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Inflation: You Ain’t Seen Nothing Yet

Before we get into this weekend’s Daily Reckoning, consider this little snippet of news about the American Spring from the 5 Minute Forecast:

Andrew Wordes shed his mortal coil in a blaze of… well, it’s hard to call it glory.

For the past seven years, he’d been fighting city fathers in Roswell, Ga., over his desire to keep chickens in his backyard. He hired lawyers. It got expensive. So expensive he couldn’t keep up his mortgage payments.

Monday morning, shortly before police showed up to evict him, he called Atlanta’s WSB-TV, where his saga had become a running storyline. A crew arrived.

“I appreciate everything you’ve done,” he told reporter Mike Petchenik. Mr. Wordes then went inside… and blew his house to kingdom come. He’d doused the place with gasoline in advance; his body was so badly charred he wasn’t officially ID’d till yesterday.

Having had chickens in our backyard, before an unknown member of the Queensland wildlife made them disappear, this little story struck close to home.

Self-immolation is running hot as a form of protest these days. The American patriot battled over his right to keep chickens and the Arab protester about his right to sell oranges. Makes you feel privileged to live in Australia, right?

Except, you might have noticed, that Andrew Wordes’s story featured a mortgage he could no longer pay. And that’s the crucial link to today’s Daily Reckoning.

When Times Get Tough, the Tough Get Going

The famous Aussie battler is complaining about the cost of living. According to politicians and pollsters on the TV program Q and A, the cost of living is the number one election issue.

You’d think that would delight someone like us, who warns about the threat of inflation all the time. Finally, people are taking it seriously!

But the cost of living debate is actually incredibly cringe worthy and embarrassing. We’ll tell you why in a moment. First, why should you care? Well, it’s time to get your perceptions in order, or you won’t handle the coming storm very well. When things get truly bad in Australia, it’s your own sanity that is most important to protect, not just your wealth. Forewarned is only forearmed if you prepare yourself and your wealth.

So, let’s take a look at what Australians are so worked up about and why it’s measly compared to what’s coming and what you should prepare for.

Our favourite complaint about how difficult it is to make ends meet is this one from the Age. It’s all about the ‘precariat’ Australians are living in – where their lifestyle is precarious for financial reasons. In other words, they are having trouble finding jobs that suit their lifestyle. Kathy Carra was interviewed about her situation and she complained about having 40 jobs in the last 12 months. 40 jobs in 12 months! And Australians are struggling? Of course, the real reason Australians feel like they’re struggling has to do with spending. Kathy bought a house. Another precariat resident bought a ticket to Europe. We’ll get back to the spending later. What’s amazing is that these people are struggling by the Australian definition. This is nowhere near struggling.

Here are some examples of true hardship that Australians would be justified to complain about, if they experienced them:

  • Youth unemployment above 50% (as it is in Spain).
  • Debt wakes, where younger family members say goodbye to Mum and Dad before emigrating to avoid their debt burden. They cannot return without fearing debtors prison. (This is happening in Ireland right now.)
  • Elderly turning to crime in record numbers because of the cost of living (as they are in Japan).
  • The federal government using debt collectors to chase up education debts. (In America, one victim of the government’s chase has ‘cut meat from his diet and stopped buying gas to drive his 82-year-old mother to doctor’s visits for her Parkinson’s Disease.’
  • A mainstream and respected health news website reporting that the government raided public utility funds to pay of its debtors, leaving hospitals with bouncing cheques. (Greece.)

These are problems that Australians, as a nation, only fear in their nightmares.

But they are also whinging about the price of petrol. Zero Hedge reports that the Europeans are paying around $10 per gallon, which is around $2.50 per litre in Aussie dollars. Petrol prices are low in Australia. And they’re not rising anywhere near as fast as in recession-struck Europe: ‘Italy has been hit the hardest with Fiat Uno drivers paying 18% more this year than last for a litre of petrol’.

There is one problem that Australians can justifiably complain about. But nobody mentioned it during the Q and A TV debate that inspired today’s Daily Reckoning. Apparently, inflation doesn’t feature in the cost of living rising. Don’t tell us you believe the government’s 3.1% rate. Inflation can take place in all sorts of places outside the government’s definition. Like house prices and equity prices.

But even if we do take the government’s 3% rate of inflation, a dollar today will be worth about 23 cents in 50 years. Put differently, after 50 years of 3% inflation it would take you $4.38 to buy what a dollar does today. The chart below shows what just 1% more or less inflation than the 3% can do over time. With a 4% inflation rate, the green line, it would take 50 years for $10.50 to buy what $1 does today.

Fifty years of debasement

The problem with this is that it increases exponentially. Inflation feels slow initially, but steadily gathers steam, even if it stays at a constant rate. That’s what people find so confusing. Your cost of living may only rise at 3%, but 3% a long time ago amounted to far less in nominal terms than it does today. 3% inflation on a cup of coffee that costs $1 appears less painful than 3% inflation on a cup of coffee that costs $5. One is an increase of 3 cents, the other of 15 cents.

Taken to its logical conclusion, steady low inflation is horrifying. Here is a 150-year chart of the same data above. 2%, 3% and 4% inflation are shown. After 150 years at 3% inflation, it takes $84.25 to buy what $1 does today. At 4%, it takes almost $360.

150 years of debasement

But get this. Going by the RBA’s actual performance, which is an inflation rate of 5.8% on average over the last 40 years, it takes more than $8000 dollars to buy what $1 would 150 years before.

All this inflation creates a constant rat race environment. You have to keep running to keep up.

But nobody seems worried about inflation. On Q and A, they’re all talking about how Julia Gillard’s taxes have increased their living costs. And that’s before they’ve been introduced!

The biggest factor in Australian’s outrage over their storm in a tea cup is the perception of stability. It has been perfectly viable to live paycheque to paycheque for Australians because the world they live in is so stable. A catastrophe consists of having to end your Foxtel subscription because you didn’t get the promotion you were expecting. The fact that people can run their household budget so narrowly is quite an achievement. But what happens if the economy takes an actual hit? What if those 40 jobs a year aren’t waiting for you?

Remember, the cost of living can only be a blight on society if it is caused by the central bank’s inflation, or if it reflects people’s out of control spending. Higher prices is the economy telling you to slow down. Actually, it’s not just telling you, it’s forcing you to slow down. Unless of course, you go into debt.

And that’s the one thing Australians can justifiably grumble about, even if they got themselves into it.

Until next week,

Nickolai Hubble.
The Daily Reckoning Weekend Edition


About the author: having recently escaped from academia, Nick decided to drop his tights (the required attire of a trapeze artist) and joined Port Phillip Publishing. Instead of telling everyone about the Daily Reckoning, he now spends his time writing for the weekend edition.

ALSO THIS WEEK in The Daily Reckoning Australia

Heralding the Unsung Benefits of Frontier Markets
By Joel Bowman

Watching them acquiesce so willingly to the thugs’ demands, you almost feel betrayed, like your friends have turned into comrades and gone over to the dark side. You feel yourself giving them the evil eye. And they feel it, too, finding any excuse to avoid eye contact with you while you’re pressed up against the back of the agent’s wandering hand. Then, when the hand wanders a little further, you’re promptly, rudely, reminded who the real enemy is.

Warren Buffett Scorns Gold. Bad Move!
By Addison Wiggin

The billionaire “Bond King” is also singing gold’s praises these days. Bill Gross, the guy who founded PIMCO, the $1.3 trillion financial firm dedicated to managing bond portfolios, remarked last month, “Recent central bank behaviour, including that of the US Fed… may as well induce inflationary distortions that give a rise to commodities and gold as store of value alternatives when there is little value left in paper.”

How to Avoid Investing Idiocy by Ignoring the Fed
By Dan Denning

That is, it’s absolute idiocy to base your investing strategy on expectations for more stimulus from the Federal Reserve. That is not the best reason to buy stocks. It is not even a reason. It is a hope, or probably just a gamble. At the worst, it is a giant, unproductive distraction from thinking about the things that will really determine whether you make or lose money in the next 10 years.

Why Saudi Arabia is Trying to Talk Down Oil Prices
By Dan Denning

The Saudis don’t want oil users looking for other suppliers. They think talking down the price will prevent oil consumers from thinking about alternatives. For investors, though, now is a very good time to think about who is going to provide the world with the energy it needs over the next 50 years. Not just the developed world in Europe and North America, either. We’re talking about the WHOLE world, including China and India. The energy they require will have to come from multiple sources. That’s a clear opportunity for investors.

Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
Nick Hubble

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15 Comments

  1. Rick W says:

    I have been concerned with prospect for inflation but so far I am staying ahead of the game and cost of living is coming down.

    - My government subsidised solar panels and roof insulation have the household in credit from gas/electricity perspective.

    - My new diesel car is more luxurious, uses half the fuel and cost less to buy than the 10 year old Australian made car it replaced. Also I have reduced car usage by telecommuting with the rapid development of internet. Apart from occasional trip to Bunnings I do most of my shopping on line. Most items purchased direct from China have zero mail cost – that cost is covered in the stated price.

    - House prices are between 10 to 50% down on 2 years ago depending on where you are buying. Rents are also falling in some locations. Interest rates have dropped in the last year.

    - I noted yesterday that an Australian retailer was selling a 32″ HD LCD TV for $250. Four years ago I paid $2500 for the same thing.

    - Staples like vegetables, fruit, nuts and milk are not noticeably more expensive especially when buying in-season.

    The MIT billion prices project shows US inflation is not particularly severe:
    http://bpp.mit.edu/usa/
    Roughly 1% per year on the prices they are able to scan.

    Steve Keen has the best handle on what is happening and we are certainly in a debtdeflation phase. I expect that will get a lot worse as Spain collapses.

    Individuals in Australia need to operate more efficiently. Produce more for less. The 7bn people in the world cannot possibly consume at the level of average Australians. There is a long-term leveling process as under developed countries build their economies starting from knowledge already available in the developed economies. If they operate more efficient economies then they will do more with the limited worldwide resources like liquid hydrocarbons, land, sunlight, water and general environment.

  2. Biker says:

    Rick W: “Rents are also falling in some locations.”

    Certainly are, in locations with high unemployment and higher crime rates.

    While we agree with your comments regarding alternative energy, the need for economic efficiency and the drop in price of new technologies, the _basic_ essentials are rising rapidly. Queensland epitomises voter backlash directed at inflation in the day-to-day cost of living.
    Inflation differs quite marginally from past years.

    Steve Keen has a grip? Only on the most flaccid of economic concepts.
    Keen has been proven consistently wrong. His insistence on publicising his laughable predictions as widely as possible has made landlords wealthy.
    We could never have predicted the increase in rents in locations in which Aussies really _want_ to live. What’s his own place, the home he sold into martyrdom, worth these days? :D

  3. Rick W says:

    Steve Keen determined debtdeflation would persist for more than 10 years from the crash of 2008. Australia has only just started to experience the beginning of the slide into deflation. The process was delayed by encouraging more new home buyers into the housing ponzi scheme. The debtdeflation in Australia has a long way to go. Private debt is high by world standards. Our net national debt position is alarming considering the country has enjoyed elevated income from mining exports for the last 10 years. How is it possible that the country has a trade deficit when mining exports are at record level.

    The data on Surry Hills unit prices shows SK could have done better with timing if he had have anticipated the various government enticements. However prices are now falling and the turnaround from the peak is startling:
    http://www.domain.com.au/public/suburbprofile.aspx?mode=buy&searchterm=surry%20hills

  4. Doug says:

    I work full time for the minimum wage in a job where I interact with a lot of ordinary people. Here are my observations concerning the Aussie Battler.

    These people are drug addicts in one way or another. They spend their money on booze, smokes, junk food, coffee, etc. They are obsessed with entertainments and distractions, such as watching TV shows, playing on their fancy phones, and going out (which means getting drunk). They have the means to pay back their financial debts, even on their low incomes, but they can not let go of their chemical addictions and entertainment expenses. I buy raw produce and cook real food to eat. I drink only water. I invest part of my spare time into reading and learning. I don’t have any financial worries (far from it actually). If the Aussie Battler cut out their so-called “living expenses” they wouldn’t be battling anymore, they would be thriving.

    These people also buy whatever is cheapest. If they need a pair of shoes they buy the cheapest pair made in China, and then do it again three months later when they fall apart. They won’t buy a high quality pair of shoes made in Australia that will last them years, because they cost more. Even if something is cheaper in the long run, they “can’t afford it”.

    It’s difficult to have any sympathy for the Aussie Battler.

  5. X says:

    Inflation is entirely a monetary phenomenon. Inflation is good for those who are in debt, as the amount they owe is priced in nominal terms, not real terms and gets inflated away.

    Imagine if you were struggling with a million dollar mortgage, and inflation was running at 7% per year. In ten years, your principle owing would be 500K in real terms. Assuming wages match pace with inflation, inflation is the best thing that can possibly happen to the irresponsible and profligate. Which is exactly why we are going to get a lot MORE inflation from the current crop of central bankers, because most of the idiot population are drowning in debt.

  6. Lachlan says:

    The BRICs etc are getting out of the dollar at a firm rate now. When the USD is no longer the reserve currency and it may not be much longer you won’t see any deflation. Instead the prosperity mirage we’ve lived in will be lifted as prices rise ahead of wages. The AUD can’t stop the tide coming in forever. In the USA shadow stats reports inflation at 9% or more and people I know there agree.
    Hopefully this land being the low populated commodity rich place it is we will trade with the beneficiaries of the new normal (Asia) and continue being the lucky country…unlike some of Europe and US. Ninety percent of the worlds population lives in the northern hemisphere.
    As for Steve Keen he is obviously smart but that does not mean he did not miss some factors of fundamental importance along the way. I am not predicting real estate prices will go anywhere in particular however. They have softened of late, we can show for fact. It’s obviously a more complex argument than was broadly thought.

  7. Lachlan says:

    Good post Doug. I earn an average amount and feel like a king in the lucky country. Not that I don’t want more ;)

  8. Biker says:

    Let’s be realistic, folks. Inflation _already_ reduces mortgage debt by a quarter to a third every decade.*

    While many of us might agree with Doug’s perceptions of the Aussie ‘battler’, if he’s able to buy a house (and hold it) he’ll have a home in retirement.

    However if this doofus rents and invests his savings, he’ll rent-for-life.
    What makes us think someone as dumb as Doug portrays him will succeed investing in shares, PMs or any other asset class? :D

    * Over at MMA, Kris seems to have recently discovered this debt reduction principle, but hasn’t yet applied it to property… ! ;)

  9. Lachlan says:

    Biker I suppose looking at the US we should fear the boom and bust cycle as valid as it is and in relation to RE also but where I agree with you is that Australia does have fundamental differences. The status quo changed in the USA because the manufactured boom ran out of road. In Australia there is more road left as I see it ie more ways that authorities can kick the can. More room for stimulus, more room for immigration. Who knows what they will do. Or will they choose to drive this beast off the road anyhow. I don’t know. I am just saying you are right about us not being the US. Also the sub prime crisis was the critical point at which at which Benny and the Inkjets started their daily gig. It’s too late to clean up their mess now. This Oz RE market might just flag sideways for good while…not unlike the share market.

  10. Biker says:

    Lachlan: “This Oz RE market might just flag sideways for good while…”

    The downturn in residential construction, resulting in ever-increasing rents (primarily in desirable locations) has some compensatory outcomes, Lachlan. It’s unlikely Australia’s population will fall… and that bogeyman the bears have waved at us for years, oversupply, has been shown to be bogus.

    We’ve recently tested rental extremes and have been rewarded.

    On one hand, an increase in investors might push property prices up, but on the other, rents might actually plateau as residential construction increased… !~

    All a matter of balance, I guess!~

  11. Winston says:

    I was worried for a second, but it looks like wage growth has been between 3 and 4% (in Aus anyway) over the last 10 years, meaning the ‘debasement’ (whatever that means with fiat currency) is non-existant. Phew!

  12. X says:

    The primary problem with inflation, especially wage inflation, is that it drives up the cost of labour relative to the rest of the world. This eventually results in either decreasing profitability for businesses or trade barriers/tariffs.

    What many people (*cough* Biker *cough*) seem to forget is that there is mineral/metal commodities in other parts of the world such as Brazil and Botswana. Our current advantage of those places is our geographical proximity to Asia, and our relatively stable political system. But even that was not enough to keep Aluminium smelting in Australia when the price of energy spiked. BHP began shipping bauxite mined in Oz to Iceland where the electricity was cheap enough to cover the extra cost of the shipping.

    If Australian wages increase too much, places like Brazil and Botswana will start to look attractive for primary resources, despite their political instability.

    The second problem with inflation is that although your debt is decreasing in real terms (as it is priced in nominal terms), everything else (food, energy, toilet paper, etc) is increasing in nominal terms. Traditionally wage increases lag behind inflation. This is because inflation happens automatically as a result of the incompetence of the central bank or government (in Australia’s case, both), but wage increases need to be either legislated or fought for through industrial action.

    During this lag period, highly leveraged people can experience extreme repayment stress, and if the bulk of that leverage is tied up in property, it can cause a rush to market to (a) de-lever and (b) lock in any capital gains.

    We have seen the beginning of this process in the last 6-12 months with both a sudden spike in industrial action, particularly from those whose wages are not set by the marketplace, but through legislation or collective bargaining (i.e. highly unionised or government employees), and a spike in the arrears rate on mortgage books.

    We are going to see a lot more of both industrial action and arrears/default as ongoing inflation bites into disposable income and causes repayment stress.

    Finally, banks decrease in profitability in inflationary environments (because the cost of economic capital increases in proportion to the debasement of the currency). To maintain the lifestyle that Phil Chronican has become accustomed too, he and his fellow muppets at the head of the big four will need to either (a) fire a bunch of people or (b) increase their interest rates or (c) all of the above. This will cause a strong contraction of spending by the middle class, which will have knock on effects for the rest of the economy.

  13. shortchanged says:

    Here in the once, Apple Isle, Biker, that brown smelly stuff is hitting the fan. A drive down any street will show you that Tas. is for sale. Even my own landlord, recently asked if i would make an offer on the house. That, and BHP, Alcoa closing down and that never ending saga, Gunns, so desperate for money, they are in the process of changing their name, because Gunns and Pulp Mill, is so toxic, forgive the pun.For anyone investing in RE Tas is not the place, at least not yet, maybe in about five years time but then Taswegians are use to long sale times, something in the air, or not, maybe. Some wag recently penned that Tas. is reverting to its rightful place as the ‘welfare Isle’.

  14. Biker says:

    Depends why one is buying, SC. Quite a few retirees see Tassie as a low-cost retirement option.

    While it doesn’t appeal to us, we can understand why, at the end of a working life, some might choose that option… .

  15. Jason says:

    Australians can be pram-shaking whingers at times. Why the hell should anyone be sorry for these suckers who run out and borrow beyond their means. I get so sick of seeing these middle-class whingers in the Daily Tabloids whining about ‘how tough it is’ to pay off the $800.000 McMansion and the $70,000 4×4 drive. Bugger them, If you can’t afford it…you don’t have it. Yet our corrupt government still allows tax dodging socialist walfare handouts such as negative gearing and ten thousand other monetary payments to help Mr and Mrs Middle Class live like kings on a debt binge.

    As for the inflation rate, it is way above the 3.1% fairy tale quoted by the useless Reserve Bank. How will Australians cope when the Second Great Depression hits? More likely with more pram-shaking complaints in the ‘letters to the editor’ of the Daily Tabloid, until the job losses come, then they will react as every other nation struck down will react. WAR.

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