"There is probably no better way to rebuild household wealth... than to sustain moderate rates of inflation"

Inflation, Warren Buffet, and You

Warren Buffet is a very shrew investor. His oped in the New York Times today warning of the evils of inflation was likely one of his best. Mr. Buffet tells readers that we must quickly get the budget deficit down or risk becoming a "banana-republic economy."

To help make his case on inflation, Buffet quotes Keynes, the great guru of all depression fighters everywhere: "governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens." The problem with this quote, as Keynes well-knew and often talked about, is that not all citizens stand to lose wealth from inflation.

Most citizens in fact stand to gain wealth from inflation. Most citizens are debtors, primarily as a result of a home mortgage, but also due to student loans or other forms of debt. These citizens will stand to gain from moderate rates of inflation. For example, if the inflation rate is 3 percent annually over the next five years, then someone who owns a $300k home can expect the price to rise by roughly 15 percent to $345k (this ignores compounding, which would make the increase somewhat higher). If the person has a mortgage of $270k, then their equity will have more than doubled from $30k to $75k, even before counting any payoff of principle.

By contrast, if the economy has zero inflation over the next five years, then this home will still be worth $300k in five years, giving this homeowner no additional equity. In fact, there is probably no better way to rebuild household wealth and restore balance to the economy than to sustain moderate rates of inflation (3%-4% annually), just as the country did through most of the post-World War II period of rapid growth. By rebuilding wealth, consumers would be able to consume more and businesses would be able to invest more.

It's fine that Mr. Buffet differs with this view, but it might have been worth noting that he is someone who does stand to lose "an important part" of his wealth through inflation. Mr. Buffet is heavily invested in the financial sector, owning large amounts of insurance companies and major banks, such as Goldman Sachs and Wells Fargo. The financial sector will be hurt by inflation because the mortgages and other loans that it has issued will be worth less money.

In other words, Mr. Buffet has a direct personal interest in preventing inflation, just as the CEO of a health insurance company has a direct personal interest in preventing a robust public insurance option. Most people would recognize the latter, unfortunately they may not recognize the former.

Remember, Warren Buffet is a very shrewd investor.

Posted via web from Jim Nichols