How inflation swindles the equity investor (1977) | Hacker News Reader

How inflation swindles the equity investor (1977)

fortune.com

121 pointsmudil123 comments

The main takeaway for me is that is Buffett encourages investors to invest in companies that reinvest all earnings in resource saving capital investments. He argues that is the proper way to increase standards of living, and not with distributions of earnings to investors or redistribution to the government in printing money. That is, stocks that don't pay dividends, and require the government to have a balanced budget.

My argument against this, and is one he has made in later years, is the greed of modern management discourages investors from long term investments in a company. Specifically, outrageous salaries for subpar results, golden parachutes, or acquisitions of questionable value. Wells Fargo's management either lied or was not doing their job, and yet their CEO was paid compensation of $20 million in 2014 (did a quick google search for a figure). Meyer's spent Yahoo's money on acquisitions that people she knew owned, enriching many friends in her network. I really don't feel like subsidizing a connected person's cash grab.

Dividend stocks are a way to get some control over management that tries to pocket the earnings for themselves. Investors flee a stock that even looks like it could cut it's dividend which avoids some of the wasteful acquisitions and compensation (management is forced to buy in as an investor to get the dividends). If the stock goes down you can reinvest the dividends. If it goes up you can sell the stock and reinvest in one that has a better yield.

"Looting" of companies by their management is starting to look like an increasing problem. Usually in failing companies, but one day it will turn a success into a conspicuous failure.

UK examples: Jaguar Land Rover, BHS, Carillion.

> "Looting" of companies by their management is starting to look like an increasing problem.

I think it's been a problem since the 80's. When I look at management pay issues and corporate raiding that was the era Buffett began talking about it if I remember correctly. Futurama even made fun of it indirectly in an episode.

My only regret is that i have boneitis

People who have authority over where money flows tend to authorize it flowing to themselves.

A group of people who each controls the destination of a money flow but can't choose themselves choose each other, thereby choosing themselves.

I disagree with his point too, for a different reason (not that your reason isn't valid).

Whether it's good to reinvest dividends should really depend on economies/diseconomies of scale. If a business is able to invest in something that really will save resources, or if they may leverage existing resources to open new markets in a more efficient way than a startup or competitor, then it's a good idea to reinvest the dividends. It was a good idea for Amazon to make use of their existing computing infrastructure to enter a new market (cloud computing) via reinvested earnings even though they didn't really save any resources by doing so.

Likewise, if a business were able to reinvest their earnings to save resources, but only achieved a 1% ROI on that investment (e.g. every $100 we spend on making our factory energy-efficient cuts costs by $1/year for the foreseeable future), then investors should take the dividends instead as they could get a better yield just through treasuries. I guess this isn't technically an example of diseconomies of scale, but just think of any company with "too many cooks in the kitchen" syndrome and you'll know what I mean.

To a rough approximation, any "reinvested" money by a business is simply a tax-protected reinvestment of the dividends that the stockholders would receive instead. That's why it's not enough to look at whether those capital investments save resources. That money needs to actually be better spent within the business than it could be individually by the business' investors elsewhere.

From Buffet’s explanation, it doesn’t sound like it’s inflation in and of itself that swindles the equity investor, but rising or falling inflation. I.e. if inflation were constant, the market would easily adjust, but when it rises or falls slowly over decades, investors are bound to make decisions that will turn out to be wrong in the future.

It seems to me that exactly the same is the case for interest rates: no rate is “right”, but falling or rising rates will force market participants to make wrong decisions:

* In a rising interest rate environment, all bond purchases will prove unwise, since the investor could have earned a higher rate by waiting a bit longer.

* In a falling interest rate environment, all bond selling (issuance) will prove unwise, because the issuer could have paid a lower rate by waiting a bit longer.

Isn't really unexpected change that cause investors to make wrong decisions? Expected change should be already incorporated into prices.

Real interest rates - those set by banks based on demand for money, and not set by central banks are a price signal. What we have now is straight market manipulation which causes problems.

Interest rates should be a signal about consumption vs investment.

Does a "real interest rate" per your definition actually exist? Googling the term returns an inflation-adjusted interest rate.

In theory if we didn't have central banks this might be possible. However, central banks "print" money to adjust short-term interest rates that are a lever for influencing demand for money. It seems unlikely that it is possible to decouple supply from demand in the real world.

In this case I think "real" interest rate means a rate derived in the free market, rather than at the whim of central planners (fed).

My point is that the notion of a "real" interest rate as defined doesn't exist. The idea of a currency that cannot be manipulated is a chimera. Here are two reasons:

1. Currencies are created by some government or government-equivalent (e.g., maintainers of bitcoin/bitcoin fork), and these governors set the supply of currency. Sometimes they use interest rates, sometimes they just print more currency, sometimes they set a schedule for mining digital currency, it doesn't matter. However, the "free market" is inherently manipulated by the "owner" or "creator" of the currency.

2. If you consider a "commodity-currency" like gold or diamonds (or probably bitcoins) whose supply is not determined by a central authority, these commodity-currencies can also be manipulated. In fact, without the check of a government, capitalism works in such a way that these commodities become centralized into a few large holders who are incentivized to manipulate the currency. This is why governments like to get off of the gold standard, so they can manipulate their currency without interference from other governments.

> Does a "real interest rate" per your definition actually exist? Googling the term returns an inflation-adjusted interest rate.

> In theory if we didn't have central banks this might be possible. However, central banks "print" money to adjust short-term interest rates that are a lever for influencing demand for money. It seems unlikely that it is possible to decouple supply from demand in the real world.

With gold standard, central banks could not directly print money. It was abandoned by the US about 40 years ago, and by Europe, even earlier (because world wars).

The gold standard gets abandoned because countries want to manipulate their currency independently of the impact of other countries' currency manipulation. This is sometimes because they want to pay for costly wars via currency manipulation, but that's not the only reason.

You can still manipulate a gold standard it just takes more effort. EX: This coin represents 2% less gold every year.

Then prices include the weight, not the nominal value. Also, it's a lot of effort. You can also lower the content of gold in coins, but the process of remaking existing coins would be quite expensive.

Paper money is much easier in this regard.

It may sound odd, but gold coins are not on the gold standard. The gold content represented a value floor, but their value should exceed that, or they would have just used bars not coins. If nothing else they where less likely to be fake.

Gold standard only really refers to paper money which was used as a proxy for actual gold. Arguably it's even preferable to physical coins as historicly people would often clip them.

Bank no longer need customer’s money.

If I record correctly, bank can borrow from the Fed and turn around and leverage up and buy bonds and notes. Basically risk free money for banks.

A commercial bank needs some sort of collateral, e.g. customer deposits, in order to borrow money from the central bank.

"Real" means inflation adjusted in the economics and finance world.

Let's call it a "True" interest rate. Central banks directly influence the shorter end of the yield curve. They can influence the longer end only indirectly.

> Does a "real interest rate" per your definition actually exist?

I think the closest measure we have is the difference between the interest rates banks charge from loans compared against the "overnight rate" of interbank lending. This is controlled by the fed (through the federal funds rate) and is another control the fed has to control interest rates.

If I remember correctly, one of the hindrances for the 2008 recession recovery was that the interest rates (offered by banks) remained high as the fed lowered the federal funds rate. The goal of the rate is to control lending and in that recession it was not working.

What problems has the fed caused since the 1980's? Prices are stable, employment is good.

Prices are not stable, but increasing at 3 to 4% per year.

Employment is okay, but more than a 10th of the population is in their working years but not working.

Since '81 it's actually exactly 3% per year, and since '90 it's 2.36% per year. The variance is around 1%, I'd call that pretty stable.

Fair point, and also depends on which measure you're looking at.

https://fred.stlouisfed.org/graph/?g=iFuv

Predictable increases == stable.

"but more than a 10th of the population is in their working years but not working."

Fed has very limited set of things they control. They don't do fiscal or policy.

> What problems has the fed caused since the 1980's? Prices are stable, employment is good.

Which prices have been stable since the 1980s?

Prices, in US Dollars, have more or less been stable. Some have risen a lot (e.g., medical, education). Some have gone down a lot (e.g., clothing). Overall though....stable-ish.

Some of this the fed controls, some of this they don't. They are not all powerful. For example, the share oil revolution has done a lot to reduce prices. Has nothing to do the the fed. China coming online as manufacturing powerhouse has also reduced prices. Again, fed has nothing to do with that.

Healthcare prices are stable? Once you have food, shelter, and heat, that’s the next thing on the list and it’s a crushing liability for almost everyone.

Real interest rates are a monetary measure, to be contrasted with nominal interest rates [1]. I believe you are referring to the rate of interest absent a central bank.

[1] https://www.imf.org/en/Publications/WP/Issues/2016/12/30/The...

correct - I used the wrong term.

One could equally say that its bad for someone whenever a stock price moves. I think it's okay for interest rates to vary, that's just the normal reponse of the market to changing conditions.

It's not contraversial that inflation should be steady. That's literally the point of a central bank.

Actually according to Buffet even _constant_ inflation can be very bad if the business is capital intensive with high fixed-costs. See my point here: https://news.ycombinator.com/item?id=16458373

Bear in mind that most bonds are callable so the seller really has little choice in a falling rate environment.

"* In a rising interest rate environment, all bond purchases will prove unwise, since the investor could have earned a higher rate by waiting a bit longer.

* In a falling interest rate environment, all bond selling (issuance) will prove unwise, because the issuer could have paid a lower rate by waiting a bit longer."

Not quite. Bond prices incorporate future expectations of real rates and inflation rates and then also associated risk premiums. Thus, a bond purchase will lose money only if realized rates come in higher than what is already discounted. That is, it is possible for short term rates to rise, and yet a bond increases in value (i.e., because the ST rates came in lower than what was already assumed in the bond).

> Bond prices incorporate future expectations of real rates and inflation rates and then also associated risk premiums. Thus, a bond purchase will lose money only if realized rates come in higher than what is already discounted.

Isn’t the fact that bond interest rates falling for the past ~35 years — on a 5-year average — then a testament to the market being unable to predict future interest and inflation rates?

If the market were able to correctly predict future interest and inflation rates, the rate of interest wouldn’t change. So, as far as I can see, the fact that it has been dropping, on average, for the past three decades seems to indicate that the market fails at this prediction under our current monetary system.

Or, perhaps a better question: if the rate of inflation were to slowly increase by one percentage point per year, for the next 30 years, what would be the right real rate of interest right now — assuming we knew this were going to happen? In other words: how do you discount a rate that’s slowly but steadily changing (even if it’s in a known direction)?

With regards to short term rates, I should have explicitly written “the long/bond rate of interest” since the two indeed are fairly independent.

> if the rate of inflation were to slowly increase by one percentage point per year, for the next 30 years, what would be the right real rate of interest right now — assuming we knew this were going to happen?

the rate would increase exponentially according to the number of days between the present and the maturity date. the rate for securities that could be redeemed on demand would steadily increase, but represent the lowest rate (because you would always have the option to decide to claim your money). whereas a 30 year cd would have the highest rate in the market.

There is an important aspect which is not well remarked in the article: high fixed-costs businesses are the ones that really suffer inflation.

If every time you want to expand you need to make significant investments (and there will always be a delay before it starts making money), inflation will affect your costs way before it will affect your revenue.

Even worse, because fixed assets need to be replaced due to obsolescence every once in a while, you'll end up increasing your costs way more than you're increasing your revenue just to maintain the current production level.

TL;DR: The more the delay between investment and revenue generation and the more capital intensive it is, the worst.

Depends how you fund the investments.

If you fund them by taking on more debt, then higher inflation is a benefit - it reduces the value of your debt compared to your product.

In a context of _constant_ high inflation that's not true: the interest rates will already be discounting the future inflation.

You have a positive gain of that type in case inflation grows more than expected. Enough to offset the negative impact given by the delay costs-revenue? Probably not in most cases.

In fact the positive effect applies to debt made in the past which precisely because of inflation is likely to be lower than the new debt you need to take on (on which the negative effect applies).

Of course also the opposite could happen: inflation grows less than expected after you took on a lot of debt.

So for a capital intensive business it'd just be better to operate in a context of constant low inflation.

Economists usually say that with constant predictable inflation money is "neutral" meaning that the interest rates adjust to offset any higher cost so that businesses shouldn't be affected by inflation (except for a bit of "menu cost", that is the overhead cost of having to update price lists more often.

Low inflation has huge potential downsides in that fiat money can't have negative nominal return while it is quite normal for private investment returns to go negative sometimes (thermodynamics says that things, including stores of value, tend to degrade with time unless you put work and energy into them).

This is the famous zero lower bound problem. It means that when private market rates go negative, people transfer their savings to cash, the world switches from producing real stuff and building real businesses to people hoarding intrinsically worthless pieces of paper (pieces of paper that might not be able to buy that much in the future because production will have gone down.

On top of this, if you keep interest rates above market rates and inflation too low for a long enough time, that is if you keep rates high at 0% when they should be at -3%, market pressure will build for an uncontrolled inflation rebound when all the cash hoarded on the sidelines start flowing in an economy with lowered production. It is much easier to keep inflation stable if you keep it high enough so that the investment market can always clear and never hits the zero lower bound.

Low inflation is usually desirable, just think that achieving 2% inflation annually is the main mandate for the European Central Bank.

That's because even at 1%-2% inflation a year is difficult to spark the so-called thesaurisation phenomenon you're implying.

In general I agree with you, I'd just change "low inflation" with "deflation".

On the "money" being neutral with constant inflation. Yes, sure. It's the business dynamics that are not neutral. Quick example:

- Say you have 10$ costs and 10$ revenue every year.

- One year you expand production and you have to pay an additional 10$: so 20$ costs and 10$ revenue for that year.

- With 0% inflation you have a 10$ loss (20-10), while with 10% inflation you have (20 * 1,1 - 10) = 12$ (about 11$ on constant prices terms) in loss (revenue won't grow till next year).

First, the ECB has nearly destroyed western civilization with their overly tight stance during the past decade. They destroyed the economy of their weaker members like Greece, eliminated the means of subsistence for their vulnerable workers which emboldened fascists and geopolitical foes like Russia.

It was not difficult to spark the "thesaurisation". Excess reserves at the ECB and the Fed shot up by trillions. Natural market rates for investment were estimated by some around -4% and the central banks kept their rates very high at close to 0%. Yes deflation is worst but low inflation can be terrible in some situations.

"With 0% inflation you have a 10$ loss (20-10), while with 10% inflation you have (20 * 1,1 - 10) = 12$ (about 11$ on constant prices terms) in loss (revenue won't grow till next year)."

Not true, inflation means that revenues are constantly rising faster and financing costs are lower in real terms.

> Yes deflation is worst but low inflation can be terrible in some situations.

Agreed. But not because of what you are implying: "...people transfer their savings to cash, the world switches from producing real stuff...". That is rather a risk resulting from deflation.

I agree because higher inflation can help an economy plagued with insolvent debt to "assimilate" it gradually and create new room for healthy debt.

> Not true, inflation means that revenues are constantly rising faster.

That's precisely what I'm denying: there's often a significant delay between the outflows of money and the inflows they generate (typically in high fixed-costs businesses).

If you're expanding production every year and you see the added revenue only the year after it's not difficult to see how inflation would have a negative impact (even if constant!).

>That is rather a risk resulting from deflation.

There doesn't need to be deflation. As long as the real return on cash (around -2% when interest rates are zero) is higher than market safe return on investment (which can be lower than -2%) it can cause a gridlock in the investment market.

>If you're expanding production every year and you see the added revenue only the year after it's not difficult to see how inflation would have a negative impact (even if constant!).

I don't follow at all. Inflation means prices are rising with time. So the investment early in time is made when prices are lower and the revenues are made later when prices are higher and thus you make higher revenues relative to what you paid for your investment. Inflation helps you here!

Insufficient inflation would be the problem. You make your investment when prices are high so you pay a lot, then when it comes to sell your product you get a insufficiently high price and low profit.

It's all part of the cost of capital calculation: https://en.wikipedia.org/wiki/Cost_of_capital

> As long as the real return on cash (around -2% when interest rates are zero) is higher than market safe return on investment (which can be lower than -2%) it can cause a gridlock in the investment market.

That way holding cash is better than buying a government bond but you're still loosing purchasing power holding cash, so why not spending it?

The real problem is when holding cash increases your purchasing power over time.

> So the investment early in time is made when prices are lower and the revenues are made later when prices are higher and thus you make higher revenues relative to what you paid for your investment. Inflation helps you here!

You reason as if you make the first investment and then that's it. It's not what really happens in most businesses.

Imagine you make an investment every year which produces the revenue for the year after.

>That way holding cash is better than buying a government bond but you're still loosing purchasing power holding cash, so why not spending it?

You want all retirees to spend all their money at once? What if they planned to live for another while?

Safely carrying value into the future is a service that can sometimes cost you. There is nothing unnatural about negative returns. If cash has zero returns when when market rates on private safe investment is negative, savers start accumulating pieces of paper or electrons in accounts instead of things that have real world value and create economic activity. This puts the real investment market into a gridlock and production drops.

>Imagine you make an investment every year which produces the revenue for the year after.

Yes and it always helps you when the prices are higher when you sell than when you buy.

The article says just the opposite.

> Cheaper leverage? Not likely. High rates of inflation generally cause borrowing to become dearer, not cheaper. Galloping rates of inflation create galloping capital needs; and lenders, as they become increasingly distrustful of long-term contracts, become more demanding. But even if there is no further rise in interest rates, leverage will be getting more expensive because the average cost of the debt now on corporate books is less than would be the cost of replacing it. And replacement will be required as the existing debt matures. Overall, then, future changes in the cost of leverage seem likely to have a mildly depressing effect on the return on equity.

To be honest my intuiton is like yours. I still haven't managed to reconciliate my intuition with the above quote. I guess it would be something like this: It is true that inflation means that the stream of cash you will pay back is worth less, but the costs of keeping your business running (which in turn is what generate those stream of cash) also goes up. When this happened, lenders become more strict.

You can read further down:

> Nevertheless, given inflationary conditions, many corporations seem sure in the future to turn to still more leverage as a means of shoring up equity returns. Their managements will make that move because they will need enormous amounts of capital — often merely to do the same physical volume of business

In this light, it's interesting as a counterpoint to look at inflation's systemic effects.

After the 2008 real estate loan bust, many economists hoped for more inflation so that the existing pool of loans would be a little more manageable for the debtors. (In Japan, they've been trying to increase inflation for decades). Even today, on financial news feeds and Bloomberg, when economic observers talk about "good news on inflation" they usually mean inflation going up, not down.

I guess, overall, there's a sweet spot for inflation. Or what's good for corporate profits and banks is sort of opposed to what's good for the overall collection of people in the economy.

> Even today, on financial news feeds and Bloomberg, when economic observers talk about "good news on inflation" they usually mean inflation going up, not down.

Indeed, the sweet spot is believed to be 2%. It's good news because we've been under that for so long, not because the more the better.

> After the 2008 real estate loan bust, many economists hoped for more inflation so that the existing pool of loans would be a little more manageable for the debtors.

I'm not an expert, but I'll just point out that debt from a loan that you've put into a house probably doesn't have the same mechanics as debt from a company trying to fund its capital requirements. Not saying I agree or disagree with those economists, just pointing out maybe they're different.

Regarding business debt ---- > It is usually floating rate and has a shorter term. You will have to roll the debt more often as you refinance. Thus, you will pay the higher inflation costs. And if inflation costs are unpredictable, then lenders will require a higher risk premium on the inflation piece.

> TL;DR: The more the delay between investment and revenue generation and the more capital intensive it is, the worst.

I think you're talking about high interest rates, not high inflation. High inflation means that, when you start generating income, you'll generate a higher income than with lower inflation. This, by itself, helps you repay the cost of your machinery faster.

Usually high inflation also comes high interest rates, and that creates a problem if you have a delay between investment and revenue, but not inflation itself.

I'm precisely referring to inflation. See the example I'm making here: https://news.ycombinator.com/item?id=16459396

>Virtually every corporate treasurer in America would recoil at the idea of issuing a “cost-of-living” bond — a noncallable obligation with coupons tied to a price index. But through the private pension system, corporate America has in fact taken on a fantastic amount of debt that is the equivalent of such a bond.

https://www.treasurydirect.gov/indiv/products/prod_tips_glan...

So do any companies use tips to fund their pension obligations?

I assume so these days, but TIPS didn't exist when this article was written. And probably not exclusively TIPS in any case (but perhaps combined with equities, etc.).

Inflation is one of the primary justifications for a lower capital gains rate, because getting taxed on inflation is quite the slap in the face.

While I agree that being taxed on inflation is unfair, it would not be that hard to discount inflation when assessing taxes. Surely a tax system could accommodate that.

But the fact is, it doesn’t and that’s the world we live in. We need to lower capital gains taxes sometime in these next few years.

The fact also remains that the world we live in doesn’t have a lower capital gains tax rate. If we’re going to propose tax changes for the future, all proposals are as good as any other.

I didn't know what part of the world you mean, but in the US the capital gains rate maxes out at 20% for people earning over $425,000 a year and that's pretty darn low.

The question to ask is why capital gains tax should be lower than taxes on wages? If encouraging work is the priority, it should be the other way round.

Not exactly. Long-term capital gains in the US max out at 20%. Short-term capital gains (those investments held < 1 yr) are taxed at your marginal tax rate, which can be significantly higher than 20%.

https://www.nerdwallet.com/blog/taxes/capital-gains-tax-rate...

perhaps the priority is encouraging investment into capital.

Norwegian capital gains tax (no distinction between short and long term) is 30.5% for 2018, with an additional 0.85% of total net worth (mostly minus value of primary residence). I wish lowering capital gains tax was on the radar; if inflation starts increasing then this will be an excellent system for punishing people who have saved money rather than spending it immediately.

Income is income. Why should unearned income get taxed lower than earned income?

I’d go a step further and classify income as:

1. Earned income 2. Investment income 3. Gambling/lottery/short term income

Tax rate should increase as you go down that list.

Why?

Because unearned income is a lot harder to make.

At a 6% return, you need around $800k+ to get the equivalent of a $50k salary before taxes from the interest earned on your savings. When you factor in having to reinvest some of your returns to beat inflation and make up for some years of low or negative returns, you might only draw maybe $20-25k out of that $800k portfolio. Then you get taxed on it at 20% capital gains along with any state taxes, and it all adds up to a lot less money to live off of.

Most people who want higher capital gains do not have a portfolio of this size nor have they explored the reality of living off a portfolio of this size. Work to the grave I guess.

I don't see people passively living off their investments (that is taking a rake while contributing nothing productive to the economy) as a thing to be encouraged, beyond perhaps a retirement age (which has tax shelter status for a significant amount).

As a thought experiment imagine if everyone did this, or it was everyones goal.

If everyone was doing it, there would be no returns or even negative returns, and thus people wouldn’t invest. The problem fixes itself.

if there's any segment of the market that's zero sum, then some gains are at the loss of others, and eventually, some actors will fail, leading to an in equality that mimics today's.

If everyone could afford to retire early then this would imply both impressively high productivity while working and an impressively low level of inequality. Seems like a good goal to shoot for?

> Because unearned income is a lot harder to make.

You realize that 50k salary is rather close to the median individual income in the US, right? Why should the fact that you've got 800k making money for you mean that you should be taxed less than someone that earned their 50k through wages and tips?

Edit: Another way to think about it: Both the investor and the wage earner added value to their respective markets which was valued by their markets at 50k over the year. Why should one of these market actors be taxed lower than the other?

> Why should one of these market actors be taxed lower than the other?

my prevailing theory is the common belief that an investor's money brings in more economic knock-on effects, and the $50k earned by the wage earner is less "powerful". in order to incentivise the investor, they are given a tax break.

this isn't helped by the fact that those in position to make this sort of tax law are also beneficiaries of said law.

> Why should the fact that you've got 800k making money for you mean that you should be taxed less than someone that earned their 50k through wages and tips?

the lower rate of taxation incentivizes one to invest that money in legit investments, rather than spend it on discretionary consumption or invest it in an illicit vehicle that provides an untaxed return.

> Why should one of these market actors be taxed lower than the other?

I personally don't think they should but another way of looking at it is that people usually have to work (the enormous pile of cash came from someone somewhere, even if it wasn't the person who has it now). so theres no incentive for the government to cut the worker a tax break. but when you have money in the bank you can do many things with it. a lower capital gains tax allows the government to earn some revenue on the money and helps keep that person from spending it all on fun stuff and driving up the cost of resources with 800k worth of bids.

If you are talking about retirement, then we have many ways to help mitigate these losses; Roth IRAs or 401ks will let you take money out tax free, and traditional IRAs or 401ks will let you put the money in tax free.

If you are talking about non-retirement people, I don't expecting to live your entire life off of 800k in savings is realistic or something we should encourage. We need people working and producing things.

I believe the reasoning behind it is to incentivize long-term investing.

Though, it should really be a tiered system in that case - different tax rates for holding periods of <1 yr, 1-2 yr, 2-3 and so on, instead of just <1 yr & >1yr

It's one thing to lower tax on investment income. But the problem with capital gains taxes is that they don't just cover investment income, they also cover lots of earned income. Stock options, IMHO, should never be taxed as capital gains since they were "purchased" largely with an employees time. And they're not the only form of capital gains that derive from selling your work product. If we are to cut capital gains, we also need to restrict capital gains to pure financial investments and ensure that every form of compensation for work is taxed as normal income.

Is this accurate? If that was the case then interest from savings accounts and CDs wouldn't be taxed at the marginal tax rate as ordinary income is.

Interest from saving accounts and CDs is "ordinary income". "Ordinary income" generally is anything that is not classifiable as a "capital gain". "Capital gain" is gain from the sale or exchange of a capital asset. See https://en.wikipedia.org/wiki/Ordinary_income

Doesn’t that mean you just need to take more risk?

Why are you singling out capital gains? Your argument works equally well for labor-based income, but capital gains are already taxed much less than labor.

There isn’t enough time between labor being performed and it being paid for inflation to have much effect. Long term capital investments have plenty of time for inflation to pile up and distort the naive calculation of “gain”.

I see your point, but it seems to rest on the rest on the way we determine when capital gains are realized. Capital gains accumulate regularly just like other sources of income; in my mind the tax obligation is incurred at the time of the gain, just like the tax obligation on other income.

For practical reasons the state does not demand the tax until the accumulated gains have been realized by selling the asset. This makes sense for illiquid assets like stock in your private startup, but I don't think it should change the calculation of when the tax was incurred and how much. For liquid assets like shares in public companies, I think it would actually be perfectly reasonable to demand the tax on unrealized gains.

No. If I pay you $1 and you get taxed $0.5 you are still $0.5 better off than you were before. If inflation raises you salary to $2 and you get taxed $1, you are still one (inflated) dollar better off than you were before you were paid.

But if you buy a stock for $1 and it goes to $2 as a result of inflation, you get taxed $0.5 on the $1 gain, but your resulting $1.5 has less purchasing power than the $1 you invested.

Everyone would be in the same boat, so I don’t think you would lose any purchasing power as it is relative.

Labor is taxed year-by-year so inflation does not have much influence on it. Capital gains tax taxes the sales of things (capital) that might have been held for decades. Buy a piece of land and hold it for 20 years. If inflation is 3% then the dollar value will go up by a factor of 1.8 without any real increase in value but if you sell it you will get taxed on that inflation created gain. Some see that is not "fair". That is the spin, anyway.

I think the way to mitigate this problem is to index capital gains to the CPI and then tax gains like income. This cleans up the tax code quite a bit, stops favoring capital over labor, and balances out the pressure on the CPI with having a powerful group of people wanting to have it go up. At the moment CPI is probably under-reported and keeping social security and other inflation adjusted things lower than they would be otherwise.

I don’t think CPI needs to be used to mitigate the problem of taxing inflation on assets. It would just increase the politicization of CPI, which is already not realistic.

The market can easily adjust prices for assets to factor in the cost of inflation and taxes.

So inflation + capital gains taxes serve as a brake against spiraling wealth growth, and that's a good thing for the economy.

He certainly has a fair point.

The problem, however, these days, is the way a monetary policy hyper-focused on eliminating inflation swindles the wage-earner.

I'm by no means well-educated on finance. However, it seems like inflation has been the boogeyman of every major policy decision in the US for the decades I've been watching. So far, the dire predictions haven't come true, but we've faced growing wage inequality for 30 years.

I've read that the Fed has a dual mission - keep inflation/deflation in check and unemployment at healthy levels, but I only ever hear their concern for inflation risks.

As a result I tend to discount concerns over inflation, assuming that the major problem will be the issue we aren't addressing...is my reaction reasonable?

All central banks have been focused on the other issue since 2008. No one has been very worried about inflation until very recently.

Banks, perhaps. Everyone else (conservative pundits, fiscal pundits) seem to be declaring imminent crippling inflation on a regular basis, yet it never seems to happen, even when the banks/govt take the action (or don't take the remedy) to this threat.

Qe1 and Qe2 in the US were both accompanied by much hand wringing and doomsaying (for example), but the logic of the fear never made sense to me.

The Fed has used both lack of employment growth and lack of wage growth multiple times to explain holding off on raising rates.

Yes, but they've also raised rates a number if times in the last few decades over -fears- of inflation that wasn't yet present, even with employment/wages weak.

The Fed tries not to screw employment up, but I've not heard if them taking action to impact employment while they will for inflation. Even when inflation is too low by the Fed targets.

All of this, however, is my only lightly informed opinion so I am open to being shown any errors.

The trouble with being a wage-earner in inflationary times is that you constantly have to argue for pay rises, which are far from automatic. This is partly why there were so many strikes in the 1970s.

And that's just to plateau.

The irony is that it is an economic precept that pay rises magically happen and are endowed upon the laborer. At the same time, screwing the laborer out of the value of their wages is a deliberate policy of inflation:

https://krugman.blogs.nytimes.com/2010/02/13/the-case-for-hi...

That's backwards. Inflation swindles the wage earner. Have you ever been a wage earner?

A very different time when equity returns were 12% and inflation was in the 5-10% region.

we are probably on the verge of at least the inflation part of this - there is no way we are going to be able to do $1T deficits for long.

Why not?

Not just snark, that's a key question. 30-year yields are currently at just over 3%.

$30 trillion * 3% = saying goodbye to Social Security, Medicare or the entire US military, pick one.

That's assuming the market complies with 3% rates. And that the dollar doesn't do a nose dive (as it did when Bush & Co. went wild with spending), debasing the US standard of living, setting off a nasty chain reaction of consequences.

Who is going to buy $1 trillion of new US debt every year? Sooner rather than later, nobody. That's nearly equivalent to the sum that Japan and China are each holding. There's nobody left on earth that can absorb another $10 trillion in US debt in the next ten years, while continuing to maintain the existing $21 trillion pile. What will happen, is perpetual QE, debt monetization. The Federal Reserve fiscal death spiral begins and they have to forcibly maintain hyper low rates forever.

Already the $15 trillion those clowns have added to our national debt over just ~16 years, is going to steal the money we need annually for infrastructure spending. The interest cost on $15 trillion at just 2% is enough to not only rebuild all US infrastructure over ten years, it'd build us bullet trains out the wazoo. All because they couldn't maintain basic fiscal discipline after 9/11.

Or, alternatively, taxes have to go up a lot.

The US has spare taxing capacity that most developed nations do not, however the rich are likely to be inclined to absorbing inflation rather than seeing their taxes go up a lot, they'll fight that. They can adjust assets, to a reasonable degree, to respond to inflation.

After Japan's savings rate hit near zero, and the people of Japan could no longer finance their government's reckless spending, they had to turn to Yen debasement to manage their debt interest problems (attempt to inflate the problem away by destroying the currency), the consequences of that are extremely ugly over time unless you slash spending, growing a lot faster, or massively raise taxes (or a combination). Today their debt interest cost is over 1/3 of tax revenue. At those levels, you stop being able to maintain things you need to maintain, and the debt robs you of being able to make large investments for the future. That's where the US is heading over the next 10 or 15 years, and it already can't afford to deal with its existing spending needs.

The consequences of a falling dollar isn't "a nasty chain reaction of consequences", it's to import less and export more, which increases employment and leads to increased tax revenue.

> After Japan's savings rate hit near zero, and the people of Japan could no longer finance their government's reckless spending, they had to turn to Yen debasement to manage their debt interest problems

What? Japan is notorious for struggling with deflation, not inflation.

I’ll just leave this here: https://fred.stlouisfed.org/series/FYOIGDA188S

Debt is not “accumulating” in the way you imagine it is. Debt load remains fairly stable, and old debt is paid off as new debt is taken on in roughly equal rates as a percentage of GDP.

If the world would give you trillions of dollars at 2% and your return in that money exceeds 2% it would be pretty stupid to pass it up.

The viewpoint of bemoaning debt because just think of what we could have paid for with that interest is wrong because it completely discounts the immediate and long-term value of the things which the debt financed to begin with.

Bemoan whatever you perceive as wasteful government spending, but just like companies won’t achieve the highest returns by being debt free, neither do households and especially not governments.

As siblings have pointed out, borrowing $30trn then having to pay $39trn in 2048 in deflated 2048 dollars is a pretty great deal.

> Japan inflation

https://tradingeconomics.com/japan/inflation-cpi

"Japan Inflation Rate at 34-Month High of 1.4% in January" - wow, feel that debasement.

https://www.ft.com/content/e26d36e6-918b-11e7-a9e6-11d2f0ebb... "The fears about Japan’s debt are overblown": "The real interest rate Japan pays on its debt has fallen steadily. With short-term interest rates now negative, the country gets paid to borrow for short periods."

http://www.bbc.co.uk/news/business-35436187 : Japan's rate went negative. The government can "afford" people paying it to take their money off their hands all day long.

The trick to all this is to remember how much of that debt is ultimately owed to pensioners - not all of it but a surprisingly large amount; paying about 1/3 of tax revenue to pensions in a country where 40% of people are over 65 suddenly doesn't look so unreasonable.

> Who is going to buy $1 trillion of new US debt every year? Sooner rather than later, nobody. That's nearly equivalent to the sum that Japan and China are each holding.

One problem with this narrative is that the vast majority of US government debt is owed to US citizens.

People have been saying that for ten years now.

If inflation ticks up, the Fed will raise rates, which will dampen inflation but increase the interest on new treasuries, which will presumably compel the administration to cut spending and raise taxes, and borrow less.

...which in turn would yield an incredible risk of deflation. Monetary and fiscal policy is not as easy as turning a dial on the economics machine. The consequences of deflation in the US would be very dire.

Ten years?

People have been saying that since before Clinton got in office.

Catastrophic inflation from government spending has been just around the corner for 40 years now. The 1970s were an odd time for many reasons, and they won't repeat again. But for some reason too many people base their predictions of the future from what happened between 1974 to 1984.

I don't see how such an ideologically driven administration would raise taxes. Instead they will definitely attempt to cut domestic transfer payments and assistance to the needy. The money for the outrageous tax cuts for the wealthy 'needs to come from some where' after all.

When you look at the numerous members of the administration that have already racked up 20million plus taxpayer-funded tabs for private flights on personal business there is nothing to point to as far as fiscal discipline with this administration.

The 12% figure doesn't refer to return on stocks, they refer to company's return on requity. Just because a company is compounding their equity at that rate it doesn't mean your investment in that company's stock will get that return: it depends on the market conditions when you bought and sold.

> With bonds yielding only 3 or 4%, the right to reinvest automatically a portion of the equity coupon at 12% was of enormous value. Note that investors could not just invest their own money and get that 12% return. Stock prices in this period ranged far above book value, and investors were prevented by the premium prices they had to pay from directly extracting out of the underlying corporate universe whatever rate that universe was earning.

EDIT: And adding to the above (i.e. it's "return on equity" that was 12% not, "equity returns"), here's a report from Goldman Sachs in 2012 where they estimate the return on equity of the S&P 500 to be around 15.5%. So it seems that at least when it comes to ROE it's not really different times.

http://blogs.marketwatch.com/thetell/2013/07/26/sp-500-retur...

Is it still common to get 12% return on the market?

My layman impression is that with ETFs, ~6% is the current average return.

I think the more commonly cited number is 7% as an inflation-adjusted total return.

It’s not been hard to get more than those returns in recent history.

The Nasdaq-100 total returns have been 32% last year and 155% over the past five years. This is a average of just over 20% a year.

Source: https://www.nasdaq.com/markets/indices/nasdaq-total-returns....

I imagine if you looked at the 5 years leading up to 2000, the nasdaq would have some astronomical annualized returns. However, it’s too specific an index and too narrow a time range to draw any meaningful conclusions about the kind of total market returns an investor can expect over the next several decades.

Important to remember that they’re averaging over a decade to get that annual return figure. I still hear 10% thrown around as a rough estimate (if you believe anyone is capable of making such a prediction) — though Jack Boggle has been cautioning that we should expect much lower returns over the next twenty years (more like 3-4%).

But if that's true, isn't that just keeping, just barely, with inflationary predictions? Especially given the new tax bill increases the deficit wildly, which will lead to a bond glut / money printing exercise?

If so, what's the market going to do, if not reallocate capital from the stock market to a less risky asset?

I mean, I honestly have no idea. The concerns about inflation are real; we have high employment, and a relatively strong economy. Stocks (and Real Estate in certain areas) are at high valuations already. The tax bill is stimulus at a time when we don’t really need it - and it doesn’t address inequality, which economists like Robert Gordon consider one of the major headwinds against lifting productivity.

I think it’s the Dutch who have a saying that the point of investing isn’t to make money - it’s to not lose what you already have.

Buffet has said something like, “I’d rather have a lumpy 12% than a smooth 10%”. Higher risk can mean higher reward.

I’m not offering investment advice; but for myself, I still think being invested in stocks for the long haul is smart. As they say, if it isn’t, then there are bigger problems to worry about. Doesn’t hurt to hedge against some “black swan” events too.

Just be wary about advice from buffet. He's rich enough that he can basically buffer swings in the market. For the rest of us, employment might be market-procyclical: We lose the ability to buy in at the bottom of the market because we're at employment risk and maintaining personal cash reserves is critical and it's more likely that we have to sell off to stay afloat.

For sure. That’s why a safety net is a core of so many strategies. And again, amateur opinions here - not offering investment advice.

It's not 12% return on the market. The 12% figure refers to "return on equity". That is, how fast a company can grow its equity. Buffet being a very long-term investor who often buys controlling chunks of business, can reasonably equate this to a sort of return his investment. If you're a regular retail investor, you can't. How fast a business is compounding their equity doesn't necessarily get reflected in the value of the stock that you bought.

Historical returns of stocks in the equity market are around 6-10% depend on time period considered.

Historically its about 9% but its been trending lower and many expect future returns to be a tad lower. Subtracting 2-3% for inflation and you are about correct for real returns.

The market is so volatile that if you take an average over a period long enough to get a meaningful answer, you are including data from the time Buffett was originally speaking.

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