The Inflation Podcast

Will increased rates cause housing prices to fall? Three examples.

Thanks for listening! If you have thoughts on the episode and want to leave a message to be played on the next show, leave a message on Speakpipe, here: https://www.speakpipe.com/widget/inline/pea4g5z4z98p69vucu5o7l822aoq989s Example 1: Imagine a person making $50,000/year. Divide that by 12 and they earn $4,333/month. Back in July 2000, 22 years ago, the House Price to Income ratio was 4.5, so if you made $50,000 then a house would cost roughly $225,000. Average mortgage interest rates were 8.2%. Assuming you put down 20%, let’s run the numbers for a 30-year fixed rate mortgage. At an 8.2% interest rate, the monthly payment (principal and interest) is $1346. Assuming 1% annual taxes (so $2,250 per year, or $187 per month) and $750 per year for insurance, we are at $1597 for a monthly all-in. Is that affordable? Let’s look at what mortgage brokers use to qualify lenders: monthly housing expenses divided by gross (pretax) income. 1597 / 4333 = 36.8%. This is workable — lenders like to see this so-called “Debt-to-income” ratio as low as possible, but anything under 43% is allowed. If the person has any other debt to consider (student loans, car payment, credit card debt, other mortgages) that also has to be factored in.  Example 2: Okay, so let’s zoom forward to November 2021 and run the same calculation. Interest rates on 30-year fixed rate mortgages are around 3.1%. Houses have increased in value, both in absolute terms and, more importantly for this calculation, compared to incomes. The Home Price to Income Ratio went up from 4.5 to 7.5, so at the same income of $50,000 the house is now $375,000 but we have the lower rate — so let’s see how it plays out. One note — we now need $75,000 to put down rather than $45,000 before, but let’s assume we find that $30,000 somewhere. Okay: Hooray, the loan is only $1,281 (principle and interest) so actually cheaper than the other one. I kept the insurance the same, $750/year, and kept the property tax at 1% of value, so $3,750 per year or $312.50 per month. All-in we are at $1,657, so $60 higher than the first example with the lower house price and a higher interest rate. Great! All’s well in the world. Now our debt/income ratio is 38.2% instead of 36.8%, but we can still get a mortgage and get on with our lives.  Example 3: And how does it look now, 8 months later, with rates at 5.73% (today’s average rate) and Home Price to Income Ratio at 8?  Our house now costs $400,000 and we need another $5,000 to put down (80K total), and just the loan costs $1,863. With taxes and insurance, our all-in is now above $2,000, at $2,259. This represents a 52.1% debt/income ratio, and it’s going to be nearly impossible to get a loan at this amount. Remember, this is pretax, and lenders want you to have some room in your budget for non-housing expenses, like, you know, food.  Links:  https://www.weforum.org/agenda/2019/04/50-years-of-us-wages-in-one-chart (mentioned)  https://www.numbeo.com/property-investment/rankings_by_country.jsp?title=2022-mid&displayColumn=0 https://www.longtermtrends.net/home-price-median-annual-income-ratio/ https://fred.stlouisfed.org/series/MORTGAGE30US https://www.cnbc.com/2022/06/30/housing-shortage-starts-easing-as-listings-surge-in-june.html

July Inflation Update: 9.1%

Yesterday the Bureau of Labor Statistics issued the June CPI numbers. We are now running at an annual inflation rate of 9.1%, up from 8.6% last month. This is the largest 12-month increase since November 1981. The BLS defined the increase as broad-based, with energy, shelter and food being the biggest contributors. Energy The energy index rose 7.5% overall after rising 3.9% in May. gasoline 11.2%, natural gas at 8.2%. Electricity index also rose 1.7%. The energy index overall rose 41.6% for the year, with gas rising Shelter The shelter index increased 0.6% in June, as it did in May. Rent index rose 0.8%, and owner’s equivalent rent rose 0.7%. Lodging away from home (hotels and such) actually fell 2.8% in June after a string of increases in recent months. Food The food index rose 1% in June, the sixth consecutive increase of at least 1% in that index. Food away from home rose 0.9%. The only major grocery group to decline in June was the index for meats, poultry, fish and eggs which fell 0.4%. Overall, food at home rose 12.2% over the last 12 months. CPI To review, the bulk of the CPI is made up of Shelter (32%), Commodities (21.2%) like apparel, new/used vehicles, alcohol, tobacco, Food (13.4%), Energy (8.6%), Medical Services (6.8%) and transportation services (5.8%) My main take away is that the longer this elevated inflation continues, the longer it will continue. Anyone not asking for a significant, 8-10% raise from their employer at this point is effectively getting a pay cut. Eventually people are going to take their financial lives in their own hands, and when they do, I think it’s going to lead to a wage-price spiral where people get raises, but everything becomes more expensive because everyone is getting raises just to keep up. The Fed now knows it needs to act, and it needs to act quick. So what are the likely results from this higher-than-expected inflation print? It will likely lead the Fed to a 75-100 basis point (fancy way for saying .75% or 1%) federal funds rate hike in at the July FOMC (Federal Open Market Committee) meeting. This is pretty significant — the current federal funds rate is 1.5%-1.75% (it’s set as a range between an upper limit and a lower limit) so with an increase of 75-100 basis points it would go up to 2.25-2.5% or 2.5-2.75 depending on how aggressive they choose to be.  The popular viewpoint at the moment is that the fed will continue tightening until they “break something,” and then they will ease up. A bit of historical context here might be helpful. For the last 20 years we have had both historically low interest rates and quite low inflation. Post financial crisis in 2008 they had many years of 0% rates (which was a first at the time), until 2015. When they tried to raise rates up to 2.5% in the period of time from 2015 to 2019, the hiking cycle was cut short when the economy was showing signs of stress. The Fed has what they call a “dual mandate” which is 1. Stable Prices and 2. Full employment. They really shouldn’t be concerned about asset prices (real estate, the stock market, etc.) but they have started to be more and more influenced by the markets. In the covid period, The Fed responded by moving rates back down to zero, by resuming Quantitative Easing, by sending out stimulus checks and increasing the amount of unemployment, pausing student loan payments, and that sort of thing. Links: BLS.gov news release https://www.bls.gov/news.release/pdf/cpi.pdf Reuters https://www.reuters.com/business/past-fed-hiking-cycles-sanguine-severe-may-say-little-about-this-one-2022-03-17/ Brookings: https://www.brookings.edu/research/fed-response-to-covid19/

Greedflation, Empanadas, and Tyson Foods

You may have have heard the term Greedflation floating around lately. What is “Greedflation,” where did it come from, and are there merits to the idea? In this episode we will be looking at a NY times article by Linda DePillis called “Is Greedflation Rewriting Economics, or do Old Rules Still Apply?” A link to the article is in the show notes.  From the article: Since prices started to escalate a year ago, politicians and economists have seized on inflation to tell their preferred story about what went wrong, and what policies would bring it back into line. Some say it’s very straightforward: Supply and demand, Economics 101. The White House and progressive organizations, however, say wait a minute: This time is different. In a time of extraordinary disruption, they contend, increasingly dominant corporations are taking the opportunity to jack up prices more than they otherwise could, which is squeezing consumers and supercharging inflation. Or “greedflation,” as the hypothesis has come to be known. Robert Reich, former secretary of labor and Berkeley professor, just tweeted (and got 10K retweets): “Let’s be clear: inflation is being driven in large part by monopolies that are driving up prices for the sake of profit.   On the other side, we have Lyn Alden, a prominent macro commentator and investment strategist with a finance and engineering background: For people saying that “corporate greed” is the main cause of inflation… corporations are always greedy. They didn’t randomly get more greedy in 2022. A lot of broad currency was created in a short period of time while real supplies (commodities, infrastructure) were limited. You can probably guess which side of the argument I land on. In my opinion, Whenever prices go up, there is always one or two unhappy people who say “we need to do something about “”Price Gouging”” with serious looks on their faces. But they never get very far with this argument, because the market sets prices and any effort to have the government set prices has always led to inefficiencies and shortages. When no one supports your policy or idea, it’s time to move on. And if you don’t want to move on, it’s time to change the name. I think that's what we're seeing here with Greedflation. But we have to give this argument a full chance, so I’ll read a portion of this article and analyze it.  Links: 1.  Is "Greedflation" rewriting economics, or do the old rules still apply? https://www.nytimes.com/2022/06/03/business/economy/price-gouging-inflation.html?searchResultPosition=1  by Lydia DePillis, @lydiadepillis 2. https://twitter.com/RBReich/status/1538283894901862400?s=20&t=n_mCEoOPv-4bjzLDVv0XJQ @RBReich 3. https://twitter.com/LynAldenContact/status/1533210428238614529?s=20&t=n_mCEoOPv-4bjzLDVv0XJQ @LynAldenContact 4. Tyson Foods earnings call:  https://www.fool.com/earnings/call-transcripts/2022/02/07/tyson-foods-tsn-q1-2022-earnings-call-transcript/ 5. "Corporate Profiteering" PDF with transcripts of earnings calls:  https://groundworkcollaborative.org/wp-content/uploads/2022/06/RESEARCH-Corporate-Profiteering-Findings-22.06.08.pdf Other Mentions: Michael Faulkender John Zhang Donnie King Brett Briggs Samim Bassul

Zombie Companies with Nicolás Águila

Today Nicolás Águila will be joining us from Germany. Nicolas is a doctoral researcher in Economics (@nicolasaaguila) at the Unizersitat Witten in Germany. He co-authored a paper with Juan M. Grana in the International Review of Applied Economics called “Not All Zombies are Created Equal." https://www.tandfonline.com/doi/full/10.1080/02692171.2022.2045911 He also co-authored a more conversational article in Jacobin discussing Zombie companies which I will link to. It’s called “The Rise of Zombie Firms Risks Another Disastrous Crisis”. https://jacobin.com/2022/05/zombie-firms-neoliberalism-debt-productivity-crisis What are Zombie companies? Firms that can’t make enough profits to even cover the debt payment on their interest. The phenomenon started in the mid 1960s and then skyrocketed in the beginning of the 1980s. There are two types of Zombie companies, making up around 40% of firms in the United States. 1. Negative profitability even before the payment of interest 2. Negative profitability only after payment of interest. The share of Zombies, on the whole, is increasing in the economy and may be a reason for stagnation. How do they manage to survive? They manage to get more debt to pay back their existing debt, or to sell off some of their equity. Why are firms investing in these unproductive businesses? Some zombies are startups that we wouldn’t expect to be profitable (Uber, for example) — but as a startup gets older it should start to show some profitability. Some won’t (Theranos, WeWork) but some will. Others are retailers like Macy’s that investors think may become profitable one the future. Some, like Boing, have a great history. Another reason is because of the financial context of the past decade with lots of credit, liquidity and low interest rates. This can prop up some sketchy firms. Will this crisis be as big as the Great Financial Crisis of 2007/2008? Nicolás is worried this is a much bigger problem than most people think, and that the results could be way bigger than the recession in 2007/2008. He thinks we need to be very careful about how we plan for the potential tsunami of bankruptcies to come. He recommends a government jobs guarantee as a buffer against the unemployment crisis to come. He hopes for eventual transitioning of these employees to the private sector, once the private sector begins to heal. Could the U.S. itself be considered a Zombie Company? No — the US’s debts are always denominated in dollars so it can always issue more of its own currency to pay its debt —so it always has an escape hatch. The crises in other parts of the world (Global South, for example) will probably lead to a flocking to the dollar, also, which will make it easier than ever to sell their bonds. They can just inflate the debt away, which Ray Dalio and Lyn Alden have mentioned recently. He also said that the flight to safety from countries in the global south will likely lead to What does Nicolas think about Bitcoin adoption? El Salvador has suffered a lot with the collapse of crypto, and this should give a clear warning sign to other countries. Central bank digital currencies may have a future, but he’s not an expert and didn’t want to speak too much on it.

Sri Lanka's Economic Crisis: Inflation >40%

The Crisis Sri Lanka has recently fell into default for the first time in history (since it’s independence in 1948) as the government is struggling to halt a full-scale economic meltdown. 22 Million people live in the Southeast Asian island nation officially known as the Democratic Socialist Republic of Sri Lanka. The government recently missed a $78 million interest payment, even after the 30-day grace period. There is a $105 million payment to China that is also late and its grace period is approaching. They currently owe $25 billion to foreign creditors but cannot pay them. $7 billion is payable this year, and the rest, with interest, is due by 2026 under current terms. They have recently announced that they are halting scheduled debt payments on a whole pile of foreign liabilities to preserve cash for essential goods like food and fuel. They currently have 5 days worth of fuel, and are waiting on a $500 million credit line for fuel from India. India has been a key supporter during this crisis, having poured in about $3B in assistance. The United Nations plans on pledging $48 million, which is will last Sri Lanka roughly 2 weeks according to their own estimates. Announcing you’re not going to pay your debts usually doesn’t do wonders for your credit rating, or your cost of borrowing money. A year ago, Sri Lankan 10-year bonds were yielding 8.5%. Today they are at 21.3%. It’s getting harder and harder to borrow money for Sri Lanka, but they have few other options as they have spent through their reserves. At the end of 2019 they had $7.6B in reserves , declining to $5.7B by the end of 2020, $3.1B by the end of 2021 and $0.05B now, or $50 Million. Besides India, Sri Lanka’s best option is the IMF. As of last week, Sri Lanka’s government is seeking $6 billion to keep the country afloat for the next six months. This was increased from the $5 billion the finance minister Mr. Wickremsinghe told parliament that he would be asking the IMF for: $3.3 billion for fuel imports $900 million for food $600 million for Fertilizer $250 million for cooking gas.  Inflation Sri Lanka has recently experienced high inflation (33.8% officially for April), which is only increasing, —39.1% for May, and likely over 40% currently. Food prices in Colombo, it’s largest city, have raised by 57.4% in May. The government has also increased their Value Added Tax (VAT) by 50%, from 8% to 12%. Their corporate taxes are also increasing from 24% to 30%. The Rajapaksa Family The Rajapaksa family has been a powerhouse in Sri Lanka for decades and they are being blamed for many of the policies that have led to this crisis. Mahinda Rajapaksa, the former Prime Minister, resigned last month, and his brother Basil just resigned yesterday. A state-run power entity, the Ceylon (salon) Electricity Board (CEB) has been planning a strike soon that, if enacted, will create blackouts. They recently agreed with the president to temporarily call off the strike, but meanwhile the capitol has still been experiencing rolling blackouts. How did it get this bad? 1. Fertilizer Ban 2. 2019 Terrorism and Covid reducing tourism 3. Poorly timed tax cuts 4. Unnecessary infrastructure projects 5. General corruption and mismanagement Sources: https://www.reuters.com/markets/commodities/fertiliser-ban-decimates-sri-lankan-crops-government-popularity-ebbs-2022-03-03/ https://www.business-standard.com/article/opinion/is-sri-lanka-the-next-argentina-122040401320_1.html https://www.nytimes.com/2018/06/25/world/asia/china-sri-lanka-port.html