Edward Charles Ponzi Jr. on Inflation and Asset Inflation

Edward Charles Ponzi Jr. occasionally comments at Angry Bear, and a recent submission became a post of its own. Ponzi makes several observations: what we have counted as growth (as in GDP growth) may be largely inflation (that statement is more accurate than you might think after you back out hedonic adjustments); that a lot of supposed asset price appreciation is similarly just inflation; because asset price gains make people look richer, everyone like low interest rates, but as we know, interest rates that are too low leads to inflation….

Now a Serious Economist would object because some of this discussion is simplified (for example, most economists believe that a little inflation, meaning currency debasement, is a good thing, because it’s better to overshoot the economic growth rate a little rather than have insufficient money supply growth hinder fundamental growth).

But my bone of contention with the current practice of economics is that very few economists, and just about none in a policy-making position, pay any attention to money supply. Now admittedly, the Fed controls only the narrowest form of money supply, the monetary base; other agents play a much bigger role than in the past in determining the growth of broader measures of money (see Harvard Management’s Mohamed El-Erain on the topic of “liquidity factories” for an example). But that is no excuse for ignoring money supply, or allowing for rapid growth of monetary aggregates (which appears to be the driver of asset price growth).

From Ponzi:

Is this correct use of language and economic concepts?

“My house has appreciated 20% this year”

“Due to inflation steak is much more than years ago”

“Prices have not gone up – so there is zero inflation”

I find much of the discussion about inflation – even by people with an economics background — to revolve around very fuzzy concepts. While there may be some understanding – in the general population and elsewhere — that inflation is an observable phenomena with some sort of “cause” — all sorts of price distortions are taken for granted while others are not.

Even “zero inflation” needs examination – if I buy an American made t-shirt for $8 in 1999 and then buy a Chinese made t-shirt in 2007 – also for $8 – that indicates what exactly?

In fact, all of our Economic Metrics are distorted by the growth of monetary and credit aggregates – to the point where intelligent people believe that the economy is growing, that they are getting wealthier and that they may borrow against certain apparent value.

What if those people are wrong? What if a “growing” GDP and a “rising” stock market are simply inflation – plain and simple – and the adjustment to factor inflation out was mis-applied? And why is a hot-dog that increases in price considered “inflation” while a house that increases in price is “appreciation”? Why is my hot-dog not “appreciating?” Maybe I should buy and bunch and freeze them. That would make them an “investment”.

I think one of the biggest problems in today’s economic landscape is how popular credit expansion and its cousin asset inflation have become. Firstly, we have been convinced that “inflation” does not apply to assets at all (ask around and see how many people can use “asset inflation” in a sentence) – and have further created a society where everyone wants interest rates to be lower.

Savers and debtors are united in their desire for low interest rates – one for obvious reasons and the other because they find asset inflation more fun than bond trading. Liberal economists criticize the Fed for raising interest rates – feeling that employment will suffer – and Conservative economists are worried about stock prices.

Who will EVER be for a higher interest rate? Who will ever want to tap the brakes? Who will ever want a little recession?

The problem is that the price of assets is somewhat pegged to the cost of money. With lots of people able to carry $650/month – it is easy to see how homes in this example could go up 40%.

Monthly payment: 30 Years, Interest rate: 6.750% Loan amount: $ 100,000.00

$ 648.60 a month

Monthly payment: 30 Years, Interest rate: 3.750% Loan amount: $ 140,000.00

$ 648.36 a month

For Mr. Homeowner, whose home has just gone up 40% — what does he think and how is he going to behave from now on? That extra $40K may have been more than he saved in 10 years of working. Why save? The Smart Money – he figures – is borrowing and buying.

Why bother with the Real Economy and its Income Model at all? Why not build your economic life on the multipliers available with the Asset Model? Borrow money, buy something and combine the increasing value of the asset with the decreasing value of the money you are paying back. Think about how many people people are doing that at scales large and small.

Unfortunately you can MAKE MONEY in the Asset Inflation Game — but you cannot build a viable economy by having an entire nation seeking Capital Gains. Asset inflation is not a wealth creation process – it is a re-pricing process. The Homeowner that watches his home go from $100K to $140K has not created any new houses. He still has 42,000 pounds of bricks, tons of sheetrock, roofing and some copper. Why does he think he is “wealthier”?

Wealth is STUFF. It is not little green pieces of paper. Wealth is washers, dryers, telephones, songs, cans of tuna fish, software, inductors, grand pianos, patents and iron filings.

We are now well along in this process. The amount of money borrowed against the worlds assets – at various valuations – is staggering. In all cases growth is assumed as part of the payoff plan – and in many cases observed “growth” may only be inflation or distortion. Our current metrics give us no clue as to how much trouble we are really in. Are we really twice as wealthy as half-a-GDP-ago? I think not. We are sitting in a house of mirrors measuring our bodies by sight.