Inflation: WHEN? HOW MUCH?

[Emperor_Gestahl]

Not saying the banks are worried about inflation currently, as we're in deflation. I'm just considering that maybe we aren't as gung-ho as Krugman wants so as not to give the banks the impression that we'll overshoot our inflation goals. As I said they have to try and anticipate many years out, too loose of spending now might alter projections and raise lending rates long before we see a whiff of actual inflation. In absence of inflation higher rates would mean even fewer people qualifying for a sound loan.

And drkitten, while I can easily imagine politicians are economically ignorant, it'd be nice to think that central bankers might be the slightest bit educated on such matters. To dismiss them all as morons is a bit hasty IMO.

 

[drkitten]

Can you elaborate on this? This seems backwards to me, at least if you take the extreme example:

Bank lends 1,000,000, yesterday, Inflation today, makes dollar worth a million times less, the loan could be paid off with $1.

So what's missing?

The intelligence of the banker.

The banker charges interest on his loan. Indeed, loans-with-interest are the primary way that bankers make money.

What's the alternative? Not lending the money? Then the banker is guaranteed to be losing money -- and he doesn't have the option of earning it.

 

[drkitten]

Not saying the banks are worried about inflation currently, as we're in deflation. I'm just considering that maybe we aren't as gung-ho as Krugman wants so as not to give the banks the impression that we'll overshoot our inflation goals. As I said they have to try and anticipate many years out, too loose of spending now might alter projections and raise lending rates long before we see a whiff of actual inflation.

And that's exactly why this scenario is unrealistic.

Interest rates are historically low right now. If bankers anticipated high inflation five years out, you'd see extremely low "teaser" rates on ARMs and on short-term loans, but you'd also see quite high rates for conventional fixed-rate mortgages and other long-term debt.

If central banks expected high inflation starting X years out, you couldn't give away Treasury securities of longer than X years. But even thirty-year bonds are delivering absurdly low yields -- and it's mostly the central bankers and large financial institutions that are buying them.

And drkitten, while I can easily imagine politicians are economically ignorant, it'd be nice to think that central bankers might be the slightest bit educated on such matters. To dismiss them all as morons is a bit hasty IMO.

The problem, as far as I can tell, is that your scenario requires that bankers act like morons. "Gee, we're really worried that in 2015, inflation will shoot up to 8% Gosh! I better not give out any ARMs that can adjust to pay 9% -- I better sink all my money instead into Treasuries at 1% which mature in 2035....."

 

[Emperor_Gestahl]

Yes if banks expected inflation 5 years out.. Right now everyone is watching deflation unfold. I'm not claiming mortgage rates are high, but that keeping them from becoming high might be part of the rationale for why we don't spend our way directly out of this deflation as Krugman wants.

Besides if losses on defaulted loans never have to be written down deflation doesn't pose any immediate risks to the banks. Inflation would be bad for any mortgages or MBS they've got and bad for all the low-yield treasuries they're scooping up.

Buying those treasuries indicates to me that the banks are confident in ongoing deflation, they seem to expect that Krugman is going to go unheeded.

 

[pgwenthold]

Interest rates are historically low right now. If bankers anticipated high inflation five years out, you'd see extremely low "teaser" rates on ARMs and on short-term loans, but you'd also see quite high rates for conventional fixed-rate mortgages and other long-term debt.

I have a friend who is looking to buy her first house (lucky her!) and is expecting to be able to get a 30 year fixed rate mortgage at 3 7/8%! No buying down points or anything.

That means that people are expecting to make a profit by getting 3.875% interest for the next 30 year! That means they expect inflation to be under 4% for that period (and presumably, a lot under 4%)

A 30 year mortgage at 4% is really, really scary, I think. Good for her, but scary for what it says about the economy.

 

[Puppycow]

The intelligence of the banker.

The banker charges interest on his loan. Indeed, loans-with-interest are the primary way that bankers make money.

What's the alternative? Not lending the money? Then the banker is guaranteed to be losing money -- and he doesn't have the option of earning it.

The alternative, if inflation were really so high, the best thing to do would be to not be in the lending business at all, and instead to put all money into tangible commodities.

Fortunately, hyperinflation is a rare exception to normal economics. It only results from deliberate massive expansion of the money supply by some orders of magnitude. It won't happen by accident.

 

[Puppycow]

I have a friend who is looking to buy her first house (lucky her!) and is expecting to be able to get a 30 year fixed rate mortgage at 3 7/8%! No buying down points or anything.

That means that people are expecting to make a profit by getting 3.875% interest for the next 30 year! That means they expect inflation to be under 4% for that period (and presumably, a lot under 4%)

A 30 year mortgage at 4% is really, really scary, I think. Good for her, but scary for what it says about the economy.

My rate is fixed at 1.8% for the next ten years.

This is why.

ETA: Curiously, the yield on 30-year US bonds is 4%, so I wonder if there's a fee involved in the mortgage somewhere that pushes the true cost up above 4%.

 

[drkitten]

The alternative, if inflation were really so high, the best thing to do would be to not be in the lending business at all, and instead to put all money into tangible commodities.

True. And we could see if that were likely by looking at money inflow and exflow into the financial companies. Goldman Sachs -- the legal entity that is the company -- doesn't really have a choice about being in the banking business, but the investors who own the stock certainly do.

Funny how people are falling all over themselves trying to own more of Goldman, instead of abandoning the company to its fate by selling stocks.

So I think we can discount that alternative as well.

 

[Puppycow]

NIA Urges Lebron James to Consider 3-Year Contract

The National Inflation Association today urged Lebron James to consider signing a three-year contract with the NBA team of his choice, instead of a five-to-six year contract, due to the threat of hyperinflation occurring in the U.S. during the next five years.

(At least they've committed their prediction to a date certain, something the inflation hawks here are not willing to do.)

I think he listened to better advice, signing a 6-year deal. Apparently he also "left money on the table" to improve his team's chances of signing other good players, so I guess that money was not his only consideration.

James, Bosh and Dwyane Wade all signed six-year contracts Friday night, each leaving millions of dollars on the table in order to provide the Heat flexibility to build a championship roster. They could have made $16.6 million apiece this season, but took less money -- none would say how much less -- to get the deals done.

Read more: http://sportsillustrated.cnn.com/2010/basketball/nba/07/09/lebron.bosh.ap/index.html#ixzz0tdZl3F7R

 

[soylent]

You already had double digit inflation if housing is included in CPI. Now the credit-bubble has popped and I think you're experiencing mild delfation; the government is taking on almost as much debt as is disappearing in the private sector.

In order to get serious inflation two things have to occur. You have to keep having these trillion+ budget deficits every year until trust in the ability to repay evaporates; I find this the most likely outcome because I see no evidence of any kind of recovery. The problem will arise very suddenly, it always does, see Greece for what it looks like. Then the response to higher interest rates must be to print huge gobs of money to make up for reduced borrowing capacity and to pay back interest on existing borrowings; I don't think even Bernanke is dumb enough to do this, because it could easily end in the destruction of the dollar; and that's all he has to offer. At this point I think you'll be forced to accept a deflationary depression where the government doesn't borrow and the private sector continues deleveraging.

 

[drkitten]

You already had double digit inflation if housing is included in CPI.

No. This sentence is a non-starter, since housing is included in the CPI; in fact, it's the single largest component (about 42% of the index).

 

[Tippit]

No. This sentence is a non-starter, since housing is included in the CPI; in fact, it's the single largest component (about 42% of the index).

Except for the huge disconnect between rents and home prices.

 

[drkitten]

Except for the huge disconnect between rents and home prices.

Well, that's kind of the point. The price of "housing" (which is most appropriately measured by rents or rent equivalent) didn't increase, which is precisely why we haven't seen double-digit inflation.

Stupid investment strategies are not a component of consumer prices, nor should they be.

 

[MikeMangum]

Well "hoarding cash" isn't the only alternative to lending to regular people.. You just said they could hedge, but if they were sure of inflation why not just make said "hedges" their main position and not lend anything?

One of the problems is that the Fed has implemented policies that creates incentives for banks to exactly that: hoard cash. The Fed is lending at essentially 0% interest, but is now (for the first time ever) paying interest on deposits. The result is that banks are borrowing from the Fed for free and immediately depositing that money back in the Fed for the interest payments. It's literally free money.

 

[Tippit]

Well, that's kind of the point. The price of "housing" (which is most appropriately measured by rents or rent equivalent) didn't increase, which is precisely why we haven't seen double-digit inflation.

Stupid investment strategies are not a component of consumer prices, nor should they be.

No, the point is that CPI doesn't measure everything that matters, like asset prices. If monetary inflation winds up in asset prices instead of consumer prices, it represents a loss of purchasing power from those who don't have assets to those who bought the assets with the newly created fiat money. The measure of inflation should be broad purchasing power, not some contrived and manipulated index of select consumer prices.

If in order to buy a house I have to take on even more debt at even worse terms because the market is inflated, then I have lost purchasing power to inflation despite what lying government indices tell me. That most of the recent home buyers should have been renters (many of whom ultimately wound up as glorified renters) doesn't change reality.

 

[drkitten]

No, the point is that CPI doesn't measure everything that matters, like asset prices.

Well, it covers everything that matters to consumer prices, hence the name.

It doesn't cover the price of wholesale steel girders, either. That's part of the PPI. "Assets" aren't consumer goods -- which is why the S&P 500, which tracks the value of large-cap stocks, another asset class, is not part of the CPI.

If monetary inflation winds up in asset prices instead of consumer prices, it represents a loss of purchasing power from those who don't have assets to those who bought the assets with the newly created fiat money.

Wrong as usual.

If asset prices go up, consumers don't buy assets. Shrug. Hell, this is even true within consumer goods, and the CPI reflects that appropriately. If the price of rice goes up tenfold, that doesn't mean inflationary pressure if the price of a substitute good like noodles stays steady. If Coke doubles its price, people will drink Pepsi instead. The CPI recognizes what most intelligent people do -- when prices for one product go up unreasonably, people switch to other goods, negating most of the inflation. You only get inflation when all goods in a (sub)category rise....

If in order to buy a house I have to take on even more debt at even worse terms because the market is inflated,

Yes, but you don't "have to" buy a house at all. Similarly, I've lost no purchasing power because the S&P 500 has gained 30% or whatever since last October.

 

[lomiller]

If in order to buy a house I have to take on even more debt at even worse terms because the market is inflated

Inflated from what? Houses don’t have some set underlying price that is separate from their current market value. All they have are prospects for going up or down in value, and you said yourself that expanding the money supply assets go up in value. Meanwhile when you pay back the loan you are giving them “devalued” dollars, or dollars that can’t buy as much as they could at the time you borrowed them.. How is this anything but a benefit to you?

 

[drkitten]

Inflated from what? Houses don’t have some set underlying price that is separate from their current market value.

No, but the housing service they provide does. Which is what CPI measures under the name of "rent equivalent."

Basically, how much could you rent your current house out for -- or alternatively, how much would it cost to buy the house you're renting? Which is more or less how the CPI backroom boys calculate it -- by asking people that question.

The long-term historical average is that a house will sell for about fifteen years' rent. Of course, that's about as useful as any average ever is (the average American has one testicle and one ovary); right now you can buy a house in Miami for about eight years' rent, or one in Manhattan for something like 32 years' rent. But that does mean that if Miami housing prices start to go up but rent prices stay the same, then the value of housing in Miami isn't changing, but the asset of houses as an investment is.

This is basically a neat way of separating the value of houses as a consumer good (i.e. of the housing service) from real estate as an asset class.

 

[lomiller]

No, but the housing service they provide does. Which is what CPI measures under the name of "rent equivalent."

Basically, how much could you rent your current house out for -- or alternatively, how much would it cost to buy the house you're renting? Which is more or less how the CPI backroom boys calculate it -- by asking people that question.

The long-term historical average is that a house will sell for about fifteen years' rent. Of course, that's about as useful as any average ever is (the average American has one testicle and one ovary); right now you can buy a house in Miami for about eight years' rent, or one in Manhattan for something like 32 years' rent. But that does mean that if Miami housing prices start to go up but rent prices stay the same, then the value of housing in Miami isn't changing, but the asset of houses as an investment is.

This is basically a neat way of separating the value of houses as a consumer good (i.e. of the housing service) from real estate as an asset class.

It’s almost like someone thought of all this stuff when the CPI was developed!

 

[Tippit]

Inflated from what? Houses don’t have some set underlying price that is separate from their current market value.

Are you suggesting that the housing bubble was predominately a function of the supply of houses, and not the supply of money? Because you'd be wrong.

All they have are prospects for going up or down in value, and you said yourself that expanding the money supply assets go up in value. Meanwhile when you pay back the loan you are giving them “devalued” dollars, or dollars that can’t buy as much as they could at the time you borrowed them.. How is this anything but a benefit to you?

Expanding the money supply causes assets to go up nominally in price. If the side effect of inflation is to benefit debtors, this must be paid by someone, namely creditors. But creditors are protected to the extent that they may be compensated for their loss of purchasing power by the interest rate. To this degree, it is the debtor who has the burden of servicing with their labor what amounts to more interest on larger debts over longer periods of time, due to the real estate inflation. Of course, this doesn't change the primary effect of inflation, which is that the people who benefit the most are the ones who first exchange the fiat money for goods or assets in the real economy, at the expense of everyone else. Not to mention the disasaterous consequences when the bubbles burst.