Arnold Kling  

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The Problem With Economic Sanc... Menzie Chinn's Course on the C...

A commenter points to an essay by Rob Arnott.

The lion's share of the debt reduction may well be accomplished through reflation. We can eliminate half of our debt in 15 years if our inflation runs 5% higher than our trading partners, and if our real GDP growth keeps pace despite the inflation. Thus, if our partners are running at 3%, then an 8% annual inflation rate would do the trick. To keep debt service costs, we need to persuade our creditors that we're serious about a strong dollar, even as we work to weaken the dollar...This is not a smooth and comfortable road, but it is the only politically expedient path.

I think it is important to note that anticipated inflation and unanticipated inflation have different effects. Unanticipated inflation reduces the real value of debt quite powerfully. Inflation that was anticipated, and thereby priced into interest rates, not so much.

Later, he says this:

the developed world has huge debt and demographic problems. But many emerging markets are the opposite with younger populations and foreign reserves instead of debt. A case can be made to invest significantly more assets in the emerging markets as their comparative advantage becomes increasingly self evident...After an immense rally in emerging markets stocks and bonds in 2009, this is not a "buy now" recommendation. But...slowly shift from a developed markets portfolio to one more representative of the size and growth of emerging market economies today and tomorrow.

A friend recently reminded me that a classic inflation hedge is real estate. It is difficult to invest in emerging market real estate in an informed way. But in principle, that may be the best way to hedge against our future as a Banana Republic.

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COMMENTS (6 to date)
Thomas Sewell writes:

That's why if you aren't totally convinced about the utility of buying gold as an inflation hedge, or you want further diversification, purchasing US real estate right now is a pretty good deal in those markets that have bottomed out.

There are places in the US that will all the foreclosure sales are now below their lowest ever average selling price (adjusted for inflation), but with larger, nicer, modern homes built in the last 10 years. Raw real estate is even cheaper some places, because developers aren't buying. If you have cash you want to turn into title to real property, it's literally dirt cheap right now.

Sure, there is still some risk of real estate taking another hit because of recent government buyer credit extensions expiring in the future, but even pricing that in you should be able to find a really hard hit market that will act as a good hedge against inflation, especially if you have cash that you need to turn into an inflation resistant asset.

Anyway, that's why I currently own a bunch of raw land, plus some water rights, plus two homes. It's a buyer's market, so buy low! :)

Jim Glass writes:

We can eliminate half of our debt in 15 years if our inflation runs 5% higher than our trading partners

But for the Nth time, it is not our current debt owed to the public that is our problem -- in fact, that is barely a problem at all.

The killer is the implicit debt for Medicare, Social Security, Medicaid, and federal/military unfunded pensions and benefits -- which are all literally or effectively inflation indexed -- and which discounted to present value in total now top $100 trillion.

Also, there is no way that 15 years of inflation will be 15 years of unanticipated inflation -- which mean this won't work even for the existing debt.

Bonus: Remember how much of the existing debt held by the public is short term and has to be rolled over as long as we keep running deficits (say: "forever"). Once we are seen to be inflating as policy an "inflation premium" goes into the interest rate, so the real rate increases on that rolled-over debt, making things worse for that debt, more costly, not less.

So considered two different ways that's zero-for-three. Fuhgetaboutit.

Huxley writes:

IRSA (symbol IRS) owns lots of real estate in Buenos Aires.

Mike Rulle writes:

Arnott's implied prescriptions really are frightening. He is like a Doctor in a Solzhenitsyn Cancer Ward giving instructions on how best to relieve the suffering of dying patients. The demographically suicidal "West", of course, is the dying patient. What happens when the "emerging economies" become successful and self suicidal as well?

There have to be better outlooks and prescriptions than this. It is a deterministic interpretation of history leading to the end of the world. Arnott just has not yet written the final chapter.

Boonton writes:

We can eliminate half of our debt in 15 years if our inflation runs 5% higher than our trading partners

Why is it particularly important to make such a dramatic drawdown in our debt?

Jim Ancona writes:

My 25 year old son was asking if he should start a Roth IRA. I advised him to take into account the possibility that the government will tax the proceeds again at retirement, even though the principal has already been taxed and the interest is supposed to accumulate tax-free. Changing rules--another peril of living in a Banana Republic.

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