extremely dependent on rents. I just don't see any rental pricing power given the over-build during the housing boom.

I keep thinking about your repeated references to hoarding.

It seems people hoard what they perceive will be scarce or unaffordable in the future. I think this played a key role in the housing and stock market bubbles. People irrationally believed they would be poorer if they didn't buy a stock or house immediately regardless of the fundamentals. Stangely, since Volcker, its been the irrational beliefs and not cpi inflation that has made people poorer.

Anonymous said...

Stag,

Owners equivalent rent was implemented between 1983 and
1987. Prior to 1983, house price increases or decreases were part of measured cpi.

OER changes correspond to dramatic decline in measured cpi.

Interesting to say the least.

Info is from bls website.

Stagflationary Mark said...

MAB,

I looked into how the CPI was calculated in great detail when deciding if I'd like I-Bonds and TIPS.

Unlike many bearish personalities, I'm perfectly fine with hedonics, substitution, and owner equivalent rent.

It has been said that the owner equivalent rent understates inflation during housing booms (and has been said many times). However, that same process tends to work in reverse during housing busts. An empty unsold house is not deflationary. It is a non-event. A house has to be occupied to be counted.

Like many bearish personalities, seeing vast hoards of paper dollars (as seen in the MZM) is not something I'm perfectly fine with though. Some of those dollars have clearly transitioned from benign inflationary investments (stocks and bonds) to not so benign inflationary investments (energy and food).

Anonymous said...

Stag,

Let me start by saying I despise inflation.

That aside, I have to live with things as they are, not as I believe they should be. I try to be agnostic when it comes to investing.

Regarding OER, I'm taking the middle ground from an investment point of view. The high measured inflation of the 70's was probably not as bad as perceived and the low inflation recently experienced was probably worse than stated.

Fear and greed are both extremes. Everyone denies irrational thinking in the present. In retrospect things are clearer.

I can justify appreciation in land values due to population. As a home owner though, I am certain that a house should depreciate in value. Permanently anchored or not.

Anyway, moving averages don't change on a dime. The trend is showing higher inflation, but I have a suspicion it won't go haywire. Toggle is an appropriate word here.

So far your stagflation argument is bullet proof.

Stagflationary Mark said...

MAB,

Let me start by saying I despise inflation.

That aside, I have to live with things as they are, not as I believe they should be. I try to be agnostic when it comes to investing.


Agreed. I'm trying to position myself so that I can ride the fence between inflation and deflation. If I was a true inflationist I'd be hoarding hard assets, yet hard assets seem kind of pricey to me now. If I was a true deflationist I'd be locking in a long-term yield on non-inflation adjusted treasuries. My gut doesn't think buying long-term treasuries at a near record low of ~4% when oil is pushing a near record high of ~$90 sounds like a good plan.

Fear and greed are both extremes. Everyone denies irrational thinking in the present. In retrospect things are clearer.

Yeah, I therefore sit in the middleground. As investors rush to both extremes in an effort to maximize leverage on what they are "sure" are the good choices, the middleground seems the safer place to be.

I can justify appreciation in land values due to population. As a home owner though, I am certain that a house should depreciate in value. Permanently anchored or not.

There's going to be a big wake-up call when the "median" new homeowner realizes how expensive it is to maintain and heat the depreciating assets. I'm fairly confident of that. It took me several years to realize that my home is a hole in the ground I pour money into (boat joke).

Anyway, moving averages don't change on a dime. The trend is showing higher inflation, but I have a suspicion it won't go haywire. Toggle is an appropriate word here.

Toggle is just another way to say recession. I certainly think we'll get one someday. No idea when. Probably not nearly soon enough for the perma-deflationists. I was very nearly a deflationist in 2004. I can safely say I'd be a whole lot less well off had I embraced it. I came to realize that being a deflationist means you must also be a paper fiat currency dollar hoarder. That's just not something I can do long-term. I need at least some inflation protection.

That being said, some deflationists may make a killing if they get the timing right. Those that shorted Capital One Financial recently did extremely well. Those who shorted it since 2004 also did well (but would have done even better simply hoarding rocks such as gold and silver over the period, which is the exact opposite of what a true deflationist would seemingly want to do in my opinion).

Anonymous said...

Stag,

Regarding shorting: "if they get the timing right"

That is one giahugic IF.

I'm a fan of shorting only when its done with other peoples money.

Stagflationary Mark said...

MAB,

What are the odds I try to time the shorting? I'm not even a believer in using stop losses to control risk. To me, that's a bit too much like telling the foxes how to get the chicken coop door open.

It seems that 93.212% of our clients will sell this stock if we drive the price down 10%. Hank, you slap a sell rating on it and I'll initiate some nasty volume action consistent with our Expanded Real Time Dynamic Software Power Tool Client Based Warning System™ (ERTDSPTCBWS)!

Anonymous said...

Stag,

You might be right. Perhaps we have been in stagflation for the past decade.

Over the last 10 years long bonds have outperformed stocks. Tips have out-performed stocks and bonds since 2000. Commodities are in vogue. Moreover, we have experienced both inflation and deflation in stocks and housing.

Stocks are negative in real terms and will look far worse if historical valuations return. The same is likely to be true for real-estate over the next 5 or 10 years.

As time marches on the picture becomes clearer. The term staflation did not even exist until well into the stagflationary cycle of the 1970's. Maybe everyone is running in place and they just don't know it. It all fits with the massive credit bubble and a fed that won't allow aggregate credit to deflate.

I just see little point in investing in equities, bonds, real estate or commodities here. All are overvalued in my opinion. I've never been risk averse, but investing here is based more on hope than fundamentals.

The middle ground is an orphan, which means that it is probably a safe contrarian bet, albeit a low return one. It can't be sold profitably by wall street so I don't see how it will catch on.

No matter how hard I try, I just can't shoot holes in stagflation. Real returns are nowhere to be found.

I give you all the credit in the world for thinking this through so thoroughly and seeing what the experts can't or won't. Funny how that happens when its your own money on the line.

Stagflationary Mark said...

MAB,

No matter how hard I try, I just can't shoot holes in stagflation. Real returns are nowhere to be found.

Here's how the 1970s ended, for what it is worth.

The year over year CPI peaked in March 1980 at 14.76%. At the time few believed it peaked even as the data started coming in showing it had peaked. That's very important. It shows that inflation expectations once fully established do not simply fade away. I think that is also true in reverse as well. Investors have seen 20+ years of tame inflation and that is still relatively well anchored.

The 10 year treasury peaked 18 months later in September 1981 at 15.32%. Meanwhile, in September 1981 the year over year CPI had fallen to 10.95% (and continued to fall). Clearly investors feared that the fall in inflation was only temporary. They were wrong. That's not the environment we seem to be in yet though (as seen below).

As a side note, real inflation adjusted yields were therefore very high and rising in the aftermath of the 1970s. Real yields were also very high and rising in the aftermath of the Great Depression. I don't think that's necessarily a coincidence (although the way it played out is hardly the same).

So what does this mean for us? Rising real yields are the stagflationist's nightmare.

It is always possible that the "high" 15.32% yield on the 10-year note in March 1980 is similar to the "high" 5.1% yield on the 10-year note in June 2007. The reason I say this is because perhaps we now have three to one (5% three times vs. 15% once) leverage to make the two equivalent. Maybe THAT was the peak. That's certainly one potentially large hole in the stagflationary argument.

On the other hand, I do not believe we are near the end of the stagflationary cycle yet (barring some short-term recessionary forces). I would point to inflation expectations that have been consistently too low (in sharp contrast to the end of the 1970s). Inflation continues to surprise to the upside, on average. The derived inflation expectations between the 5 year treasury and its inflation adjusted counterpart predicted 1.3% inflation over the next five years back in January 2003. WAY too low, using hindsight. Since that period, five year inflation expectations never reached 3%. Yet, for the last five years inflation has averaged 3% (and has been generally rising).

I can't prove that the inflation expectations are wrong going forward of course, or that they are still incorrectly biased to the downside. My gut thinks that investors are/were giving inflation the benefit of the doubt though (and it continues to slap them, lol). The CPI is up 4.3% year over year but inflation expectations are well below that going forward. That's just not how the 1970s ended.

In summary, I'll be questioning my outlook in earnest when inflation expectations exceed reported inflation by a reasonably wide margin (i.e., meaning the wall street herd has fully embraced the stagflation story). That's the time to abandon the stagflation story perhaps, assuming I am correct in my thinking of course (always a big assumption).

Anonymous said...

Stag,

Our debt based money system makes forecasting difficult. To me, the sheer size of the credit bubble highlights just how ridiculus things have become.

We are entirely dependent upon hundreds of millions of people spending everything they make and more on stuff they don't need and would be better off without.

Global warming (if it exists)could be solved easily by consuming less. Sadly, this simple and elegant solution will never be considered.

Attempting to apply logical reasoning to our obsurd economic system is no doubt obsurd in and of itself.

Stagflationary Mark said...

Our debt based money system makes forecasting difficult.

I see too much water and not enough levee. I've long given up trying to time it though.

Anonymous said...

Stag,

Inflation is increasing globally. Especially in Asia. Our next import perhaps.

Importantly, rising global inflation is beginning to be reported and discussed by the media. In obscure places too.

The parabola builds. And at a most inconvenient time.

Murphy's law? Seemingly, for the uninsured. But Murphy has far less impact on the prudent. Insurance only seems prudent when you need it.

Stagflationary Mark said...

MAB,

Gold and the treasury markets seem to be bracing for deflation today (gold is down, TIPS are holding steady as the yields on nominal treasuries fall). There's nothing quite like a seriously nasty day in the global stock market to rattle the inflationary cages.

However, toilet paper is also holding steady in my non-scientific Costco poll (1 out of 1 Costco customers agree, i.e. ME!). Those who sell stocks at the open to fund toilet paper purchases (and assuming the market performs as poorly as the futures market suggests), will be seeing the price of toilet paper go up (relative to stocks anyway).

Anonymous said...

Stag,

A stock sell off doesn't surprise me. To me it was a false boom. Splitting zero into +1 and -1 is not a path to wealth. Although it does give wall street additional product to buy and sell. You have to justify your existence.

I never did understand how equities were going to support so many people's bills (current cash flow needs) in retirement. But what do I know. I thought stocks were over-priced in the MID nineties. The dot-bomb boom blew my mind. And unfortunately my patience for a brief period. The real estate boom was even worse given the leverage involved.

Bonds are overpriced here too. However, I certainly understand the flight to safety (its not quality as some in the media suggest). If inflation is 4.1%, the only way 2% or 3% pre-tax yields can be a fair price is if the alternatives are totally toxic. Longer term this can't continue imo.

Your chart showing financial assets, tangible assets and liabilities relative to historic trend lines speaks ten thousand words.

Equities and tangible assets are moving as expected. Bonds will take longer. Short term deflation? Possibly. But as you have suggested, the money has to go somewhere. The equity, bond and real estate sponges seem saturated.

Any thoughts on how the liabilities will get back to trend line? Debt repudiation?

Stagflationary Mark said...

MAB,

I think the surprising thing to me, based on what I'm seeing in the stock market lately, is that I was probably not bearish enough. Go figure. I thought I was pretty darned bearish (to be completely out of the stock market and a toilet paper hoarder, lol). That being said, I left the stock market 3 1/2 years ago. The Dow was 10,150. Based on where the market looks like it is heading today, the 3 1/2 year risk and inflation adjusted return looks quite pathetic.

Those who purchased all new granite top countertops (and the box known as a house which might enclose them) based on the overwhelming "prosperity" generated during the last 3 1/2 years have to be asking themselves what the heck is going on.

Meanwhile, I'm hoarding clothes. I have 60 pairs of excess socks and am having a difficult time adding to my hoard (the three WalMart stores near me are all out of long length athletic Gold Toes, not sure why). I figure clothing has been experiencing global deflation for so long that ride is probably nearing the end. Who knows though! In any event, there's very little downside in buying anything today that I (a saver) know I will someday need.

I also bought a decent oil lamp at WalMart for just $4.97 today. How can it even be made that cheap? Hope for the best, prepare for the worst. I wasn't even THAT bearish heading into the dotcom crash. It isn't that I fear I'll be losing power, but oil lamps are cheaper than candles (and a small flame tends to calm my nerves more than a fluorescent bulb can).

Gold didn't perform so well during the recession of 1974 (~$184 in December 1974 vs. ~$110 in August 1976 according to Kitco.com).

http://www.kitco.com/charts/historicalgold.html

I suspect, based on how much it has appreciated in the last few years (much like houses have appreciated, which SHOULD scare the heck out of some, possibly even rightly so), that it might struggle a bit during our next recession (even with potentially negative real yields). If so, I might consider being a gold owner again at some point in the future (should prices come back down a bit). Then again, if prices come down on housing far enough I might even be tempted to be a landlord. Perish the thought, as I'm not really looking forward to THAT job should our "new and improved" economy not meet expectations.

Splitting zero into -1 and +1 as you put it clearly can't help us all, but can help some of us who at least partially understand the theory, or think we do!

Too good to be true? SELL!
Too bad to be true? BUY!

Damn, I really must be a pessimist. I seem to be working under the following rules.

Too bad to be false? SELL!
Too good to be false? BUY!

I'm not even remotely ready to buy yet. Things look so bad right now that the pig's lipstick is melting! That would make sense I supppose. This is still the Year of the Fire Pig (until February 7th apparently).

By the way, I believe in astrology about as much as I believe in the decoupling theory, but both make for amusing commentary, lol. ;)

Anonymous said...

Stag,

"I have 60 pairs of excess socks and am having a difficult time adding to my hoard (the three WalMart stores near me are all out of long length athletic Gold Toes, not sure why)."

Sounds like you're using "Bonetti's defense." Fitting considering the rocky terrain.

Any thoughts on how liabilities get back to trend? Debt repudiation (jingle mail)? Inflation? A magic spell from the Fed perhaps?

Anonymous said...

Stag,

Is there really a need for three Walmarts in your area? I remember one flea market per 50 mile radius.

Stagflationary Mark said...

MAB,

Any thoughts on how liabilities get back to trend? Debt repudiation (jingle mail)? Inflation? A magic spell from the Fed perhaps?

Heaven help me if the U.S. opts for repudiation. However, seeing as how the "rich folk" (i.e., Bush and Cheney) have been partial to U.S. Treasuries my thinking would be that it won't be the preferred option. It would take a VERY brave politician to argue that savers in U.S. Treasuries will not be paid.

Heaven help the municipal bond holders though, since states don't have their own printing presses. Heaven also help the next generation of Social Security retirees. Future obligations have a way of disappearing when they aren't even remotely set in stone (especially since most have come to expect future benefit reductions anyway).

As for general debt levels, when the turnip is out of money the turnip is out of money. The new bankruptcy law can't do much to change that, contrary to popular opinion.

Inflation is almost always the preferred mechanism to solve a government debt problem. It might be a slightly harder thing to do now that TIPS exist, but even TIPS holders will see their (our) net worth seriously erode after taxes (should inflation reach high levels). In the words of Greenspan (1966), "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation."

Further, from what I can tell, fixed exchange rates have forced repudiation in the past (i.e., a country's peg to our dollar that was not able to be sustained). In sharp contrast, our exchange rate has been extremely flexible (to the downside and sometimes even to the upside).

Our leaders are talking up the idea that a weaker dollar might even be somehow good for us and some of us seem to even be buying into that theory. That's clearly a willingness to embrace inflationary thinking.

The stronger/weaker dollar currency issues are just a smoke screen to me. The fact of the matter is that billions will work for fewer peanuts than we will. No simple exchange rate adjustment can "fix" that.

As for the Walmarts, I'm apparently at an epicenter in the Seattle area. I've got three within 15 miles of me (two of which I had never visited until 2008, which I shall refer to as "The Year of the Hoarding").

I just visited one of them for the first time today. I completed a set of rubbermaid roughneck garbage cans among other things. It will save me $6.00 per quarter in garbage/yard debris can rental fees. That's something I should have done a LONG time ago. Better late than never though. I figure the return on equity is quite high going forward.

I'm starting to feel like the little known 5th rider of the Apocalypse: Hoarder of Toilet Paper and Garbage Cans! D'oh!

Anonymous said...

Stag,

Interesting read:

http://www.prudentbear.com/index.php/BearsLairHome

Hutchinson is a student of world history and economics. Makes for interesting perspective given today's global economy.

I agree that inflation seems like the path of least resistance going forward. Not necessarily the best path though.

What a bizarre economic system we have today! Supply and demand are completely distorted by the Fed's desire to maintain current (excessive imo) consumption levels at the expense of savings. Do current consumption levels make people wealthier? I would argue the answer is a resounding NO for the vast majority. Moreover, I believe most would be happier with more free time rather than an abundance of trinkets and debt.

Seems to me, more savings are required, not more consumption. The path of least resistance seems to have led most into a "pit of despair."

Another Pricess Bride reference. Apparently, my sense of humor is in a rut just like our economy. But that movie really cracks me up.

BTW, you are still the only hard goods hoarder I have encountered. No danger of being swept away by the herd, YET!

My personal herd is very small too. The world produces almost nothing that makes me want to spend. Advertising has zero effect on me. It might as well be in Greek. I think my life is too cluttered, and I avoid STUFF like the plague. Its not like I view all stuff as junk either, I just have plenty without a new and improved version. New fashions don't do it for me either.

It would make more sense if developing countries were driving world consumption as they have less. But they're saving and we're spending. Go figure. I suspect Americans have forgotten what hard times are while developing countries have not.

Have you ever considered what the American economic landscape would look like if the herd adopted my anti-clutter, anti-hoarding, anti-spending ways? Short term deflation, but long term savings. I have long thought that aging baby boomers would become more like me. No sign of it yet though. I'm a gang of one.

Stagflationary Mark said...

MAB,

Moreover, I believe most would be happier with more free time rather than an abundance of trinkets and debt.

While true, very little of our society values things that are free. Too bad. There are some signs that some people are starting to figure out that a $5 latte might not be worth the entire $5 though.

Seems to me, more savings are required, not more consumption. The path of least resistance seems to have led most into a "pit of despair."

BTW, you are still the only hard goods hoarder I have encountered. No danger of being swept away by the herd, YET!

Others are using future savings to fund current purchases. Future purchases will not be possible. That is the eventual outcome of excessive debt.

I am using current savings to fund future purchases. Future purchases will not be necessary. That is the eventual outcome of excessive hoarding.

The combination doesn't bode well for future purchases, does it? Fortunately, most seem drawn to gold at 4x its recent price instead of toilet paper at just 1.1x its recent price. Inflation can therefore remain mostly tame, in theory. (Just imagine how little people would value toilet paper if it actually got cheaper in our mixed-up, non-value, momentum oriented society.)

Have you ever considered what the American economic landscape would look like if the herd adopted my anti-clutter, anti-hoarding, anti-spending ways?

Great Depression combined with Deflationary Japan? Every business goes out of business? The government resorts to drastic measures to entice you to spend? This particular outcome might require them to come to your house and physically piss (pardon my language) on your cash while singing Singing in the Rain off-key, lol.

Should you think your vision should become a reality, I'd suggest an investment in a holocaust cloak and a wheelbarrow. Just don't forget to list those as your assets!! ;)