When inflation was at 1-2%, the mental adjustment from nominal to real GDP was pretty simple to calculate. If nominal was above 2%, it means you got growth. If it was between 0-2%, you got negative real growth. If it was below 0%, there would be a media panic about the end of the world.
Now with inflation at 8.1%, a nominal growth of 4% might sound good in ‘ordinary times’, but today is deeply negative on the real end. Since almost nobody is getting 8.1%+ wage increases, it means everybody without hard assets are falling behind in relative purchasing power terms.
If we get a 2% real GDP print, with the current CPI rates, it means things increased 10% in nominal terms. Just think of all the extra tax revenues that come out of this (although CPI-linked expenses will also rise, accordingly).
There is also the impact of capital gains taxes to consider. Say you purchased an asset for $100 last year, and today it is $108.10. While you made $8.10 in nominal terms, in real terms, your investment is still worth exactly the same as it was when you purchased it. However, when you go and dump the investment, you owe the government another $1.08 in taxes at Ontario’s highest marginal rate, so you’re actually sitting in the hole. You needed a 11.1% nominal return to ‘break even’! Compounded annually, inflation is a gigantic tax vacuum for the government – and whether you like it or not, we are all paying for it.
The differential in numbers from old times is significant. It will also have the impact of making financial statements from previous eras less comparable.
Effectively, if we string together 5 years of 8% inflation (I’m not saying this will happen, just for illustration), this produces roughly a 50% distortion from real to nominal statistics, comparatively speaking.
Needless to say, this is also very convenient for historical long-duration fixed debt issuers, namely the government. Returns on short-term government debt are still very poor (326bps for 1-year money as I write this, in nominal terms!) in relation to the erosion of purchasing power.
An poker analogy to this is higher inflation means that the casino (government) is taking more rake off the table for each hand. We are all forced to play this economic poker game, but with inflation, the ability to win net amounts of money decreases as the take rises. The big losers are those without assets – their purchasing power continues to erode.
Agreed – a heinous wealth tax. As government debt gets eroded, do the higher-income, higher-wealth benefit from lower future tax obligations?
There’s just no legal way around that cap gain tax grab, other than load up on your primary residence. Then you are taking on significant political risk (primary residence exception to stay), along with crap load of other risk.
What about prefers – with 3 month at 2.1 and 5 year at 2.8, there maybe entities that look interesting – obscure ones like Versabank that will likely be called and likely yield in the 6-ish? Or you think the risk is too much relative to the returns?
The preferred share market is less of a wasteland than it was a year ago, but it still is not terribly favourable IMO. Perhaps I’m greedy but I remember the days when third-rate prefereds like Cannacord were trading at double-digit yields.
Floating rate stuff like TRP.PR.F isn’t terrible at this time either, but still, the risk/reward compared to how much cash flow the equity is taking in is not the best…..
For sure. You can get a 5% 5-yr GIC now at CIBC.
I actually felt my inflation expectations rise as I read this Sacha 🙂
I’m on the Board of a small non-profit and among other things that was discussed yesterday was price increases. Who *isn’t* talking about inflation these days? This makes me think the central bankers aren’t being aggressive enough. But on the other side of it, what happens when (not if) the stock market dives. Are the bankers going to chicken out?
It seems like alot of these labour relations are settling either before strike or within a week of striking. I have no data to support this but living in a heavy union area I have noticed that these quick deals are usually the company ceding, while long strikes tend to end with workers ceding. There is a real possibility that wages rise more than people are expecting. This would entrench inflation but it could also mean multiples compress without further price reductions in equities.
Sacha, I was in the recession camp for the last few months but all this chatter about it is tickling my inner contra, I’m not so sure anymore.