Defenestrating Thoughts from the Bivouac

A while ago, I wrote about inflation and thought it was be interesting (or depressing) to revisit it. Though the Bureau of Labor Statistics (BLS) Inflation Calculator is most likely understating real inflation, it’s still alarming data. Crissy and I plan to have our first child in one to two years. For us to have the same real income my parents at the same point in their life (two years before their first child was born was born), we need to make over 4 times than my parents did.

Why? Because $1 from 1974 is worth $4.21 today according to the BLS.

And that’s just cash flow. Inflation is eating away at our savings as well, since money in the bank is losing value via the inflation tax.

The current recession is interesting. From my limited understanding of economics, economic downturns can be inflationary or deflationary. And, of course, as we learned from the 70′s it can be the dreaded stagflation. Not one seems to agree on what we’ll see this time around. My hunch is that we’ll see substantial deflation as “paper assets” disappear.

The Fed will continuing trying to print our way out of trouble and will keep lowering rates. I think, at best, this will do nothing and at worst, we’ll see stagflation.

Why do I say deflation is likely?

First, the downturn in housing is likely just starting. As house prices drop, more people have negative equity on their house: they will be “underwater”, since they owe more than the house is worth. When this happens there is an economic incentive to “walk away”. The lendor takes a loss since the original asset (the loan) is replaced with a repossessed house worth less than loan value. That lost worth is a deflationary event — the money is now gone.

This should follow in losses in unsecured debt like student loans, car loans, and credit card debt. If people can’t make their mortgage payments, they probably can’t make these payments. So again, the lendor takes a loss on their original investment; another deflationary event.

I expect the same thing to happen to commercial real estate. If money is tight, the market can support less stores. What will happen to all the new strip malls? They will likely sit vacant. So the builders lose money and at best can sell these for a loss.

This same analysis applies to the monoline insurers, banks, and hedge funds — basically anyone that touches SIVs.

Alternatively, the Fed could keep printing dollars and saddle us with stagflation. I really hope that doesn’t happen.