"Mash Mash". In around 2400 BC the Sumerians had this phrase for compound interest that works against the borrower. They were focused on the ongoing issue of debt compounding at a geometrical rate (The Price of Time, Chancellor).
One should be concerned with the rising levels of government debt. In the past, governments ran budget surpluses in times of prosperity. This allowed them ammunition to prime the pump with budget deficits when the economy slowed.
In today's world, deficits are a constant. Current economic management appears comfortable with the accumulation of so much debt that...........
Interest payment on the debt can equal the cost of national medical care (Canada)
Leaving Pension funds non-funded or underfunded (U.S.)
Gutting the military of personnel and equipment (Canada)
Underinvesting in infrastructure (both the U.S. and Canada)
It seems to me that the only way to postpone the inevitable day that buyers of debt say NO to further purchases (referred to as "bond vigilantes"), is to reward them with higher than normal interest payments (while continuing to inflate the economy, diminishing the value of the issued debt).
Stuart Kirk argued a similar theme in the National Post. He argues that "inflation could well be the solution, as a broader policy known as financial repression. Reducing debt requires inflation to exceed interest rates for a prolonged period of time".
Governments for the past decade held interest rates at such low levels, that the annual interest payments on the debt were manageable. That time has come and gone.
Interest levels (in my view) should stay in the current range for the foreseeable future. Today's interest rate level is reasonable and typical of more normal times. Savers deserve to receive, at least, a breakeven interest rate on their savings (a 5% savings rate less taxes at 40% = a zero return after inflation of 3%). But what if the level of inflation is much higher than publically calculated and we want to grow the real value of our capital? How do we protect ourselves without undue capital risk?
The damage inflation causes is less noticeable over short periods. But extend the time frame and watch out. A millionaire in 1923 would need $50 million today to live the same lifestyle. 100 years ago a mansion cost $50,000. (Bloomberg, January 14, 2024)
Hard Assets are protection against Long Term Inflation
The following 220-year chart covers a considerable time frame. What stands out is that stocks are the big winner. Interestingly, the 6.9% compound annual rate of return over 220 years is very similar to the U.S. stock returns over the last 20-50 years.
Bonds, Bills and Gold had positive returns but were certainly more modest. The entry "U.S. Dollar "is a reflection of the diminishing buying power of one dollar. One dollar in 1801 bought 4 cents of goods in 2021
(Long-term Returns- Calculated after inflation, Jeremy Siegel, Stocks for the Long Run)
Stock Market (what about a shorter time frame)
$1,000 invested in the S&P 500 during the last 44-years has appreciated from $1,000 to $100,246, for an annual rate of return of 11.31% (inclusive of dividends). If we adjust for inflation the annualized return drops to a still respectable 8.09% (creating an after-inflation real asset value of $28,372)
Real Estate
I purchased my first house 43 years ago for $150,000. Today that house would sell for $1,750,000. Producing an annual compound rate of return 5.9%
Compared to other industrialized nations, Canadian real estate is unusual in its price appreciation. This is explained by a combination of restricted supply, strong demand due to immigration, beneficial tax treatment and a healthy dose of speculation.
The often-quoted Case-Shiller index (U.S. residential real estate), also indicates a sharp appreciation of home prices above inflation. Speculation abounds in the short term. In the long term, housing has provided an attractive return relative to inflation.
Taxes (even if you get your asset allocation right, taxes will take a bite)
You can see why people flock to Florida with its lower tax levels. Tax rates affect where you live and how you invest. Two of my uncles in the United Kingdom experienced top marginal income tax rates of 97% in the 1970s (there is not much of an incentive to work when you keep 3 cents on the dollar). In high tax jurisdictions (New York, California, Canada) just being able to save funds for long-term investing is a struggle.
Real estate, fixed income and stock market holdings make up the lion's share of investments for those with the economic ability to save. You can argue that fixed income makes sense for cash flow needs and volatility reduction. As a long-term storehouse of value, past results for fixed-income capital protection are not overly impressive.
I am ignoring price trends for items such as transportation, communication, electronics and food. For those without savings, these are the pressing issues. It is hard to see possible solutions to lower prices for essential items. As a start; increased competition through decreased regulation would be helpful.
A significant weighting in equities and real estate has historically helped to minimize financial repression. Mash, Mash.........
regards, Tim
Tim Morton, CFA is a retired portfolio manager with 45 years of experience working with private clients and is the editor of mortonir.com and a contributor to Barron's. My comments are not to be taken as investment recommendations. They are purely for discussion purposes. Please see your registered advisor for investment advice.