Inflation As Solution: Hosing The Middle Class

The FOMC’s often and clearly stated policy of creating sufficient inflation has been effective: up 3.8% from August 2010 and up a breathtaking 36% from January 2000. But there are winners and losers, according to Glenmore Investments.

Tax revenues? Huge winner. Yes, inflation is taxable. If we bought a stock in early 2000 for $100, and we sold it today for $136, we’d pay taxes on a “gain” of $36 though that “gain” just kept us even with inflation.

Stocks? Losers. For the NASDAQ to reach its 2000 high on an inflation-adjusted basis, it would have to close at 6,800, the S&P 500 at 2,040, and the Dow at 15,000 (based on the BLS CPI Inflation Calculator). OK, we did earn dividends, but we also paid fees, commissions, and taxes. Yet the eye-popping ups and downs of the markets tend to distract us from the insidious, hidden worm that gnaws away at our assets day and night.

Home owners? Losers. The housing nightmare hasn’t fully played out yet, but it’s already destroying the old saw that housing keeps up with inflation: Adjusted for inflation, home values are now back at a level they first touched in 1989 (excellent graph here).

Bondholders and savers? Huge losers. The Fed has taken the credit markets hostage with its asset purchases and interest rate policies, and the U.S. Government owns 95% of the mortgage market outright through Fannie Mae, Freddie Mac, and the FHA. Between them, they can do with the credit markets whatever they want. So the Fed has forced yields below the rate of inflation across the entire yield curve. Bondholders and savers turn over their money without being compensated for inflation or credit risk, and their income streams have dried up.

Gold and silver? That’ll be a fun conversation a few years from now.

Debtors? It depends. Inflation is good for debtors if their salary, operating profit, etc. rises at the same rate or faster than inflation. The $1,000 payment of a fixed rate 30-year mortgage will get easier to make as income goes up with inflation. A business that can raise its prices and keep its costs down (!) will also benefit.

Middle class? It gets hosed. Wage increases make the Fed nervous. It wants inflation in goods and services. But when wages go up, all hell breaks lose, and it slams on the brake. Alan Greenspan’s Fed famously did so in 1999 – 2000, and then started again in 2005. In 2006, Ben Bernanke’s Fed continued the rate increases. The stated goal was to avoid an “inflation spiral” where rising wages and prices push each other up. The actual result was that real wages (adjusted for inflation) crashed 1.8% from a year ago and 9% from early 2000.

The Fed’s bifurcated approach to inflation and wages has devastated the middle class over the past decade, not at one fell swoop, but in tiny increments, year after year, in a planned disciplined manner that makes hyperinflation unlikely. Declining real wages result in declining purchasing power. The hole is often filled by using credit cards. But the ensuing pile of costly debt only makes the problem worse. Squeezed from all sides, homeowners find that mortgage payments get harder to make, not easier. And they join the ranks of the losers among the debtors.

Companies can be winners or losers. They benefit from cheap labor, cheap or free capital, and an ability to raise prices to make their numbers look good. Walgreens reported a 6.5% increase in sales today. How much of that was due to price increases? However, inflation can eventually eat into corporate profits through rising input costs and expenses (healthcare, for example). Over the longer term, a hollowed-out middle class spends less. Demand becomes an issue, and job creation dries up. That’s where we are today. Yet, the Fed seems determined to stay the course.

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