Tuesday, May 3, 2011

Inflation Mentality

May 3, 2011
Inflation can help an investment portfolio

Instead of fearing inflation, why not embrace it in your portfolio? Let's examine ways to play the trend and make money from inflation, specifically via exchange-traded funds.

Forehead. Desk. Whack. Whack. Whack.

September 22, 2007
Warren Buffett on 1970's Inflation

For inflation acts as a gigantic corporate tapeworm. That tapeworm preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism. Whatever the level of reported profits (even if nil), more dollars for receivables, inventory and fixed assets are continuously required by the business in order to merely match the unit volume of the previous year. The less prosperous the enterprise, the greater the proportion of available sustenance claimed by the tapeworm.

Under present conditions, a business earning 8% or 10% on equity often has no leftovers for expansion, debt reduction or “real” dividends. The tapeworm of inflation simply cleans the plate....

Embrace the tapeworm.


Mr Slippery said...

The author of the article sure has the Bernanke attitude.
1. "wager" on something, how about an ETF?
2. "play" inflation, sounds like a fun game
3. inflation can "help"

Inflation is more fun than sea monkeys -- just add some to your portfolio along with water and watch it grow!

Stagflationary Mark said...

Mr Slippery,

Great list! "See Monkey" economics. Do what monkey does. Hey, it worked during the housing bubble.

What really gets me about the article is the reference to TIPS.

As I have said time and time again here, inflation does not help holders of TIPS "make money". All it does is reduce after tax real returns due to the taxation on the inflationary gains. It therefore makes NO sense that I should "embrace inflation". Inflation s**ks.

If inflation hits 20% and stays there, then I will experience plenty of fear. I'll be making 21.5%, paying 7% of it to the tax man, leaving me a net of 14.5% as prices rise 20%. How is it going to make me happy to lose a about 5% of my purchasing power each year?

nanute said...

Inflation can be a bad thing, for sure. Especially the type you describe. Here's a snip from the late Bill Vickrey on inflation:....The main difficulty with inflation, indeed, is not with the effects of inflation itself, but the unemployment produced by inappropriate attempts to control the inflation. Actually, unanticipated acceleration of inflation can reduce the real deficit relative to the nominal deficit by reducing the real value of the outstanding long-term debt. If a policy of limiting the nominal budget deficit is persisted in, this is likely to result in continued excessive unemployment due to reduction in effective demand. The answer is not to decrease the nominal deficit to check inflation by increased unemployment, but rather to increase the nominal deficit to maintain the real deficit, controlling inflation, if necessary, by direct means that do not involve increased unemployment. (Fallacy#4)http://www.columbia.edu/dlc/wp/econ/vickrey.html

Stagflationary Mark said...


The answer is not to decrease the nominal deficit to check inflation by increased unemployment, but rather to increase the nominal deficit to maintain the real deficit, controlling inflation, if necessary, by direct means that do not involve increased unemployment.

I hope he's not trying to imply that price controls will control inflation. Those didn't work out so great in the 1970s nor pretty much any other time in recorded human history. And if he's not talking about price controls, then what are the direct means?

The Failed Keynesian Phillips Curve

In my opinion, if we try to inflate our debt away then we will face even higher unemployment.

Stagflationary Mark said...

The price of oil is $100+, real 5-year TIPS rates are negative, the CPI has been running very hot (as seen in current 4.6% I-Bond rates), and unemployment remains stubbornly high. I'm thinking that this "unanticipated acceleration of inflation" experiment is currently being attempted again (2008?).

Good luck on that one working out as intended!

Just an opinion of course.

nanute said...

Mark, I think he talks about your question in #6:.....What may be needed is a method of directly controlling inflation that do not interfere with free market adjustments in relative prices or rely on unemployment to keep inflation in check. Without such a control, unanticipated changes in the rate of inflation, either up or down, will continue to plague the economy and make planning for investment difficult. Trying to control an economy in three major macroeconomic dimensions with only two instruments is like trying to fly an airplane with elevator and rudder but no ailerons; in calm weather and with sufficient dihedral one can manage if turns are made very gingerly, but trying to land in a cross-wind is likely to produce a crash.

One possible third control measure would be a system of marketable rights to value added, (or "gross markups") issued to firms enjoying limited liability, proportioned to the prime factors employed, such as labor and capital, with an aggregate face value corresponding to the overall market value of the output at a programmed overall price level. Firms encountering a specially favorable market could realize a higher than normal level of markups only by purchasing rights from firms less favorably situated. The market value of the rights would vary automatically so as to apply the correct downward pressure on markups to produce the desired overall price level. A suitable penalty tax would be levied on any firm found to have had value added in excess of the warrants held......

I'm not sure that this would be considered price controls in the traditional, failed sense.
The point is that whenever the economy gets overheated, the fed instinctively raises rates to slow growth and keep inflation in check. The result is usually a constraint on wages, and a rise in unemployment.

Stagflationary Mark said...


It sure looks like price controls to me.

I found this quote from William Vickrey on Brainy Quote.

If unemployment could be brought down to say 2 percent at the cost of an assured steady rate of inflation of 10 percent per year, or even 20 percent, this would be a good bargain.

It would be a good bargain. I don't think we would be anywhere near that lucky though. I think our entire economy would become unglued.

Stagflationary Mark said...

I should mention that nobody is going to believe the "assured" part. Nobody.

Stagflationary Mark said...

I also don't see much evidence that higher inflation generally leads to higher employment (as seen in The Failed Keynesian Phillips Curve link I offered earlier).

I think that's especially true these days. Any hint of higher inflation and the speculators dive right in to commodities. As I've said before, there don't appear to be any wage inflation speculators though. Go figure.

getyourselfconnected said...

Control inflation without affecting the market forces???? I will need a diagram.

AllanF said...

I didn't read the article because I have no doubt it is stupid.

However, as a point of fact, those with first access to money and both the willingness and ability to lever their capital it at a rate greater than their personal CPI (we'll call it iCPI, for the Apple generation) would embrace inflation with gusto.

Perhaps even to the point of trying convincing others inflation is a free lunch the Govt is handing out and they should get some before it's too late.

And that's the perennial lesson from inflation. In the beginning it feels great, at least for anyone with a voice, and even for those not levered up. Inflation starts on the left-hand side of the bell curve and takes a few years to make its way to the right-hand side of the bell curve.

The only ones complaining at this stage are the perennial party-poopers, the ones that were warning against the last bubble. And who wants to listen to them, what with the implicit admission that they were right and everyone else was wrong?

Stagflationary Mark said...


We have a great tradition of borrowing from the future in order to meet the needs of the present.

Stagflationary Mark said...


Awesome comment. I'm a complete believer.