How Long Does It Take Prices to Double?

Jeremy Horpedahl2 Comments

Let me start by saying high rates of inflation, especially unexpected inflation, are bad. Still, it is useful to have some historical context. We’ve experienced the highest inflation rates in a generation lately, especially in 2022, but past generations experienced inflation too. How to compare?

Here’s one approach. Using the latest CPI-U data, we can see that prices on average approximately doubled between March 1996 and February 2024. That’s 335 months to double, or just shy of 28 years. How long did it take prices to double if we keep moving backward in time from March 1996?

It only took 194 months for prices to double from January 1980 until March 1996, just a little over 16 years. Prior to January 1980, prices doubled even quicker, this time taking less than 10 years! Prior to that, it took 24 years for prices to double between WW2 and 1970, and before that you have to go back 31 years to 1915 for another doubling. Judged by this, our recent history doesn’t look so bad.

That doesn’t mean everything is OK. As I said above, unexpected inflation is the worst kind, since individuals and businesses aren’t planning for it. And we’ve had 20% inflation in the past 4 years — something not seen since 1991 over a 4-year time period. A 20%+ inflation rate is unusual to us today, but it certainly wasn’t in the past: basically all of the 1970s and 1980s had 20%+ inflation every 4 years, sometimes more than 40% or even 50%.

Finally, while unexpected inflation is bad, we also care about the relationship between wage increases and price increases. We can rightfully bemoan rapid, unexpected price inflation, but if wages are increasing faster than inflation, we are still better off (on average). The BLS average hourly wage series for production and non-supervisory workers only goes back to 1964, so we can’t do a full comparison with the CPI-U, but we can compare the three most recent doublings of prices.

Keep in mind with the chart above that prices (as measured by the CPI-U) increased by 100% for each of these time periods. So, for the 1970s and 1980-1996 periods, wages actually rose by less than rate of inflation — wage stagnation! If we used the PCE price index instead, those time periods still don’t look good: PCE prices increased by 88% for 1970-1980, 85% from 1980-1996, and 78% since 1996. With either price index, the 1996-2024 period is clearly the best of these three, and it’s not even really close.

Let me finish where I started: the recent inflation is bad. I don’t want to downplay that. But some historical perspective is also useful.

See also a similar post and calculation on inflation doubling that I wrote in June 2022, which includes some discussion of 19th century inflation too.

Business Development Companies: My Favorite Class of High Yield Investments

Scott Buchanan1 Comment

It is easy to find securities which pay over 10% yield. It is not so easy to find securities which pay over 10% yield AND which maintain their share price over time. Many funds, especially closed-end funds, follow the “melting ice cube model” – they pay high current yields by slowly liquidating the fund assets, since the generous distributions are not matched by actual money-making by the fund’s investments. Oh, and the fund managers charge a nice fee for slowly giving you back your money. The result is that over longish time periods (e.g. five years) the stock price and the dividends decline.

I have been burned numerous times by such “high yield traps” in my longtime exploration of high yielding securities. A glorious exception has been business development companies (BDCs). These companies operate much like banks, lending out money and collecting interest on those loans. They lend to smaller, shakier enterprises that cannot get loans from banks. BDCs get to charge these (desperate?) clients very high interest rates, often around 6-7% over SOFR, which is the replacement for the old LIBOR benchmark, and which is very close to the current Fed funds rate. So back when regular short-term rates were near zero, BDCs were charging around 6%, and now (with Fed funds at 5.3%) they lend out money at around 11%. BDC’s leverage up by about 1:1 by issuing bonds, which boosts net income; this cash inflow is offset by really big management fees. The net result for us equity shareholders is that BDCs are paying out around 10-12% per year in dividends. That varies, of course, from one BDC to the next.

(If you just look at the usual “Forward Yield” value in your brokerage account or Yahoo Finance, it might only show like 9% or so. The reason is that BDCs, in good times like now, often pay out significant “special” dividends, which supplement the regular dividends; but only the regular dividends show up in the standard yield reporting).

One of the largest and oldest BDCs is Ares Capital Corporation, ARCC. If you just look at share price, ARCC does not look too inspiring. In the past five years, its price is up only about 9%, which is way less that the S&P 500 standard fund SPY. (But at least it is not down, like the generic bond fund AGG).

But when you look at total returns, which includes reinvested dividends, ARCC actually beats out SPY (85.7 % vs. 83.9% total returns), which is a noteworthy feat. Another large BDC, HTGC (green line in the plot below) did even better, with roughly 1.8 times the yield of SPY:

The current yield of ARCC 9.3%. This is on the low side for BDCs; ARCC is regarded as very secure, and so its price gets bid up. The yield of HTGC is 10.6%, while relative newcomer TRIN is paying 14%.

Lending to small, sometimes starting-up companies sounds risky, but the risk is mitigated by being at the tip top of the company’s capital stack. The loans are typically secured first-lien, which means in event of bankruptcy, they would get paid off before anything else. If the client company goes totally belly-up, the recovery on these loans is historically about 80%. In practice, a good BDC will often work with the client to come to some arrangement where the recovery is close to 100%. (For unsecured bonds, recoveries in bankruptcy are about 40%, while preferred stockholders get a few crumbs like shares in the reorganized post-bankruptcy enterprise, and common shareholders get zip). If you invest in a small cap stock fund like the Russell 2000, you are owning common stock in some of the companies that BDCs lend to. As such, you are actually in a much riskier position than owning shares in a BDC. Just saying.

Sound interesting? My short list of BDC favorites includes ARCC, HTGC, TRIN, TSLX, and BXSL. For one-stop shopping there are funds which hold a basket of BDCs. BIZD is the venerable big gorilla in this category. It blindly holds the largest BDCs by market cap. A newer, much smaller ETF is PBDC, which uses active, hopefully smart management. Since inception about 18 months ago, PBDC has beat out BIZD by about 12% in total returns, which more than compensates for its higher management fees (0.75% for PBDC versus 0.4% for BIZD).

Disclaimer: As usual, nothing here represents advice to buy or sell any security.

How to Train Your Artificial Economist

mdmakowsky2 Comments

Apparently Claude 3 Opus AI/LLM is a pretty decent economist:

As much as I appreciate the prospect of an AI economist, allow me to ask the most annoying and, in turn, most important, question an economist can ask of any proposition: “Compared to what?”

It seems to me any consideration of the quality of economic analysis produced by an AI/LLM model demands a series of comparison points. We need bad economic analysis. We need AIs that generate mediocre, decent, atrocious, acceptable, and perhaps if possible, brilliant economic analysis for comparison. Which, it seems to me, is entirely possible given that a large language model (LLM) is trained on reams of text. So, lets do it. Let’s see how many different artificial economists we can produce and observe. A digital zoo of economic Pokemon with less violence and more discussion of underlying elasticities.

What happens when we train Claude on every edition of Mankiw’s principles textbook? Cowen and Tabarrok’s textbook. All of the principles books. The most daunting book in all of graduate economics? What happens when we train it on sociology and anthropology textbooks? NYT and WSJ editorials? What happens when we let it consume nothing but Presidential State of the Union addresses? Campaign speeches? Every book in the Google digital library? Twitter? The economics subreddit? A perfectly respectable blog?

How should we evaluate the outcomes? Should it attempt to complete the prelimary exams to continue your PhD training at the University of Chicago? The final exams in Intermediate Micro and Macro Economics at the University of Virginia? At what price would it have sold shares of Gamestop? Perhaps it could write an explicit function that would advise a family when to buy instead of rent based on age, city, income, and number of children. Maybe it could manage to pull off a reverse-Sokal hoax, writing a paper making a genuine scholarly contribution worthy to pass through the review process at a top 25 peer-reviewed economic journal. Maybe it could convince your brother-in-law to stop asking for stock tips and just buy into index funds.

In the end, the market test for what stands as a valuable contribution from an AI is what will matter for most of us. But the time is quickly approaching when we will leave behind awe- and angsted-filled proclamations of whether an AI model is discretely good or bad, useful or dumb. The next step demands granularity of evaluation and consideration. Perhaps not false cardinal (continuous) values, but ordinal rankings aligned with useful and actionable assessments of their analysis. And in case you think this is dull or tedious, consider for a moment what it will mean to evaluate the analytical skills of AIs stratified by their training materials. It will stand for many as a meta-analysis of the broad merit of entire disciplines, literatures, and oeuvres. It will be coarse and efficient, messy and cruel. It will cultivate and distill the core messages of intellectual and social identities, many of which were previously latent, if not outright inert. Subtext will be made text, it’s merits evaluated and compared.

That last bit is perhaps the most terrifying. The entire culture of etiquette and politeness, of politics, is built around the institutions that ensure that too much is never said too directly. I have no doubt that this has some of you salivating. You are so very comfortable in your truth that it enrages you when you are implored not to call ideas silly, arguments wrong, people stupid. A utopia of the mind awaits us in this new world of AI-adjudicated debates and augmented salons. Be careful what you wish for. And don’t be so sure your imagined AI arbitrator is going to be remotely fair. Or on your side.

An AI is only as good as the material it is trained on. Genuine insights are found in economics journals by the thousands every year, but fallacies and sophistries are found by the billions in the endless sea of casual text that fills the internet, airwaves, and podcasts. We all (all) spend large parts of our day being casually wrong about things because it costs us precisely nothing to be wrong. The law of large numbers, in the parlance of statistics, will innoculate AIs from such intellectual food poisoning as the randomness of our errors cancel out. What that won’t save us from, however, is the raw populism underlying much of the casual text out there. Is it outlandish to say there are more people who receive rewards, pecuniary and non-pecuniary, for telling people what they want to hear rather than the truth? Have you ever consumed any media ever?

I’m not an AI doomer. I remain rather sanguine on the entire enterprise. But part of the human condition is never knowing for 100% sure what is right or wrong. We pass that on to all of our intellectual offspring, no matter how smart or artificial they are. Or least, we should.

Let parents pay to take kids out of school

Joy Buchanan7 Comments

Elementary school kids can miss a day of school. If they are doing something wholesome and constructive on their day off, no one would claim that it hurts the child who is doing the alternate activity.

Does it hurt other people? There is an ungated section of this Matt Yglesias post concluding that when rich people pull their kids out of school it “… ultimately harms less-privileged children.” For now, assume that is true. We could internalize the externality, like surge pricing on toll roads. Let parents pay a fine to take their kids out of school. The fine would fund programs that help everyone. Let parents pay back into the public good. Charge $25/day which could go toward buying classroom supplies for the inconvenienced teacher.

This flexibility might lead to richer families keeping their kids in conventional schools, which seems like a good thing. No one would have to pay the fine. There is and would still be a system for excusing absences due to unavoidable things like surgery.

Requiring a doctor’s note for excused absences is already a tax. Requiring a parent to miss half a day of work to go take a child to the doctor is more punishing than paying a $25 fine, for many families.

The fine could even increase with the number of missed days. Only super rich families would be able to afford to take 2 children on a 3-week trip. I wouldn’t be able to afford it. But I wouldn’t mind if our school generated revenue off of those who can. Those people would probably donate a new playground in exchange for a plaque.

Is another example where it would be reasonable to charge people to not use something? In a way, insurance companies try to fine people for not using the gym. Running with this example, paid private schools could easily call this a tuition reimbursement for high attendance. Unfortunately, I think it would be politically impossible to implement in public schools.

The Money Value of Time

Zachary Bartsch1 Comment

Economists rightly make a big deal out of specialization and trade. They proceed to go one step further and say that it’s better to pay someone else to perform some service, even if you can perform it yourself. One the assumptions underlying this advice is that time and money are both fungible and convertible.

How are economists right and wrong about the convertibility of time and money? In one sense, we can change how much we work and change how much income we have. That seems plain. But it also requires some start-up costs to have an easy go-to means of earning more income. For example, Uber drivers are registered with Uber already.  Joe from the street can’t start driving tomorrow without substantial preparation.

If economists are wrong about the convertibility of earned time and earned money, then they still have standing. We all have an endowment of time, if not money. But there are plenty of goods that have a money price and a time price that have an inverse relationship.  The advantage of having a time budget is that you can offset some of the money price of goods with time such that more of the money budget can be spent otherwise.

For example, I had to buy a new golf cart battery. One option was to spend $2,400 for a guy to come replace my old battery for me. The other option was for me to spend $1,500 and one evening to do it myself. Given that I typically do chores in the evening anyway, the time-cost to me didn’t feel all that imposing.

Further, if I free up some time, then what happens to it? I can leisure. That’s what economists call any time spent that isn’t working. But after that leisure, it’s gone. There some saving your time for later in the form of bringing other chores earlier in time. But there’s certainly no allowing your time to earn compound interest. That’s where the advantage of self-service really shines IMO. I can give up $900 and enjoy one evening of leisure. Or, I can given up an evening of leisure, put the savings into an investment account, and then reap double the evening’s worth seven years later. Then I’ll have two nights of leisure rather than one. To me, that’s the biggest difference between time and money. I can earn interest on my money in a way that I can’t earn interest on my time.

When Will the Fed Raise Rates?

James Bailey4 Comments

Everyone else keeps asking when the Fed will cut rates, and yesterday Chair Powell said they will likely cut this year. Either they are all crazy or I am, because almost every indicator I see indicates we are still above the Fed’s inflation target of 2% and are likely to remain there without some change in policy. Ideally that change would be a tightening of fiscal policy, but since there’s no way Congress substantially cuts the deficit this year, responsibility falls to the Federal Reserve.

Source: https://fiscaldata.treasury.gov/americas-finance-guide/national-deficit/

Lets start with the direct measures of inflation: CPI is up 3.1% from a year ago. The Fed’s preferred measure, PCE, is up 2.4% from a year ago. Core PCE, which is more predictive of where inflation will be going forward, is up 2.8% over the past year. The TIPS spread indicates 2.4% annualized inflation over the next 5 years. The Fed’s own projections say that PCE and Core PCE won’t be back to 2.0% until 2026.

The labor market remains quite tight: the unemployment rate is 3.7%, payroll growth is strong (353,000 in January), and there are still substantially more job openings than there are unemployed workers. The chattering classes underrate this because they are in some of the few sectors, like software and journalism, where layoffs are actually rising. Real GDP growth is strong (3.2% last quarter), and nominal GDP growth is still well above its long-run trend, which is inflationary.

I do see a few contrary indicators: M2 is still down from a year ago (though only 1.4%, and it is up over the past 6 months). The Fed’s balance sheet continues to shrink, though it is still trillions above the pre-Covid level. Productivity rose 3.2% last quarter.

But overall I am still more worried about inflation than about a recession, as I was 6 months ago. Financial conditions have changed dramatically from a year ago, when the discussion was about bank runs and a near-certain recession. Today the financial headlines are about all time highs for Bitcoin, Gold, Japan, and US stocks, with an AI-fueled boom (bubble?) in tech pushing the valuation of a single company, Nvidia, above the combined valuation of the entire Chinese stock market. All of this screams inflation, though it could also indicate a recession in a year or so if the bubble pops.

At least over the past year I think fiscal policy is more responsible than monetary policy for persistent inflation. But I can’t see Congress doing a deficit-reducing grand bargain in an election year; the CBO projects the deficit will continue to run over 5% of GDP. That means our best chance for inflation to hit the target this year is for the Fed to tighten, or at least to not cut rates. If policy continues on its current inflationary path, our main hope is for a deus-ex-machina like a true tech-fueled productivity boom, or deflationary events abroad (recession in China?) lowering prices here.

Shrinkflation: Not Just for Cookies

Jeremy Horpedahl2 Comments

Cookie monster is mad:

But he’s not the only one. President Biden is mad too.

By now, hopefully we’ve all heard of shrinkflation. But if you haven’t, it’s when the unit price (e.g., the cost per pound) increases not because the price of the good went up, but because the product shrank in size.

Let’s be clear about a few things. First, this is nothing new. Here’s an Economist story from 2019 (pre-pandemic and pre-Bidenflation) talking about shrinkflation. You can find many such anecdotal stories back even further.

Second, the BLS is aware of this. They track it, and price it into the CPI. Take a look at the price data which underlies the CPI: it’s all stated in units. Price per pound, price per dozen, etc.

Moreover, the BLS also recently gave us some data on how frequently this happens. It’s pretty rare. Even among food items, which are a category the includes a fair amount of shrinkflation, only about 3 percent of products experienced any downsizing or upsizing from 2015-2021. That’s right, sometimes packages get larger, not smaller, which effectively lowers the unit price. “Shrinkdeflation” anyone?

Continue reading →

A Contrarian View from Apollo: No Rate Cuts in 2024

Scott Buchanan2 Comments

The mainstream view for the last 18 months has been that Fed rates cuts are always right around the corner. Markets are acting like the cutting cycle has already begun.

Apollo Global Management is a well-regarded alternative investment firm. (Disclosure: I own some APO stock). Their Chief Economist, Torsten Sløk, recently published his outlook, which differs sharply from the mainstream view. He notes that by various measures, the economy is heating up (or at least staying hot), and inflation has started to creep back up, not down. In his words:

The market came into 2023 expecting a recession.

The market went into 2024 expecting six Fed cuts.

The reality is that the US economy is simply not slowing down, and the Fed pivot has provided a strong tailwind to growth since December.

As a result, the Fed will not cut rates this year, and rates are going to stay higher for longer.

How do we come to this conclusion?

1) The economy is not slowing down, it is reaccelerating. Growth expectations for 2024 saw a big jump following the Fed pivot in December and the associated easing in financial conditions. Growth expectations for the US continue to be revised higher, see the first chart below.

2) Underlying measures of trend inflation are moving higher, see the second chart.

3) Supercore inflation, a measure of inflation preferred by Fed Chair Powell, is trending higher, see the third chart.

4) Following the Fed pivot in December, the labor market remains tight, jobless claims are very low, and wage inflation is sticky between 4% and 5%, see the fourth chart.

5) Surveys of small businesses show that more small businesses are planning to raise selling prices, see the fifth chart.

6) Manufacturing surveys show a higher trend in prices paid, another leading indicator of inflation, see the sixth chart.

7) ISM services prices paid is also trending higher, see the seventh chart.

8) Surveys of small businesses show that more small businesses are planning to raise worker compensation, see the eighth chart.

9) Asking rents are rising, and more cities are seeing rising rents, and home prices are rising, see the ninth, tenth, and eleventh charts.

10) Financial conditions continue to ease following the Fed pivot in December with record-high IG issuance, high HY issuance, IPO activity rising, M&A activity rising, and tight credit spreads and the stock market reaching new all-time highs. With financial conditions easing significantly, it is not surprising that we saw strong nonfarm payrolls and inflation in January, and we should expect the strength to continue, see the twelfth chart.

The bottom line is that the Fed will spend most of 2024 fighting inflation. As a result, yield levels in fixed income will stay high.

[END OF EXCERPT]

The big question, of course, is whether these recent signs of increased inflation are just blips of  noise, or the start of a new trend. Time will tell if Sløk’s contrarian view is correct, but I have to respect his intestinal fortitude in putting it right  out there, without any weaselly qualifications. He refers to many charts which are in his original article. I will reproduce four of these charts below:

What I’ve been watching

mdmakowskyLeave a comment

The nature of power, the stories people tell about us, and the stories we tell ourselves is a current throughline within seemingly everything I’ve been watching lately.

Dune Part 2. Loved it, IMAX recommended. The sheer scale of story isn’t just something exposited, you feel the crushing weight of it throughout. The film is trimmed to the point where some detail is skipped over, but the upside is the story never loses momentum. The underlying political economy remains relevant at all times.

Shogun feels true to the source material. Beautifully rendered. The possibility of power, and in turn the taking of power from others, can force your hand. How many coups are forced by the expectation of a coup? Funny how a world can hinge on an inelastic resource, be it a planet’s worth of hallucinogen or a single sailor’s navigational human capital.

The Great. Funny, decadent, ludicrous, and pitch dark at different times, I see a shocking amount of my own worldview in the writing. The alchemy of fear and self-interest swirling around power makes for an incredible comedic substrate. I recommend this to anyone who will listen and I’m probably going to write more about it.

The Kid Detective. How did none of you tell me about this movie? Much like Confess Fletch, it is an absolute gem that fell through the cracks of a theater-less pandemic. A dark comedy about the tragedy of being labeled a prodigy and how that can short-circuit a young person’s development, set within a town short-circuited by a crime. It’s not a happy movie, so don’t expect a happy ending, but it felt honest at every step.

Videos for Teaching Inflation in 2024

Joy BuchananLeave a comment

I’m teaching principles of macro this semester. Making macroeconomics sound important to students is partly about explaining that recessions are painful and significant.

As Alex Tabarrok says, “The Great Depression is Over!”  Maybe Gen Z can appreciate the significance of the Great Depression, but it is history. Gen Z has heard of the Great Recession, but keep in mind that a student who is 20-y-o in 2024 was 4 in 2008. It’s a weird one, but there has been a recession more recently. The Covid Recession is what I like to link to, when possible, in class.

To teach the inflation chapter this week, I’m using video clips that I’ll put up here as resources for others.

To start off the inflation chapter and bring in a more global perspective, I show: “Zimbabwe’s inflation rate hits triple digits”  This 2-minute news clip was produced by Al Jazeera. They talk about lending and policy in addition to retail price increases.

After we have gone through some definitions, I show two clips of an economic forecast that was recorded in 2021. I don’t usually show such long clips in class, but I’m relying on dramatic irony to make it interesting. The students know the path that inflation took from 2020 to 2024, but Dr. Doti in the video does not. I stop the video occasionally to point out connections to our textbook.

Chapman University’s 2021 Economic Forecast Update was presented virtually on Wednesday, June 16, 2021.

Dr. Jim Doti predicts that an unprecedented increase in the money supply after Covid will lead to inflation. He’s not right about everything, but that’s what makes it so interesting. Right after showing students the quantity theory of money equation, I can show them someone trying to apply it from about minute 25 to about minute 35. (don’t start the video from minute 1)

Then, I go back to my lecture and introduce the Fisher effect. Next, we watch about minute 38 to minute 43 of the 2021 forecast because of the direct connection of inflation to interest rates. Partly this just helps illustrate how messy the real world is.

Also, I pull from one of Jeremy’s 2023 posts to illustrate the long run neutrality of money. “The Rate of Inflation is Falling, But Prices are Still Rising (And So are Wages)“