Consider a House To Hedge Against Inflation

The housing market, having walloped the bejesus out of tens of millions of Americans, may seem an unlikely hedge against inflation.  But history shows that home prices tend to move up briskly during inflationary times.  During the 1940s, inflation burst out, driven first by World War II rationing and then by pent up consumer demand after the war.  Consumer prices moved up about 72%.  Census Bureau data indicates that housing prices moved from a national average of $2,938 in 1940 to $7,354 in 1950 (unadjusted for inflation).  That's an increase of 150%.

During the stagflation of the 1970s, consumer prices rose 112%.  Housing prices rose from a national average of $17,000 in 1970 to $47,200 in 1980, an increase of 178% (unadjusted for inflation).  You can find Census Bureau data on housing at https://www.census.gov/hhes/www/housing/census/historic/values.html.

The data show that housing prices rose faster than inflation during two of the most inflationary decades in the past 75 years.  Of course, the sales prices of houses don't tell the entire story.  You can't directly compare prices of housing against prices of stocks or inflation-adjusted bonds like U.S. Treasury TIPS, because housing requires periodic lawn mowings, plumbing repairs, new roofs, maintenance of HVAC systems, and replacement of dishwashers.  It's also taxed locally every year, and sometimes hit up for special assessments if the water or sewer systems need to be gussied up.  But you'd directly or indirectly bear those expenses anyway if you rented.  So owning a house and capturing the upticks in value might work out well for you during inflationary flareups. 

Why would housing be such a good inflation hedge?  Professional economists might be tempted to wheel out a wagon load of regression analyses to demonstrate their erudition.  But the simple and obvious explanation is that a hard asset with substantial utility will have significant value no matter what the paper currency is doing.  A house provides shelter, warmth, indoor plumbing, and a private place to pig out on high fat, high sugar, low nutritional value junk foods while long-term parked in front of a 124-inch TV, parboiling your brain without the neighbors seeing what a couch burrito you really are.  Market forces will adjust the paper value of that hard asset upward when the fiat currency is going haywire.

At the moment, inflation seems to be spotted about as often as the ivory-billed woodpecker.  But that doesn't mean it's extinct.  History shows that inflation can be quiescent for long periods of time, and then burst forth like an oil well blowout.  Inflationary pressures right now are doing a fan dance, often out of sight but still faintly visible in profile.  Ultimately, unless the Fed and other central banks can repeal market forces, their massive money prints and asset purchases of recent years will eventually inflate paper currencies.

 Housing, like politics, is first and foremost local.  Some markets would make mediocre investments no matter what (like areas with high unemployment).  Some types of housing, like condos, may not be ideal for inflation hedging.  Their values tend to be less stable than that of the 4-bedroom, 2 1/2 bath Colonial with the white picket fence and English sheep dog.  A house isn't a substitute for sensible investment diversification.  Stocks, TIPS and perhaps other assets might also play a role as reasonable inflation hedges in a well-diversified portfolio. 

It's hard to have confidence in housing after the free fall in prices of recent years.  But investment success can often come from buying disfavored assets.  Buying bubbly assets like bonds (especially junk bonds) isn't likely to be the epitome of financial perspicacity.  Home sweet home, be it ever so humble, may work out better if inflation rears its ugly head.

The Fiscal Cliff Negotiations: Just Who Is Barack Obama?

Recent negotiations over the fiscal cliff, which seem to be faltering after initial signs of progress, raise a persistent question about Barack Obama:  has he any political principles?  After campaigning this fall to protect the poor and middle class, he agreed in fiscal cliff negotiations to changes to the income tax structure and Social Security that are more damaging to the poor and middle class than the prosperous segments of American society.  By accepting Republican demands for the Social Security inflation adjustment to be the Chained Consumer Price Index, Obama has effectively reduced inflation protection for Social Security recipients, military retirees and federal civilian retirees, the vast majority of whom are low or middle income.  At the same time, because the same inflation adjustment would be made to income tax brackets, the brackets would rise more slowly during inflationary times.  That would effectively result in heavier taxation across the board, a seemingly regressive result.  Additionally, Obama agreed to raise the threshold for higher tax brackets from his original position of $250,000 to $400,000.  To be cynical, this might be viewed as a gift to the upper middle class professionals who often are his supporters and contributors.  And to be more cynical, it can be observed that many lower income folks, especially older whites heavily reliant on Social Security and/or military pensions, tend to be Republican more often than Democrat.  Perhaps the President sees little to lose in imposing austerity on them.

One wonders if Obama, after four years of dealing with the Great Recession, understands even the basic structure of the U.S. economy.  Our economy is 70% consumption.  Money in the hands of the poor and middle class gets spent.  They don't have enough to save hardly a penny.  This spending stimulates the economy.  Money in the hands of the upper middle and upper classes is frequently saved, allowing the rich to get richer relative to other income categories.  By raising taxes on the poor and middle class while cutting benefits to Social Security recipients, and military and federal civilian retirees, the President is reducing consumption and its stimulative impact on the economy, while exacerbating the inequality in wealth distribution.  What policy sense does this make?

During his first term, Obama demonstrated time and time again at critical junctures that he is a clever politician and dealmaker much more than a leader.  He craftily co-opted his most serious Democratic rival, Hillary Clinton, by making her secretary of state.  And he kept the liberal wing of the Democratic Party at bay by putting one of their number, Joe Biden, in the Vice President's residence.  But he has few loyal constituencies.  His one signal achievement, the Affordable Care Act, may transform life in America.  But transformational legislation doesn't necessarily bestow greatness on a President.  Lyndon Johnson's Great Society programs transformed America far more than anything Barack Obama has done or will do.  Indeed, the Voting Rights Act of 1965 enfranchised black and other disadvantaged Americans, paving the way for Obama to win the White House.  But Johnson has been denied the mantel of greatness.  While this is due in large part to his foreign policy catastrophe in Vietnam, it's also because Johnson, like Obama, was a consummate politician without any large loyal constituencies.  There's no one running around singing Johnson's praises.  Obama will always be remembered as the first nonwhite President, and there's a measure of greatness in that.  But John Kennedy was America's first non-Protestant President, and in 1960 that was an achievement not far from Obama's achievement in 2008.  Kennedy is remembered today for his charisma and charm.  But he doesn't rank among the great Presidents.  And, because Obama seems to value a deal more than principles or loyalty to constituents, neither will he. 

Inflation Protection

The Federal Reserve just told us that inflation isn't a worry. But let's remember that this is the agency that solemnly told us the mortgage crisis was manageable, even though one of its own members warned of problems. The Fed also didn't see the credit crunch coming, even though it's the top bank regulator. Then the Fed had to wing it with massive amounts of printed money in order to prevent the financial system from collapsing. Perhaps, in spite of official reassurances, one might wonder if those truckloads of printed money will have an unexpected inflationary effect. If you want a little inflation protection just in case, here are a few suggestions.

U.S. Treasury TIPS. TIPS are inflation adjusted U.S. Treasury bonds. They pay interest and also provide an inflation adjustment. You're taxed on the inflation adjustment as well as the interest, so your true inflation protection is reduced by taxes. And you have to pay taxes on the inflation adjustment on an ongoing basis even though you don't actually receive the amount of the adjustment until the bond matures (which could be years in the future). So you may have a cash flow issue. Nevertheless, there's no credit risk and that means something in these days when credit is still crunched.

U.S. I Savings Bonds. You can buy I Savings Bonds, which are inflation adjust savings bonds. Unlike TIPS, you don't have to pay any income tax on I Savings Bonds until the bond is redeemed or matures. Unfortunately, you can't buy more than $5,000 of I Savings Bonds a year. If you want to invest more in a U.S. Treasury obligation, you'd have to buy TIPS.

Inflation Adjusted Annuity. Some insurance companies offer annuities that provide for increased payments to compensate for insurance. These annuities aren't cheap--they often start paying at levels significantly lower than the amount of a fixed annuity you could buy for the same amount of capital. But there's a certain level of comfort in knowing that you'll get an increased monthly payment if inflation flares. Remember that annuities are subject to the creditworthiness of the insurance company. Also read the fine print for any limitations on the extent of the inflation protection. For more, see http://blogger.uncleleosden.com/2007/06/annuities.html.

Social Security Benefits. Social Security is actually a government sponsored annuity that adjusts for inflation. Although you can't get retirement benefits before age 62, Social Security is one of the best "investments" Americans can make. Do your best to maximize your benefits by working as long as possible. See http://blogger.uncleleosden.com/2007/05/mysteries-of-social-security-retirement_02.html.

Some Pensions. Some pensions adjust for inflation, at least to a limited degree. If you have pension rights, make sure you understand how your pension works and build up your credits to maximize benefits. See http://blogger.uncleleosden.com/2007/05/how-to-retire-without-saving.html.

Stocks? Over long periods of time, stocks keep pace with inflation and even sometimes exceed inflation. But we're talking 25, 30 or more years. During the inflationary 1970s, stock investors lost their shirts to the depreciating dollar. If you bought stocks in the early 1970s, you didn't recover your losses on an inflation adjusted basis until the early 1990s (not a typo, not kidding). If you're 25 and saving for a retirement 40 years from now, stocks are a good idea for much of your portfolio. But if you're 70, don't view stocks as inflation protection. It might be worthwhile to have a modest portion of your money invested in stocks, just to catch any market upswings. But for inflation protection over the next 10 or 15 years, think about TIPS and I Savings Bonds, or maybe an inflation adjusted annuity from a very highly rated insurance company.

None of the above offer complete protection against inflation. But they're worth keeping in mind if you're not entirely sure you can rely on official assurances that all is quiet on the inflation front. Think about diversifying your inflation protection. Put some money in I Savings Bonds and TIPS, and possibly in an annuity or stocks. And keep working as long as possible.