Posts filed under “Inflation”
The “Miracle” of Compound Inflation
April 21, 2011
What the CBO Assumes
Scylla and Charybdis – The Federal Reserve and the FDIC
La Jolla, Toronto, and Cleveland
Albert Einstein is famously quoted as saying, “Compound interest is the eighth wonder of the world.” And compounding is indeed the topic of this week’s shorter than usual letter, but compounding not of interest but of inflation. As you might expect, I am giving a great deal of thought as to how we get out of our current financial dilemma of too much debt and deficits that are far too high. While I will use US data for our illustration, the principles are the same for any country.
Let’s start with a few graphs from the St. Louis Fed database (a true treasure trove of numbers). First, let’s look at nominal GDP over the last 11 years, from the beginning of 2000. The data only goes through the third quarter of last year, so sometime this year it is quite likely that GDP will top $15 trillion.
So, the economy has grown by roughly 50%, right? Give or take, that’s close to 4% growth (back of the napkin calculation). And in dollar terms that is correct. But what if we took out all the growth that was due to inflation? The economy would only have grown to $12.5 trillion. And in fact, “real” or inflation-adjusted GDP growth was just 1.9% on an annualized basis for the last decade, the lowest growth rate since the ’30s. What cost on average $1,000 in 2000 is now $1,250.
Now, to see this in an interesting graph, the Fed has real GDP based on 2005 dollars. You can see that we are about back to where we were in 2008, prior to the crisis, and growing well below trend. But if we adjust for inflation, growth has not been close to what it was in nominal terms.
Now let’s run through a few “what-if” scenarios. What if the next 11 years look more or less like the last, with 4% nominal GDP growth? That would mean that in 2022 nominal GDP would be 50% larger than now, right at $22.5 trillion. But that is with only 2% inflation.
What if inflation were 4%, with the same growth? Then nominal GDP would be $30 trillion! What a roaring economy, except that gas would $8 a gallon (assuming current levels of supply and demand). In essence, you would need $2 to buy what $1 buys today. Don’t even ask about health-care costs. If your pay/income did not double, you would be in much worse shape in terms of lifestyle. That is the insidious nature of inflation.
Very interesting set of charts looking at Consumer Prices from The Chart Store. Over the course of 12 post WW2 business cycles, the following shows the periods of Inflation. Two things worth noting: The current cycle versus the composite of all prior cycles is relatively modest. This suggest that inflation is currently tame. However, as…Read More
The link to John Melloy’s post in our early reads caused a bit of a stir. Sure John Williams is a bit controversial, but he has been hammering on the “Official Data Understates Inflation” for decades now. Sometimes, it helps to shift your perspective ever so slightly to get a better view on things. The…Read More
Peter T Treadway, PhD
Historical Analytics LLC
April 11, 2011
LESSONS FROM THE PAST – THE GERMAN HYPERINFLATION
“On the afternoon of July 31st, 1914, the Reichsbank, on its own initiative, suspended the conversion of notes, which in the previous days had come, in great quantities, to its branches to be exchanged for gold. On August 4th the conversion of notes was suspended by law, with effect as from July 31 st… in the two weeks from July 24th to August 7th the quantity of Reichsbank notes in circulation increased by more than two milliard marks. Thus was initiated a monetary inflation that was without precedent in history.”
From The Economics of Inflation – A Study of Currency Depreciation in Post War Germany, Constantino Bresciani-Turroni, p 23.
The above quote is from a book written in 1931 which has now achieved cult status. I have been researching the German hyperinflation period post WWI in order to get some idea as to how to survive investment-wise were such a hyperinflation to befall the US.
Germany During and After WWI – A Lesson in Monetary Inflation
The argument can be made that the German experience is not relevant for the US. Germany after all was the loser in major war and was severely punished in terms of reparations and territorial concessions by the victors. But there just might be some relevance especially when we are evaluating QE2, the expansive US budget deficit and today’s inflationary international monetary system. In fact, the German hyperinflation of 1921-1923 had its roots in massive money printing and debt financing that began when WWI started in 1914. Investment-wise, it’s better to be a citizen of country that is on the winning side of a war. But had Germany won that war, the country would still have been in dire economic straits.
Most investors today are vaguely aware of the German hyperinflation of 1921-1923. They’ve probably seen the parabolic graph showing German prices going to levels best expressed in exponential terms at the end of the period. They’ve all heard stories of people carrying huge amounts of currency in wheelbarrows just to buy routine items. They probably think that German holders of fixed income securities were wiped out by this incredible hyperinflation as their investments became effectively worthless.
This perception would be slightly off. In fact, by 1921 most of German fixed income holders who had patriotically bought government bonds, mortgages etc during the war were already wiped out largely by the high inflation that cranked up in 1914 and accelerated into the hyperinflationary period beginning in 1921.
Rogoff and Reinhart in This Time Is Different refer to “default by inflation” as the default method of choice for countries which have over borrowed in their own currency. WWI Germany fit that description. Today the US along with Japan and the euro countries have been borrowing in their own currency with wild abandon. Rogoff and Reinhart define hyperinflation as over 500% per annum. The list of countries that have experienced this extreme version of inflation is longer than you might think. But Rogoff and Reinhart also have compiled a list of countries that have experienced 20%-40% inflation and have therefore in real terms defaulted on debt denominated in their own currency. That list unfortunately is a very long one. A bondholder doesn’t need hyperinflation to go broke. A few years of (unanticipated) 20%-40% inflation will do just fine in terms of seeing his or her investment become worthless in real terms.
From 1914-1921 Germany suffered from accelerating but “only” high inflation. In 1914 when the war began the Reichsbank suspended convertibility of the mark into gold and Germany was taken off the gold standard. (The word “Reich” was still innocent then.) Britain and France also suspended the gold standard. The onset of WWI marked the end of the classic gold standard that had worked so well and had produced near zero inflation for the prior thirty-five years. (The attempt to revive the gold standard in the mid 1920s ultimately proved to be a deflationary fiasco. Like Humpty Dumpty there was no putting the gold standard back together again. But that’s another story.)
To repeat, the German inflationary process began in 1914 when the war began and not in 1918 when it ended. The hyperinflation phase in 1921-1923 was the culmination of this process. German inflation increased steadily from 1914 on as did the depreciation of the mark against the dollar on foreign exchanges. The war was long, costly and financed by massive money printing and borrowing from a clueless if patriotic public. That wasn’t the plan in 1914. The war was supposed to be short, Germany was supposed to win and, as in the Franco-Prussian War of 1871, the hapless losers would pay an indemnity. (The French unfortunately for Germany had a similar plan.) Consequently, the war was financed in Germany not by an increase in taxes but by borrowing and massive money printing. This was a deliberate decision and, like today, there were some people who understood what was happening and opposed it.
The German stock exchange was closed and did not reopen until December 1917. In fact most of the world’s major stock exchanges closed when the war started in the summer of 1914. New York and Paris reopened in December 1914, London in January 1915. Unlike investors who were citizens of their opponents, German investors thus were basically ignorant as to the value of their equity holdings for most of the war. Even when the exchange reopened, in the following years German investors had a hard time evaluating their shares in real terms because of the inflation. Many an investor thought he or she had made money in paper marks when in fact in real terms they were suffering substantial loses in real terms.
A few numbers from Bresciani-Turroni might be helpful. He had several choices in measuring the inflation, i.e., domestic price data, gold as the reference point or the dollar/market exchange rate. He used all three. The different measures did not always move in exact lockstep in the short run but in the long run they paint the same picture of accelerating inflation and economic ruin. All numbers quoted here are as Bresciani-Turroni presented them and are not always totally consistent from period to period but are indicative nonetheless.
Tons of talk and pixels being spilled over the imminent inflation threat. It bears an eerie resemblance to what we heard from the likes of Jerry Bowyer and Art Laffer two years ago. I’d fade it now, exactly as I suggested back then (here and here, the latter piece co-authored with Bonddad): Exhibit A —…Read More
Visualizing Economics looks at what happens to the classic Case Shiller housing graph when you adjust for size, quality, etc. My longstanding view has been that the bubble was in credit, and the credit bubble caused the overall housing boom and bust, as well as select regional bubbles. > click for ginormous version Source: Visualizing…Read More
Back in 2005, I posted this table on Cheap Gas vs other items; it contained the following table: > Other “Refined” Products Compared with Gasoline Product Unit Cost Price per Gallon Lipton Ice Tea $1.19/16 oz $9.52 per gallon Ocean Spray $1.25/16 oz $10.00 per gallon Gatorade $1.59 /20 oz $10.17 per gallon Diet Snapple…Read More
Following the record low data in New Home Sales yesterday, we looked at a 50 year chart of that plumbed the depths of that data series. Today, I want to expand upon that and look at a 120 year chart of real vs. nominal home prices, via Visualizing Economics. There are a few noteworthy items…Read More