Saturday, June 07, 2008

The Poor Person's Inflation Hedge

I taped my June 22, 9:30 PM appearance on Larry Kane's Voice of Reason show here in Philly yesterday. (CN8 in the Philly market; if you get Comcast, check your local listings). The subject of consumer debt came up and I pointed out that inflation expectations are such that Americans act rationally when they run into debt, especially if they can reasonably expect their wages to keep up with price increases. Borrowing is of course the poor person's hedge against inflation: there's little better investment than having a big fat mortgage inflated away in real terms.

Say you have a $100,000 mortgage (perhaps on what today is a $75,000 house) and earn $20,000 per year -- the debt is 5x your earnings. If inflation runs at 10% per year for a few years and your wages keep up, or eventually catch up, you'll still owe $100,000 (minus any principal repaid, which is minimal at first on a 30 year mortgage) but make say $25 or $30k per year -- only 3 or 4x your earnings. The higher inflation is, the easier it is to repay the debt. Why do you think the government isn't quaking in its boots about the cheap dollar and high prices for everything from oil to bread? It's $9.4 plus perhaps $99 TRILLION in hock. (See the counters on this page and Thursday's post.)

Running up credit card debt is not such a good hedge against inflation because the interest rates on consumer revolving credit are, and likely to remain, well above the rate of inflation (even the actual rate the government is hiding). But cc debt offers a second type of hedge, one against falling real wages (when wages lag inflation). Bankruptcy laws are more stringent than they were a few years ago but until they bring back debtors' prisons ...

So if you don't like what is going on in the economy, watch the show, and buy the book!

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