“Rising Oil prices are like a tax.” 

I’ve heard that canard repeatedly over the years. There are lots of reasons why this is not quite true – unlike a tax, lots of petrodollars leave the country, and don’t get recirculated. However, high Oil prices are a drag on very specific types of consumptive activity: driving, traveling, manufacturing, home heating are the prime endeavors that get curtailed.

Inflation is a much more pernicious a “Tax” than Oil – and on more kinds of economic activity. The ongoing reduction of the dollar’s purchasing power (a/k/a inflation) impacts much more of the economy than even energy price increases do. Consider high energy prices are merely one aspect of inflation. Everything else that rises in price – from industrial metals to insurance to housing to health care to construction materials to education to food to precious metals – impacts everything else, plus a wealth of activity that inflation acts as a tariff upon.

High inflation taxes savings, as a dollar saved becomes only a half-a-dollar earned. Indeed, why save if all you accomplish is watching your purchasing power erode? (Perhaps this is why the savings rate has plummeted). Inflation also hurts investment, as it reduces real returns, and therefore discourages parking monies for longer periods of time.

As we have heard so often from the politicos, if you want less of something, tax it more. Those who are willing to appease inflation and sacrifice long term purchasing power for a short term growth spurt do just that:  They discourage savings, retard investment, reduce consumption, dampen hiring. If you ask me, that’s a really bad tax policy.

Consider a home purchased in 1970 for $100,000; If it was sold for $400,000  $514,949 today, (according to BLS Inflation calculator) the gain would merely cover inflation. In real, after-inflation terms, your returns were zero – Nada, zip, zilch, nothing. And that is why inflation is so pernicious, and why it is incumbent upon the Fed to stay on top of it, even daresay I at the risk of slowing growth.

Ponder this: The Dow and SPX, despite reaching 5-year highs, have returned less than 5%/year over the same period. Though CPI estimates for inflation are below 5%, we know in real world terms (where we eat and use energy) these gains failed to keep up with inflation. In other words, real returns are negative versus actual – not BLS measured – inflation. Perhaps that explains why U.S. Equity markets have under-performed every other asset class and emerging market, with the lone exception being U.S. Treasuries.

Away from inflation – or perhaps because of it – we continue to watch the markets internals slowly deteriorate: The advance decline line has not confirmed recent Dow highs; the NYSE A/D line topped out in March. Meanwhile, mutual fund cash levels are down to low levels. And, we are about to enter the seasonally weakest period of the year. We have been positioned as “uncomfortably” bullish these past few months — our view remains first half rally, second half trouble — and we note that these elements mean risk is rising.

We strongly urge increased caution.

>

Originally emailed 5/2/06 ~11am

Category: Federal Reserve, Inflation, Markets, Technical Analysis

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

38 Responses to “Rising Inflation is a Bigger Tax Bite than Oil”

  1. Ned says:

    “Consider a home purchased in 1970 for $100,000; If it was sold for $400,000 $514,949 today, (according to BLS Inflation calculator) the gain would merely cover inflation. In real, after-inflation terms, your returns were zero – Nada, zip, zilch, nothing. ”

    Not exactly. You’ve had a place to live and the only tax deduction/shelter left, on your mortgage interest, right?

  2. Bob A says:

    …and it depends on where you bought your real estate as well. where I am that $100,000 home would be worth about $1,500,000 today.

  3. ed says:

    What is your point about inflation? Yes, it changes the value of money over time, but you haven’t shown that it has any *real* effects. Savings decisions should be based on *real* rates, which can be positive even in the presence of inflation. Your example about the house is even worse. Yes, sometimes the real returns on real estate will be negative, sometimes positive, and sometimes zero…and you need to adjust for inflation. Why is this a problem?

  4. Robert Cote says:

    US median Home prices:
    1970 $23,400
    2004 $221,000

    Using real numbers that beats inflation all to heck and gone.

  5. marty chan says:

    I wish you wouldn’t keep continuing the Wall Street Journal “meme” that housing is cheap. It’s possible that if you bought a $100,000 mansion in 1970 in N Dakota or the rust belt it would not keep up with inflation.

    But if you bought a $35,000 house in San Jose it would be worth a quarter million.

    Housing responed quicker than stocks to inflation, by 1980 that house was already pressing $100,000.

    Note also the fact that the house was leveraged meant real payments were less than half of what they were when the house was furnished.

    Inflation has been and will continue to be good for many home buyers. Suppose you buy in a “bubble” market at rates exceeding traditional valuations. Inflation will counteract the tendency for prices to fall (in the long term) and reduce the real value of what you pay.

    Admittedly those who took flexible rates may get smashed in the nbext few years and until wages adjust lreduced real income may seriously deflate housing in the next few years, but if you can hold that house in a decent economic region it will adjust.

    I am concerned about inflation and think it danger, but based on repeating the lie that people routinely spent $100,000 for houses in 1970 you chose one sector that has benefitted.

    Housing was most feeble in the nineties, a time of relatively low inflation.

    Inflation hurts renters because when it happens within a few years they are paying sums equal to what buying a house was before, without tax benefits or equity, then a few years later they are paying more.

  6. B says:

    You know Steven Roach and Richard Bernstein have recently made some questionable comments and decisons IMO. Maybe they see something I don’t given they have research at their finger tips that I could only dream of. Well…on second thought…So did the Fed in 2000. Ok, cancel that thought. Maybe they are feeling pressure with markets at new highs to bend a little bit. Bernstein is the only CIO or whatever he is, of a major Wall Street firm I respect unconditionally. He upped his allocated of stocks. Still only 50% but what is he seeing? Especially given commodities start a weak cycle in May and internals are weakening. Can the market rotate without indices falling? I guess. But unless we find some new leadership, this market totally sucks. And mutual funds are taking it in the shorts unless they are singularly invested in materials related investments.

    On the inflationary question, our good buddy Bill Miller, whom I believe is a better Peter Lynch than Peter Lynch because he has proven his mettle in the worst bear market in nearly a hundred years, just issued his 1Q commentary a few days ago. It is the best piece of free advice I have seen in ages. For those who believe commodities are in a super cycle that will last forever, you may want to click on the link. A little bit of a free history lesson. It also could be used to draw a conclusion, if accurate, that inflationary pressures could be temporary. Sort of that deflationary issue I worry about if global asset based investments crumble. If that happens, the equity markets will not survive it as those are the beneficiaries of the asset explosion. The commentary is very, very worthwhile IMO. Some is anecdotal and some quantitative. But, it gives you more insight into history and alot of insight into behavioral dynamics rather than the pump you get from CNBC, Jim Cramer, the perma bears and gold bugs.

    http://www.leggmason.com/funds/knowledge/management/2006MillerCommentaryQ1.pdf

  7. marty chan says:

    Change that $30,000 house in SJ to 3/4 quarter million. Elsewhere usually at least a quarter million.

    Plus tax breaks, payments lower than rents, back then you were making those payments off of 10 or 15 K, now 50 or 60K assuming no real raise.

    So you want us to cry for those boomers who are paying off their mortgages at 2 or 3 thousand a year and cry how they are the great suffering victims of inflation?

  8. B says:

    A discounted cash flow analysis of Robert’s post shows a rate of return of nearly 7%. That’s pretty good. Plus, you get to live in it and you get to deduct the payments from your taxes. Both increase the investment return from a quality of life and real dollar amount.

  9. drey says:

    CNBC had a couple of ex-fed governors on a week or two ago (one was Wayne Angell) one of whom suggested that high oil prices are not inflationary because the more Americans spend to fill their tank, the less they will spend on other items, thus containing inflation…

    On the surface it sounded like the most specious argument I have ever heard, but I’m not a good enough economist to explain why. Anyone want to comment?

  10. B says:

    Btw, since I’m bored out of my mind today, Robert’s post brings up another point. Homes in 1970 were surely not, on average, the size of homes today. So, that is really not apples to apples in all likelihood. Homes today are likely 30-50% larger as an average. Those numbers are averages so….. No proof but a guess. If that is so, the actual value of a comparable home to a home in 1970 and what it is worth today would likely be no more than the rate of inflation.

  11. trader75 says:

    It is indeed fascinating how bizarro things have become. There are number of elements that are arguably inflationary / deflationary at the same time.

    Expensive Energy: A reason for goods and services providers to transfer higher costs (inflationary)… but also a reason for companies in competitive industries to absorb costs, reducing profit margins, and a heavy weight on consumer discretionary income (deflationary).

    Raw Materials: Driving up the price of everything (inflationary)… but threatening to drive it right into the wall (deflationary). Tom Barrack, the billionaire real estate guy, prognosticated last year that the housing bubble would be done in by out-of-control construction / raw materials costs.

    Globalization: The driver for more expensive energy and commodities at the margins (inflationary)… and yet the driver for lower wages and production costs via expanded global labor pool (deflationary).

    And then let’s not forget the funny-money nature of the stimulus game. When stimulus is channeled into paper asset inflation, it’s possible to ‘beat the game’ by getting a higher return on investments than the loss one faces in purchasing power.

    If stimulative monetary policy allows an investment bank or a private equity firm to double or triple the profits they would have made in the absence of stimulus, there is an argument to be made that the benefits of such stimulus, to those who reap them in full, can actually outweigh the cost of inflation and maybe even the cost of taxation too! Farmers are pikers… Wall Street is in the midst of the biggest subsidy bonanza of all time. No wonder The Economist is praising ‘The Culture of Risk’ this month… it’s being unwittingly underwritten by anyone with dollars in their bank account.

    In sum, it’s hard to know whether we get inflation or deflation because, as Bill Gross observed a couple years ago, we are currently walking a tightrope with fire on one side and ice on the other… and the swings are getting nasty.

    Consider the words of that great macro-economist Robert Frost:

    SOME say the world will end in fire,
    Some say in ice.
    From what I’ve tasted of desire
    I hold with those who favor fire.
    But if it had to perish twice,
    I think I know enough of hate
    To know that for destruction ice
    Is also great
    And would suffice.

    I still think we get fire in the end either way, though, because the one thing every gummint knows how to do is print money. If it comes to that (which it may not), a deflationary death spiral simply will NOT be tolerated. At any cost.

    Disclaimer for B: I’m not predicting that doom is a lead pipe cinch here… we could theoretically still ‘muddle through’ as Mauldin puts it. Just assessing the lay of the land.

  12. thecynic says:

    i’ll put it this way, when Angell worked at Bear Stearns he was known as “wrong way” Wayne…

  13. trader75 says:

    Also, as long as we’re talking housing… 50-year mortgages have arrived in California: http://tinyurl.com/q62lr

    Just try and get your head around this:

    “Half of first-time home buyers are 32 or older, according to the National Association of Realtors. If those buyers get 50-year mortgages and never refinance or make extra payments, they won’t pay off their loans until they’re well into their 80s.”

  14. B says:

    I don’t believe they are inflationary/deflationary or contradictory….I believe mid term inflationary, end state potentially deflationary. That isn’t really a dichotomy or historically without precedence. And it doesn’t have to come to pass. Btw, a deflationary death spiral is something none of us want. And, the Fed may or may not be able to stop it. Theory is quite nice but getting a response from a patient experiencing myocardial infarction isn’t always guaranteed. Let’s just hope we don’t get the opportunity to test Bernanke’s hypothesis of post 1929 and how it could have been avoided.

  15. Alaskan Pete says:

    “….I believe mid term inflationary, end state potentially deflationary. ”

    Exactly.

  16. curmudgeonly troll says:

    Post office wants to raise price of a stamp to 42 cents next year. That would make it 13.5% over a year and a half. Blames energy prices.

    http://news.yahoo.com/s/ap/20060503/ap_on_go_ot/postal_rates

    These aren’t the data you’re looking for. You can go about your business. There’s no inflation to see here. Move along.

  17. jkw says:

    Deflationary death spirals can always be ended by sufficient government spending (particularly if it is spent on people with no money). The Democrats will gain power in large numbers if we start a deflationary death spiral. They will know how to spend money. They’ll probably even spend it in the right places to fix things.

    My current best guess is that we get mild inflation for another year or two, followed by several (2-5) years of deflation, followed by large amounts of inflation. I expect nominal housing prices to fall until the deflationary period ends, which will be one of the reasons the government will do everything they can to cause inflation. 70% of the country loses money if house prices fall, and they won’t put up with it for very long.

  18. rob says:

    in 1972 my friends and I were renting a waterfront home in Medina Washington from a Boeing engineer. It had a street to water parcel just south of the Evergreen Pt floating bridge. He needed cash and asked us if any of our fathers would be interested in buying it. price: $36,000. Value today? probably somewhere north of 10 million. Bill Gates lives on the same street.

  19. Robert Cote says:

    Gawd, work for a few hours and all the good points get taken. The house of 1970 was 1700 sq ft and 2006 something like 2300 sq ft. The deflation in materials and labor and transportation being important factors. Today they are wired for twice the amps and phone lines and have added cable equivalents as well. Windows have anywhere from 5 to 20 times the old R-Value insulative properties. Built-ins use half, 1/4th the energy and last twice, 4 times as long. Just more evidence of the long term deflation in certain manufactured items. If you actually put a 1970 median home on the market it could not possibly command a median price today. Too small, too outdated, too inefficient and… wait for it… in the wrong place. Use the centroid of US lower 48 population and see the median home is some 200 miles away from where it was then. Loaclly and more practically the 1970 home was too close to the urban core as well. The mitigating factor is the key; living for free or if you will a portion of the lost opportunity costs from the difference twit renting and buying. Complex analysis to say the least. The very act of ownership changes behavior making it difficult to tease out the actual asset performance.

  20. royce says:

    “70% of the country loses money if house prices fall, and they won’t put up with it for very long.”

    I remember the last big housing crash in the Northeast. There were people who lost big bucks, others who just stayed where they were, and others who were then able to buy in at a bargain price. If the asset prices go down, we lose the wealth effect and the ability to borrow against the asset, but it’s not all bad news overall.

  21. JS says:

    drey,

    Angell is technically right if the supply of money in a closed system is constant (in an Econ 101 textbook ultra simple and wholly unrealistic economic model kind of way.) Joe Average has $100 to spend and spends $25 on A, B, C and D. The next year he spends $50 on A, $25 on B and C and nothing on D. The aggregate price index shows no change at all. The problem is the US is a dynamic and open system with massive increases in the money supply so he is, in the real world, wrong. Angell of course knows this, as to his motives for saying stupid things, who knows. Think of it this way: the Fed adds to SOMA via POMO (you can look up the labyrinthine Fed acronyms and mechanisms if you want at their sites, the point is it’s how they permanently add new money to the system) – > the recipient financial institutions lend the new money (virtually ad infinitum nowadays) – > Joe Average’s latest Refi or HELOC on his inflated asset finances his SUV gas bill (and a whole lot more!) – > the price of gas remains inflated and everything else does too, because ongoing credit boom asset inflation continues to finance consumption of everything. That is to say, the volume of money in the system exceeds the amount necessary to maintain prices for goods at previous levels. So Joe Average still spends everywhere, all the time, as fast as he can. He just needs the Fed to keep inflation going to reduce the burden of his ever expanding debt and to make sure his wage stagnant (for now) job at WalMac selling to other MEW financed good citizens is secure. And then the game continues. It’s one of the Fed’s dirty little secrets, don’t tell anyone.

  22. Bastiat says:

    JKW

    B. double-freakin’ S. The Japanese government tried the spending route for years and it led no where. Japan is the king of public construction projects and they stepped up the pace after the downturn in the 80′s. In the mid 90′s they tried rebates for consumption to stimulate demand to no effect.

    They lost upwards of 20% GDP from 1991 to 2003 while their public debt rose to 140% GDP.

    The Hydra of government is a capital destroyer, not a creator. Governments are inefficiency institutionalized. If you rely on a government for economic stimulation, you will only get money spent stupidly, money thrown away with deleterious effect.

  23. D. says:

    House 1970:

    1970: 23.4
    2004: 221 for a Return = 6.8%

    BUT:

    Minus Taxes = 1.3%

    Minus Maintenance and renos = 1.5%

    For a net return of 4.0%

    Inflation from 1970-2004: 4.7%

    Apart from some areas (California, New York…) it can be shown that real estate price increases are mostly due to the increasing size of houses. Price growth per square foot has not been that great over the long term.

    As for renting vs. buying during inflation, at one point in the cycle, there has always been a short term dip large enough in real estate prices to recoup the increase in the cost of renting.

    Patience can still be a virtue.

  24. D. says:

    “Let’s just hope we don’t get the opportunity to test Bernanke’s hypothesis of post 1929 and how it could have been avoided.”

    Well, Greenspan was obsessed with Japan and he tested his thesis. Bernanke has obviously been focusing on 1929, I bet he tests it.

  25. Estragon says:

    “High inflation taxes savings” – only to the extent that after tax returns on savings don’t compensate. Large swings in the rate of inflation can cause an increase in risk premia, and that’s the real problem. Stable inflation allows for adjustments to happen in real terms for pricing that’s sticky in nominal terms.

  26. bionick says:

    This “quality/quantity” excuse for increasing prices of everything is becoming annoying. The argument goes: just look at the – pick one – size, glitter, complexity, performance, etc of this thing compared to the corresponding thing several decades ago – now it is much much better – which it may or may not actually be – than before, and therefore it costs more.

    The problem with this argument is that it forgets that training of the median worker and complexity of his work now greatly exceeds training and work complexity of the median worker then.

    Thus, if a median worker could afford a median house for a 30-year mortgage then, but now has to get a 50-year mortgage, we clearly see a deterioration in the level of his reward for much more demanding and qualified labour.

  27. John says:

    Nonsense – the “median worker” doesn’t exist and never has. The way a house is bought is simple – I decide that I might not be able to afford it now but I probably will be able to afford it in the future. I convince myself that I can come up with the mortgage. Ot truly is that simple. It was that way when I bought 25 years ago, and when my father bought 50 years before that, and it is that way today.

    Let me repeat my mantra – really slowly now so the back row can take notes: ….There….is….no….inflation.

    Absolutely no one (including the entire Fed) can prove that there is (and anecdotes don’t count). As soon as someone is able to convince me that raising interest rates somehow “cures” price increases in oil then I will agree that there is inflation. But there is not one person on this blog who can convince me of that. And I really, really want you learned folks to think about it in that context.

  28. trader75 says:

    Food for thought: the ‘median worker’ is disappearing. Meritocracies are inherently anti-egalitarian, and as societies develop more powerful tools for entrepreneurial advancement, the meritocratic element increases.

    Think about it: Accelerated technology allows high achievers to innovate faster than ever before. At the same time, technology as cheap entertainment keeps low achievers more pacified and distracted than ever before.

    The internet is a case in point: You can use the internet to research a new idea and jumpstart a business, or you can use it to masturbate your life away. Your favorite blogs could be an information asset that improves investment results and helps your career, or they could be a giant time sink that cuts your productivity in half.

    Because technology is powerful, it is dangerous. The more technology we have at our fingertips, the more ability we have to lift ourselves up or bury ourselves in trivial distractions. Because of this, the high ends and low ends of human capability are diverging. Technology magnifies both ends of the spectrum, good and bad. The ‘median’ notion is going away.

    This is a microcosm of the globalization issue also. The world is simply becoming more competitive–which overall is a good thing, because meritocracy and competition go hand in hand, but causes major dislocations in the process.

    This means the ‘median worker’ is fighting a battle on not one but two fronts—trying to catch up or keep pace with the hyper-achievers above him, while simultaneously trying to fend off the hungry up-and-comers below him.

    In the long run, our mental models of what a society is and how a society should function will have to change radically. What we end up with, who knows—there will probably be a variety of reactions and a experiments going on at once as the pace of change accelerates. For good or ill, a social sea change will be forced upon us. Whether we wind up somewhere better or worse than here, and how long it takes to improve again from there, is hard to say.

    One thing is for sure–the 20th century is over, we ain’t going back, and a lot of the mental models grounded in the recent past will die.

  29. trader75 says:

    “As soon as someone is able to convince me that raising interest rates somehow “cures” price increases in oil then I will agree that there is inflation.”

    That’s easy. Just convince Bernanke to do a 500 bps rate hike at the next fed meeting. That would cure high oil prices in a heartbeat, I guarantee you.

  30. wallaby says:

    >….There….is….no….inflation

    Depends on what you call inflation. You are talking about the stuff in CPI?

    There has been a big inflation in credit. Which has in turn inflated
    Houses
    Stocks
    Commodities
    Gold & PM

    which basically means that there are a lot of dollars chasing too few houses, stocks and commodities. A lot of this is simply credit, borrowed from the future.

    Now US has to subsume this credit by (1) producing and not consuming (exporting) or (2) producing more than what is required to payback the credit, or (3) devaluing the credit by increasing the money supply. And (3) is guaranteed to get CPI inflation unless the extra money can be made to stay out of stuff in the CPI.

    Note that the BR’s inflation tax has already occured and taxed in a very arbitrary and capricious manner. All the credit inflation that flowed into housing simply transferred wealth to those who owned houses (or could obtain credit to buy houses) at the beginning of the credit inflation cycle (circa 1% rate) to those who obtained credit or bought houses last (now).

    So simply put, all that your “there is no inflation” mantra means is that there is no inflation in whatever is used to calculate that fact.

    A low interest regime, without a punitive tax on speculative asset appreciation, will ensure that credit is used to speculate, and not for productive investment. And such speculation will inflate whatever asset it homes in on. It simply transfers wealth to those who have a hedge against inflation in that asset to those who do not. It does not create any new wealth.

    If the economy is suffering from a shortage of demand, then the Fed dropping dollars on people from helicopters is much better and will be much more fair, than low interest rates. Low interest rates cannot control where the credit ends up – in investment or gambling.

    And it has been good for gamblers – the Greenspan put, or mopping after bubbles – just breeds moral hazard

  31. dd says:

    “You can’t have runaway inflation without negative repercussions for the market,” said Barry Ritholtz, chief investment officer at Ritholtz Capital Partners in New York. “We’re dealing with inflation pretty much everywhere.”

    http://www.bloomberg.com/apps/news?pid=10000103&sid=a3YR0RN2RxuI&refer=us

  32. cm says:

    B: “Homes in 1970 were surely not, on average, the size of homes today.”

    The 50′s built homes in my neighborhood sure were. Oh wait, that’s not true, many of them had their garage converted to an extra room, so they have much more square footage now.

  33. zack says:

    Bill Miller would hate the hell out of me because I have nothing but oil, gold and RYWBX (Rydex leveraged short dollar) on in the trading account and IRAs. Up to 50% cash in the 401K.

    The document seems to me to have an element of sour grapes. You have to respect his opinion based on his long-term record. If that makes me a goldbug or a gloom-and-doomer, I would respectfully have to point to the scoreboard for the last couple of years. As traders, our job is to find and agnostically exploit bull markets. And so far, the 70s playbook has worked swimmingly.

    I think you’ll be able to spot the top a mile away. You’ll see:

    - Latam leftists confiscating mine resources. That’ll mark the halfway point.
    - Guys quitting their jobs to stake out a space in the mall concourse with a folding TV dinner table tray and an assay kit to buy your jewelry. That’ll mark the 3/4 point.
    - Survivalist shows on public access cable espousing the 4 Gs – gold, gas, guns, groceries.
    - The oil majors capitulating and suddenly beginning to think it’s a good idea to integrate vertically. BP did exactly this.
    - IPOs from companies claiming to be able to turn dog crap into unleaded regular

    That was what the 70s were like. We’re nowhere near that yet. Following the script, when you see this stuff you want to load up on zeros.

    I’m with the guys who say, intermediate term inflationary, long term deflationary. Maybe late 2008, China holds it together long enough to put on the Olympics. That’s just an arbitrary date, I have no idea why I feel that.

  34. B says:

    Did you read what Bill Miller said? Doesn’t sound like it. He said the time to buy was when they were down. ie, Early in this cycle. Not now. He never said don’t buy oil, metals or gold.

  35. D. says:

    “This is a microcosm of the globalization issue also. The world is simply becoming more competitive–which overall is a good thing, because meritocracy and competition go hand in hand, but causes major dislocations in the process. ”

    This is something I’ve been pondering for a while. The real estate boom, the philosophy of wanting everything now and the movement towards perfect parenting has really made me question the nature of competition.

    Personnally, I find that, in the name of competition, many people are killing themselves doing useless and destructive stuff. For example, expensive b-day parties for their children. Buying houses that are way too big, forgetting that in the long run a big house needs maintenance and is a money pit. Getting a degree on debt for a job that pays peanuts. Putting your kids in a multitude of extra-currirular activities instead of putting them down to bed at a decent time. I could go on.

    In the short term, it has been working because the market has been rewarding short term thinking. In the last decade, capital has been so easy that barriers to entry have dropped. Why bother investing for the long term when you can’t dream of recouping your investment? So everyone looks to build value short term and cash out as soon as they post a couple quarters of profits.

    But logically, short term thinking has to be destructive and has to catch up. I think the excess capital is responsible for the huge dislocations we have seen. How long will it last?

    Dislocations kill meritocracy. People don’t want to be left out and are running like chickens without a head. Instead of doing what they like and what they are good at, they feel compelled to look for the next bubble area. It might be competitive but is it productive or efficient?

    In the last century, most the top 10% of the population, the elite, has been in the western world. Over the next few decades, there will probably be a redistribution of this 10% from the western world to the entire world. And the ones who are putting their energies in the wrong place will be left out.

  36. trader75 says:

    “In the last century, most the top 10% of the population, the elite, has been in the western world. Over the next few decades, there will probably be a redistribution of this 10% from the western world to the entire world. And the ones who are putting their energies in the wrong place will be left out.”

    I agree 100%… and to me that is a beautiful thing. Which sounds more like a meritocracy-oriented world, one where all the centimilliionaires are clustered in a handful of places, or one where they are geographically spread all over the map. The lower the location correlation to wealth becomes, the better things are overall imho.

    In terms of competition and people killing themselves, I think you are getting into philosophical territory here. I basically agree with you, though, that a lot of folks are destroying themselves in the rat race.

    For example, check out this great article, ‘Married to the Market’: http://tinyurl.com/qmd3a

    That article makes a strong case that many of Wall Street’s alpha males, and the women who marry them, are actually losers in the game of life. Measuring success by a financial yardstick alone is an inherently stupid proposition. A guy who makes $10MM a year can be absolutely miserable. A guy who makes 40K a year can wake up every morning loving his life filled with family and friends.

    So yeah, the quality of life issue is a big one. But I think we are waking up there. There was an interesting piece in the WSJ the other day on young lawyers ‘just saying no’ to the ‘work yourself to death’ culture that used to prevail at so many law firms. They realized that’s a bullshit way to go.

    But in terms of the competition I was talking about, I think what I said still applies in terms of REAL productivity gains. When I mentioned hyper achievers getting ahead with technology, I wasn’t talking about yuppies buying Hummer H2s on credit. I was referring to actual real productivity gains in the marketplace, in the workplace, in the companies these achievers are working for and running.

    Meritocracies are anti-egalitarian not just in spirit, but in consequence. When you have a small group of people maximizing their revenues through skillful use of technology, you have those same people driving up the cost of goods and services for the others around them who aren’t getting ahead. This is why the cost of living in an advanced economy inexorably rises to levels that make the non-advanced contingent of the economy uncomfortable.

    One reason I love the markets with a passion is because understanding them requires input and insight from so many disciplines: not just mathematics and economics but history, psychology, sociology, physics, and yes even English and Philosophy (in which I majored and minored, so maybe I’m just talking my book). The things you bring up, and the realities we face on so many levels, contribute to my conviction that we are headed into a period of incredible transformative change. Whether we come out for better or ill on the other side I do not know, though in the long run betting on better is the way to go.

  37. It’s a bit awkward to illustrate inflation by applying the CPI inflation calculator to the purchasing price of a house.

    The CPI only looks at rents to measure housing inflation, not at house prices or mortgage payments.

  38. David Foster says:

    “Perhaps that explains why U.S. Equity markets have under-performed every other asset class”…huh? Equity returns being lower than inflation demonstrates that equities have not been a winner in real terms over this time period–but it would be a circular argument to claim that this outcome *caused* their poor performance.