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Inflation is Dead! Long Live Inflation! - Janszen

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  • Inflation is Dead! Long Live Inflation! - Janszen

    Inflation is Dead! Long Live Inflation!

    The Five Year, 100% Inflation Scenario

    by Eric Janszen (from AlwaysOn Network, December 29, 2005)

    In this, the final part of my series on the cycle of asset bubbles that we've experienced since the early 1970s, I model a potential inflationary outcome following the deflation of the latest asset bubbles in bonds, real estate, and the dollar. My belief is that we are likely to experience a short period of deflation followed by a long period of inflation, a process that I call Ka-Poom Theory.

    If a Ka-Poom event happens, the inflationary part of the cycle might evolve according to the model below. The model predicts an inflation that results in a 100% increase in the general price level over five years, not far short of Price Waterhouse's definition of a hyperinflation, which is defined as 100% or more over three years. But keep in mind that the difference between a major inflation and a hyperinflation is not a matter of degree. Both result in a rapid increase in the general price level, but while a major inflation is due to a surfeit of money, a hyperinflation is due to a loss of confidence in a currency. While they are related, the key difference is that inflation is mostly a monetary event, while hyperinflation is primarily a psychological event, the process of a currency losing its function as a store of value in a society.

    A major inflation can lead to a hyperinflation, but does not need to. The 100% inflation total that I use in the model is more or less arbitrary, used primarily to make the math easier. But there's no reason why in reality the inflation could not be either less or more. I have seen convincing arguments for 1000% inflation over a ten-year period, but few that anticipate an inflation of less than 50%. The Vietnam War period resulted in a 35% inflation over six years; it's hard to imagine how the additional amount of debt that needs to be monetized in our current period will not lead to inflation in excess of 35%.

    Five-Year 100% Inflation Scenario

    A 100% inflation over five years might look as follows to a household that in Year Zero has an annual income of $100,000 and a fixed rate mortgage balance of $400,000 on a house valued at $500,000.



    In the model, inflation peaks at 35% in Year Three. If 13% of income is paid annually toward the mortgage at the start of the period, at the end of five years the fixed mortgage cost falls to 6% of income and the mortgage balance represents 16% of the value of the home versus 80% at the start.



    If the homeowner increases his annual payments to adjust to 13% of income over the five-year period as nominal income rises, the amount paid in increases such that at the end of Year Five the mortgage balance has been reduced from $400,000 to $171,692. That's many years of normal debt payoff condensed into a few years.



    In this model both nominal income and home value double. In reality, since so much inflation has already happened in real estate and high interest rates will increase the real cost of borrowing, home prices are likely to rise more slowly, flatten out, or even decline.

    We're likely to experience a major inflation in the U.S. as an outcome of the bond, housing, and dollar bubbles that came about as a result of past monetary and fiscal policy errors. In fact, a political decision process that favors inflation, as evidenced by the housing bubble, started in the mid-1990s. The U.S. may muddle through an adjustment to less reliance on foreign debt, and households may regress to the mean in terms of savings and debt, as John Mauldin suggests. That is my hope. But highly leveraged nations and households are prone to crises, and with little savings and much debt, the opportunity to muddle through a crisis is limited.

    In closing this series, I'd like to relate a couple of comments that two friends have made to me about the previous pieces in this series. My friend Bryan tells me that every time he reads my column, he feels like killing himself. My friend Geoff explains he's "addicted" to the column and can't wait for the next one. I can understand Bryan's reaction, though I feel it's extreme. I have a harder time imagining what kind of masochist Geoff must be to actually enjoy reading about dysfunctional central bankers, inept politicians, deluded homeowners, complacent investors, popping bubbles, and major inflations.

    Perhaps he's experiencing what I call the Disaster Movie Effect. The point of going to a disaster movie, my script writer sister Karen once told me, is that everyone dies in a hail of bullets or a horrific explosion except the hero... and you. The hero takes off with the girl (or boy, if it's an indie movie) while you get to go home and watch Simpsons reruns. Likewise, for most Americans, an article about an economic crisis is like a movie about a pogrom in Africa. One reads about awful things happening to millions of unfortunate others thousands of miles away. Afterwards, one moves on to the story about Michael Jackson's pajamas.

    What I want to make sure I get across here, in case it's not obvious, is that I'm fairly certain that an unseemly economic turn of events is more likely to happen than not, probably in the next three years, and it's going to happen here, in the U.S. To us. To you and me. While it's likely to be worse than most of us are prepared for—that is, it will not be your average recession—it will not be the end of the world either, although there may be times when things look that way. It will certainly be the end of living high off the hog on other people's savings, and it will represent a transformation that we must go through to get to a different place.

    Whether you experience the new place as better or not is going to depend on where you started and what's important to you. While periods of economic readjustment are never painless, it's important to keep in mind that the challenges we face as individuals represent nothing worse than those that 90% of the world's citizens cope with every day with grace, dignity, and humor. No one owes us a high standard of living, and most of the world gets by without one. Our main challenge will be to accept and deal with our problems effectively in the short term. It will require strong, honest leadership. In the long term, we can count on the United States' and its people's extraordinary ability to adapt to change and come out ahead.

    (This four part series originally published on the AlwaysOn Network will be re-published on iTulip.com in flash-back order, starting with the last in the series and ending with the first, in order to elicit feedback from the iTulip.com community.)

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    Last edited by FRED; 04-14-08, 12:09 PM.

  • #2
    Re: Inflation is Dead! Long Live Inflation!

    Inflation would look like a great mitigating factor for the consumer (at least, the one holding fixed mortgages), except for one key thing.

    Someone is holding all of those fixed mortgages, which will be turned into seriously lousy investments by inflation. While I don't know the relative breakdown, banks are certanly major holders here, but in addition mortgages have been propagated outward into the financial world by being repackaged into real estate portfolios. Pension funds and individual REIT stock and bond holders are sure to be deep into them, lured in by the illusory false risk premiums of the late 90s and early 00s.

    Portfolios heavy in fixed mortgages financed at the early 00s low-rates will be money-losing propositions, compared even to short-term treasury securities at prevailing rates. Banks will not be able to support their operating costs from the income derived from them, and combined with the impact of foreclosures, we could see extensive levels of bank failures.

    No, the "little guy" here--the fixed mortgage holder--will not be the first domino to fall. But he certainly won't be insulated from sweeping waves of financial system failure that will start from the other side of the equation and propagate outward widely.

    The malinvestment has been baked into the cake, and we can't escape its consequences.

    Comment


    • #3
      Re: Inflation is Dead! Long Live Inflation!

      Originally posted by EJ
      ...
      I have seen convincing arguments for 1000% inflation over a ten-year period, but few that anticipate an inflation of less than 50%. The Vietnam War period resulted in a 35% inflation over six years; it's hard to imagine how the additional amount of debt that needs to be monetized in our current period will not lead to inflation in excess of 35%.
      ...
      I was updating a chart or two over the wekend and noticed that, factoring in John Williams public CPI adjustment figures, we've have had roughly 50% inflation since 2000.


      I also put together a new "real GDP" chart, using the same adjustments, for the period since 1982 when the CPI lies started with "homeowner's equivalent rent".


      http://www.NowAndTheFuture.com

      Comment


      • #4
        Re: Inflation is Dead! Long Live Inflation!

        lies divided by truth is going parabolic!!!

        Comment


        • #5
          Re: Inflation is Dead! Long Live Inflation!

          Monetary explanations of inflation have been popular since about 1980, but they aren't the whole truth. Inflationary signals can be a sign of problems that cost money to deal with. For instance, rapid economic and population growth in the 50's and 60's led to environmental problems that cost money to clean up in the 1970's.

          Any economy rests on a balance between the ability to solve problems and the ability to create problems. The economy exists to solve problems: to put food in our tummies, to put a roof over our head. In the process of solving problems, we create problems; we'll cut down trees to get wood, then we'll run out of trees that are close by. We can get trees from further away, or find a substitute material, but that often creates more problems. We might go to war to get trees, or find that the substitute material doesn't hold up in a fire, killing firefighters.

          Economists take pride in the human ability to solve problems. This is justified, but it takes time to solve problems. In times like the 1930's or the 1970's, solutions can cause problems that snowball. For instance, in 1974, Detroit was stuck with tough emissions requirements that it didn't know how to meet. A year later, catalytic converters went into production, but the 1974 model year was a disaster.

          Periods of rapid economic growth such the 1920's, 1960's or 1990's cause problems to spiral out of cotnrol and lead to times of confusion and crisis such as the 1930's, the 1970's or the 2000's.

          In 1980, the US economy was on the rocks; Merrill Lynch was a penny stock -- the financial service sector was on the brink of collapse because it didn't have products that could yield more than inflation. Quite possibly, the US could have gone down the road the Soviet Union did.

          Since the Reagan years we saw a "War on Inflation"; the Volker-Friedman recession of 1981 was the first battle -- it was necessary to smash inflationary expectations by proving that the government was prepared to go to any length to stop inflation, even if it meant triggering a wave of defaults.

          Like any war, the war on inflation was fought on many fronts. The phase of "free trade" and "globalization" from 1981-1999 was focused on extracting cheap resources and labor from the third world at minimum cost; often third world countries were over a barrel, and we could get them to sell things (in the short term) for less than cost.

          The success of Wal-Mart came from it's private contribution to this war: it cut costs everywhere it could -- by getting the little things right in logistics, but also by hammering workers and suppliers.

          Someday the gap between long-term and short-term costs will close, and inflation will return.

          Break the rules, and nature will punish you!

          Comment


          • #6
            Re: Inflation is Dead! Long Live Inflation!

            Originally posted by Sailor Moon
            Monetary explanations of inflation have been popular since about 1980, but they aren't the whole truth. Inflationary signals can be a sign of problems that cost money to deal with. For instance, rapid economic and population growth in the 50's and 60's led to environmental problems that cost money to clean up in the 1970's.

            Any economy rests on a balance between the ability to solve problems and the ability to create problems. The economy exists to solve problems: to put food in our tummies, to put a roof over our head. In the process of solving problems, we create problems; we'll cut down trees to get wood, then we'll run out of trees that are close by. We can get trees from further away, or find a substitute material, but that often creates more problems. We might go to war to get trees, or find that the substitute material doesn't hold up in a fire, killing firefighters.

            Economists take pride in the human ability to solve problems. This is justified, but it takes time to solve problems. In times like the 1930's or the 1970's, solutions can cause problems that snowball. For instance, in 1974, Detroit was stuck with tough emissions requirements that it didn't know how to meet. A year later, catalytic converters went into production, but the 1974 model year was a disaster.

            Periods of rapid economic growth such the 1920's, 1960's or 1990's cause problems to spiral out of cotnrol and lead to times of confusion and crisis such as the 1930's, the 1970's or the 2000's.

            In 1980, the US economy was on the rocks; Merrill Lynch was a penny stock -- the financial service sector was on the brink of collapse because it didn't have products that could yield more than inflation. Quite possibly, the US could have gone down the road the Soviet Union did.

            Since the Reagan years we saw a "War on Inflation"; the Volker-Friedman recession of 1981 was the first battle -- it was necessary to smash inflationary expectations by proving that the government was prepared to go to any length to stop inflation, even if it meant triggering a wave of defaults.

            Like any war, the war on inflation was fought on many fronts. The phase of "free trade" and "globalization" from 1981-1999 was focused on extracting cheap resources and labor from the third world at minimum cost; often third world countries were over a barrel, and we could get them to sell things (in the short term) for less than cost.

            The success of Wal-Mart came from it's private contribution to this war: it cut costs everywhere it could -- by getting the little things right in logistics, but also by hammering workers and suppliers.

            Someday the gap between long-term and short-term costs will close, and inflation will return.

            Break the rules, and nature will punish you!
            good one, sailor. that includes the rules of human nature and the politics they drive. no one likes to get ripped off, and the leaders of the countries doing the deals to sell the underpriced labor and resources (see "confessions of an economic hit man") sometimes get kicked out and new leaders who will demand a fair price (eg Evo Morales in Boliva) get elected. unless the leaders are running a police state as in china. or the leaders have too good a grasp of the levers that control elections, ala mexico. likewise for imbalances within countries. as the antispin today points out, if the wealth and income equality in the usa continues, eventually some Morales type gets elected. what's the socialist attitude toward inflation? think we all know the answer.

            the biggest factors in predicting inflation is the outcome of the 2008 election and the wars in the middle east.

            Comment


            • #7
              Re: Inflation is Dead! Long Live Inflation! - Janszen

              This is the chart the brought me to Itulip. I believed this is what would happen, or something close.

              How about an update !

              Is 2008 year 1 ? Is 2009 year two and moving higher with new presidential stimulus packages. Would the curve be flatter because of further dollar depreciation in combination with the inflation?

              Comment

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