Embrace Inflation: It is Our Only Way Out of Crisis
A response to a post by my good blog friend, Nirav:
Nirav, this is the problem with professors having opinions. Some people may want to think those opinions are more meaningful or well-informed because a given professor happens to be employed by a school like Stanford, or NYU (Roubini). But, such professors opinions about the future are no better than yours or mine. Professors should teach, and not opine.
The first thing wrong with Taylor’s opinion is his lack of command of basic financial math. A 100% change in nominal GDP over 10 years (and the resultant 50% cut in debt to GNP ratio) does not require a 10% annual inflation, but a 7.2% inflation, according to the Rule of 72, something any college finance or economics professor should know. I fully expect a 6-7% inflation within 2 years and think the Fed and Treasury are actually trying to orchestrate that.
The second thing wrong with the Professor’s opinion is the statement that a “permanent 60% tax increase would be required” to balance the budget. That statement is inconsistent with the 10% inflation conclusion. I think taxes could be left unchanged, or only increased to the degree Obama proposes, along with spending decreases, and inflation will do the rest. Not only will inflation cheapen the debt over time, it also will increase the number of dollars in which the debt is paid off. Anyone who owned a home in the 1970s remembers what a good deal inflation was at that time, so long as the mortgage was fixed. You could buy a $40K home, watch it appreciate to $80K with inflation, but pay off the debt as though it were still $40K. To the degree the Feds fix our interest costs (by issuing 30 year bonds which they should be doing in a big way right now), we will all benefit from the repayment in debt with ever cheaper dollars.
Inflation is the only way out of this box. I think the 1970s scenario is not only likely to occur, but welcome. It helped us resolve our Johnson era “guns and butter” Great Society debt of the 1960s, which in its time, was every bit as problematic as where we are today.
I would go on to say that as a responsible investor, it is important to try and anticipate the future, and not wait for it to run you over. If inflation is in our future, as I think it most surely is, then a prudent investment strategy will take that into account. The way to not only beat, but prosper from inflation is to own hard (real) assets, or stocks thereof.
Oil, natural gas, industrial metals, precious metals, timberland, ag commodities, all the equipment suppliers to those industries (Joy Global, Deere, Cat, Monsanto, Nabors, Transocean, Dow Chemical, Dupont), and even real estate or REITs in the near future (once RE stops deflating) will all benefit from a long period of moderate inflation. The Fed has demonstrated in the past its ability to prevent hyper-inflation, so that should not be a great worry. Ben Bernanke knows the economics playbook very well. So, rather than nashing teeth over the course of easy money and tax deficits, instead, put those actions to your own advantage.
Here is his post:
How to Reduce a Trillion Dollar Deficit
Related posts:
As someone who’s invested in real estate, gold, oil/gas I am betting that we’ll see inflation. However, I also think we’ll see an increase in the tax rate, particularly at the higher income brackets – it may not be effective, but it will be the popular thing to do: “soak those rich people who are making money on the backs on the lower and middle class!”
You are correct, Nirav, the probability of higher taxes is just as high as is the probability of inflation. But the move to higher taxes was guaranteed by the election of Obama, so that is already factored into the market. I am guessing that Obama will roll back the tax cuts by Bush and leave taxes where they were early in the Clinton administration. There will also be special use taxes for energy and the environment (aka, the Carbon Tax) and maybe more “sin” taxes or a Value Added Tax on luxury and non-essential products. I would not expect a Democratic Admin and Congress to add any more taxes to the underclass, so food, clothing and housing will be spared.
A 60% “across the board” tax increase seems highly unlikely to me as it would be detrimental to the economy and politically difficult to pass. But certainly, some of the specialty areas above will see more than a 60% increase to help pay down the debt and also provide social engineering.