High Inflation is Bad

Here is an article "High inflation is bad" by Moose responding to my previous post titled "Inflation. Friend or Foe?"

Thanks Moose for a great article. Let's hope that inflation rate will not be too high in 2008 and 2009.

Sidarta Tanu
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High Inflation is Bad
by: Moose

As I believe we all know, $1 today is worth more than $1 next year. Most items that we purchase every day either go up in actual price or there's less product for the same amount of price (the ever shrinking bag of potato chips that are like $1.59 now and go on sale for $.99 a bag is a good example... I remember 6 ounce bags being the norm, now you're lucky to get a 5 ounce bag with about 1/2 the bag being air!) The latter may not be considered inflation so much as the former, but since you're paying more per ounce, there is an inflation by ounce (which not everyone seems to notice or understand unless it's pointed out to them).

I believe inflation hurts the poor more than the rich, much like a rise in sales tax hurts the poor more than the rich in terms of pure purchasing power. Here in NJ we have a 7% sales tax rate. Let's say we have a unit that's retailing at $100 today in 2007. Let's say same item goes up 5% in March 2008, everything else being the same (though with Crybaby Tax & Spend Corzine in charge, who knows if the sales tax will remain the same). Now instead of pre-tax (let's assume the item is taxable) the unit being $100, it's $105. Now taxes must be computed on $105... so that's an additional $.35 in taxes on top of the unit's price... so REAL inflation would be from $107 to $112.35 (still 5%... but it's $5.35, not just $5). So for someone making $25,000 per year, that's a bigger chunk of their paycheck than someone making $50,000 or $100,000.

Consumerism is one of the things that makes the economy go... and makes people feel rich(er), even if they are poor(er) than their neighbor. If we can buy that new item as above (especially if we want it or there's a perceived need), there's a sense of pride. If we can't afford the item, especially due to inflating prices, consumers feel poorer than they really might be. Especially, if it's those 'little luxuries' we all enjoy... like cable TV (I know I didn't have cable growing up, but I can't imagine myself not having cable TV now) or dining out (yea, I could brown bag lunch, but that makes me feel poor, though I would if I needed to). Less of those things happening means less money changing hands, and less help to our economy.

I also believe inflation is a vicious cycle that helps no one in the end, especially in our negative savings rate economy. If we want a raise, that will cost the company we work for more. Eventually, that will raise prices, which will in turn make people need more money. Even though companies will make more in numerical terms, there will be about the same or maybe even less made in comparison to the year before after taking out inflation. In turn, the government would likely have to print out even more money to meet the demand for money. This lowers the actual purchasing power of our money. And the cycle continues...

Though I THINK I have found the one class of people that inflation is ok for... major sports players. Check this out, courtesy of Baseball Almanac. A mere 31 seasons ago, Michael Jack Schmidt of the Philadelphia Phillies (end Harry Kalas impression... and anyone who has heard his voice knows it) was the highest paid baseball player at $500,000 per season. Nolan Ryan was baseball's first million dollar per season man for the 1980 season. For 2006, the AVERAGE was JUST under $2.7 million! Also mentioned is that they New York Yankees' average (the highest salaried team) was slightly under $7 million (1992 was the first individual to hit $7 million, Ryne Sandberg of the Cubbies, a mere 15 seasons ago!) $327,000 was the MINIMUM. (And I believe 3-5% is the standard raise for most workers?)

Bottom line... high inflation is bad. Granted, the example at this website on Brazil is EXTREME... but it's a good indication of what would happen with high inflation and why people should be against it.

Inflation. Friend or Foe?

Some things to think about (as I think we will see more of it in 2008):

1. Why do people (and the Fed) worry about high inflation rate?
2. How does inflation impact the stock market or stock/index price (or does it)?
3. Does inflation hurt the poor more or the rich?
4. Does high inflation help anyone ? (Bueller.. Bueller.. anyone.. anyone..)
5. Does inflation make the gap closer (or widens) between the rich and the poor (and what about the middle class)?
6. Bottom line: Is high inflation rate good or bad?

What do you guys think?

Happy Holidays!

Sidarta Tanu

*Inflation is defined as the increase in the price of some set of goods and services in a given economy over a period of time.

What's in store for 2008? Stagflation and Recession.

Year 2007 is almost over and a lof of people are wondering what will happen in 2008, for the US economy, stock market, job market, housing market, global economy etc. Here is what I think will happen for US economy in general. Stagflation and Recession.

Stagflation (economic stagnation coupled with out-of-control inflation) is an interesting phenomenon. Not only it is hard to fix stagflation (from the Fed perspective on whether to cut or raise interest rate as it often will fix one side of the problem but make the other problem worse), but also it is hard to understand why stagflation even exist at the first place.
Eventhough most lending institutions are trying to clean up the mess before entering 2008 (with massive write downs), the housing issue is not over and will continue throughout the year 2008. Other loans (such as auto loan and unsecured loan) will also get impacted (higher delinquency) in 2008 which will contribute to the slowing down of the economy. New sales (Home and Auto) will also likely to stay the same as 2007 level if not getting worse. Too bad that we are having this housing bubble issue (that impact the whole economy in general), because the tech sector was just about to come back strong this year.

Warren Buffett and Charles Munger (from Berkshire Hathaway) have said several times before that the US economy system is strong and can handle a lot of abuse, but it doesn't mean it is bulletproof. In the case of the housing bubble issue, I think people get too creative with ARM, Interest only mortgage, Option ARM etc, and forget about basic common sense as house price goes above and beyond the normal level. No one can predict the top as price is regulated purely by supply and demand (as the traditional and conforming mortgages started to get ignored by many), but there are some basic metric that people can use to monitor affordability level. No, it's not the mortgage payment to income ratio. It's the house price to income ratio (think it of like P/E ratio for stock) for example .

Inflation will continue in 2008 and not only for oil/gas price but other goods as well (mainly basic goods). Check out the current price for eggs and milk for example. Items imported from the third world countries and China (clothes, toys, furniture etc) probably will still be cheap but with the trade deficit continue to increase in 2007, the US dollar might continue to weaken and prices of those imported goods might increase. In some ways, weak US currency might reduce the trade deficit in the long run. I've mentioned before that continually having trade deficit is akin to selling parts of our country to others.

By the end of 2008, recession will happen in my opinion, and it is not necessarily bad. It's just part of the economic cycle and it will come back. But it is important to let nature takes its course and let it correct by itself (some intervention is ok but the Fed must be careful not to invervene too much and create more damage to the system)

Obviously, no one know for sure when or if recession will happen. The market/economy also tend to overreact to situation (both bad news and good news). The important part is knowing when there is a good chance that recession is going to happen and how we should prepare for it. There will be a lot of opportunities in the market during recession and we can start building reserve systematically for those opportunities. Don't panic during this downturn, and if you are already long on many solid companies, just hang tight and ride it out. Keep your spending and debt level in check. And always learn from your (and other) mistakes and be financially responsible.

All the best for 2008!

Sidarta Tanu