By Dr. Jim Dahle, WCI FounderI've seen an idea popping up on forums, blog posts, and other places on the internet that seems to suggest that inflation benefits the wealthy. That idea is bonkers, and I'll tell you why.
What We're Talking About
Inflation is an increase in the cost of a good or service, i.e. when something that used to cost $10 now costs $12, that's 20% inflation. When, on average, most of what society is buying goes up in price, that is considered an inflationary environment. However, people don't really worry much about 1%-3% inflation. In fact, the Federal Reserve actually targets a rate of inflation of 2%. There isn't anything magic about 2%; that figure was just pulled out of the air (though most economists do think the best number is between 1% and 3% a year). The point of a target is that inflation needs to be stable and what is expected. That allows society a predictable, stable environment where people can borrow, earn, save, and invest without fear of a dramatic and unexpected change in prices. The inflation we're discussing today in this post is not that 2%ish level of inflation the Fed is aiming for but what happens when inflation is higher than that.
Why People Think Inflation Is Good for the Wealthy
Most of the arguments I see suggesting inflation is good for the wealthy basically boil down to “in an inflationary environment the value of your assets like stocks, real estate, your car, and your home goes up in value and since the wealthy own more of that stuff, they do better in inflation.” That argument is bunk. It's so bonkers that I can't even believe that I have to disprove it.
If you buy a house that costs $500,000 and inflation is 5% and after a year your house is worth $525,000, you're not any more wealthy than you were before. I'm sorry, you've made the mistake of thinking in nominal dollars rather than real, inflation-adjusted dollars. If you had sold that house a year ago, you could have used the money to buy $500,000 worth of stuff. If you sell it today, you can buy $525,000 worth of stuff. Which is exactly the same amount of stuff that $500,000 would have bought you a year ago.
The Wealthy Do Better Than the Poor in All Environments
All else being equal, it's better to be wealthy than poor. As writer and playwright Beatrice Kaufman said, “I've been poor and I've been rich. Rich is better.” Whether you're in a stable economic environment, an inflationary environment, or a deflationary environment, it's better to be rich—at least economically speaking. So, we're NOT talking about whether the rich or the poor do better in an inflationary environment. That's not what we're comparing here. We're talking about whether the wealthy do better in an inflationary environment or an economically stable one.
More information here:
Why You Must Adjust for Inflation in Long-Term Planning
You Can’t Hedge Against Inflation in the Short Term
The People Who Really Benefit from Inflation
You know who really benefits from higher-than-desired inflation? The indebted—especially those with long-term, low fixed interest rate debt. If you have one of those lower interest rate 30-year mortgages from 2020 and inflation averages 8% a year over the next 10 years, you're basically paying off that mortgage with money that is worth 57% less than it was when you took out that mortgage. That's a real score. Whoever owns that debt (since every debt is both a liability to someone and an asset to someone else) is getting hosed. In a deflationary environment, the opposite happens. The 30-year Treasury bondholders make out like bandits, and the debtors are ruined as they attempt to pay back their debts with ever more valuable dollars.
You know who seems to have a lot of fixed debt and not that much cash? The middle class. If we're going to do the class warfare thing, they're probably the ones who benefit most from inflation, all else being equal (which it never is).
If All Else Is Adjusted, Inflation Doesn't Matter to the Rich
If all else is equal, inflation doesn't matter all that much. It's just a number. Inflation of 5% or 10% or 25% doesn't really matter if everything you own goes up in value by the same percentage, if your income goes up by the same percentage, and if the government doesn't raise your taxes. Unfortunately, all else is never adjusted, especially the taxes. This is a major problem with inflation for the wealthy.
Let's say you own an asset that is worth $100,000. Over a few years, it goes up in value to $200,000. However, in a high inflation environment, most of that happens to be inflation such that the “real” gain is only $20,000. When you go to sell that asset, how are the taxes calculated? Do you only pay tax on $20,000? Nope, you pay them on the entire $100,000. If you have a 30% tax rate on that sale, you end up with only $170,000. You didn't even make money in real terms since you now need $180,000 to buy what used to cost $100,000.
No, inflation isn't a good thing for those who own assets. And the higher the inflation rate, the worse off they are after-tax.
More information here:
Side Hustles: The Real Inflation Hedge
The Real Problem with Inflation
Well, if inflation is bad for the owners of debt-free assets, then deflation must be good for them, right? Well, tax-wise sure, but otherwise it's the same old, same old. The value of the asset went down, but you don't need as much money to buy everything else you need. No big deal.
However, the real problem with higher-than-desired inflation and deflation is that it affects the economy in a detrimental way. People living in inflationary environments make different decisions. They don't leave their money in the bank where it can be loaned out. They might even buy “hard assets” they wouldn't otherwise buy. They invest differently. They work differently. They choose different jobs. It has all kinds of economic effects, and the overall effect is definitely negative.
Same problem in a deflationary environment, like an economic depression. When the economy tanks, nobody does better. The rich do badly. The poor do even worse. But it isn't good for anyone.
Academic Studies Don't Account for Confounding Variables
Sometimes there are studies that suggest or “prove” that the wealthy became more wealthy at the same period of time when inflation was higher than desired. The old adage, “Correlation is not causation,” applies. There are other reasons why the real wealth or real income of any given group might have gone up, but the high inflation isn't it.
Some Assets Do Better in Inflation Than Others
Naturally, some assets do better in an inflationary environment than others. Stocks, TIPS, commodities, precious metals, and cryptocurrencies are often listed as assets that do OK during inflation while bank accounts, CDs, and bonds are generally thought to do poorly. Inflation is perhaps the greatest enemy of the investor (besides the investor's own behavior), and every portfolio should be built to adequately deal with both expected and unexpected inflation. Of William Bernstein's Four Horsemen of the Apocalypse (Inflation, Deflation, Confiscation, and Devastation), inflation is by far the most common. Ignore it at your own peril.
That means most people need the majority of their assets in stocks and real estate. A significant portion of your bonds, especially if a big chunk of your portfolio is in bonds, needs to be indexed to inflation with instruments like TIPS and I Bonds. You might even want a dash of speculative alternatives thought to do well in a hyperinflationary environment in the portfolio. But even if you have assets that aren't wiped out in a nasty bout of inflation, that doesn't mean you should get down on your knees and pray for inflation. You probably still would have been better off without it, especially after-tax.
What do you think? Agree? Disagree? Do you think you've done better when inflation hits?
Inflation would be great for those who loaded up on investment properties with a 3% mortgage. However, like most bogleheads I’m debt adverse so that group doesn’t include me. I also make the financial “mistake” (but wise behavioral move) of paying off my students loans and mortgage, both of which had similarly low rates.
I agree that in general investors are hurt by inflation, most obviously bond investors. Having a job with an in demand skill is a good inflation hedge, and is real estate and likely in the long run stocks.
Spot on analysis – good points. If you could somehow know a high inflationary period was coming, you could load up on low interest debt like a 100% financed doctor mortgage loan for an expensive house, refinance student loans over a 20-30 year period at 2%, etc, but it’s notoriously hard to predict those things. As the WCI likes to say, my crystal ball is cloudy.
Another negative thing inflation does, which does disproportionately adversely affect the lower and middle class because a higher proportion of their income comes from wages, is that it masks real declines in wages. If inflation is 30% over a 5 year period, but wages only increase 25%, that is a 5% decline in wages. People who rely on wages for all of their income are hurt, whereas assets will on average have by definition increased the full 30% in comparison. Of course, real wages could decrease in a stable price environment too, so this is not directly caused by inflation, but it would more noticeable in a stable environment instead of “stealth.”
No guarantee assets will keep up with inflation. Some will, some won’t. Nominal bonds don’t tend to keep up with inflation for instance.
The elephant in the room is government debt (particularly federal). Being the largest holder of low interest rate debt, they stand the most to gain by keeping interest rates low and inflation high. Already more than $1 trillion of the annual budget goes towards interest. Imagine if bond rates climb higher and new debt and old debt reinsurance is at much higher rates. I would bet on continuing historically lower interest rates which leads to higher inflation in the long term because policy makers have to take debt servicing into consideration. Unless, of course, deficits are trimmed and brought under control or eliminated, which is unlikely to say the least. Or the debt could be monetized, which is also inflationary.
the post acknowledges that asset prices matter, and rise with inflation (an undefined term) but then builds on an assumption that asset price rise (the example in the post is a house price) is simply equal to CPI or negated by an equal rise in costs, which is demonstrably not true. Median home prices and more so equity prices have risen far more than CPI. How much of this is from “inflation” is a topic of disagreement.
The debate is significantly muddied by the use of undefined terms
I had a very similar reaction.
For instance, wealth percentile tiers have grown much faster than CPI over the last 10 years. But the article stays silent on this …?
But the author has a strong track record for insightful analysis…. Which leaves me to simply wonder if this is just a blind spot?
Not sure I’m familiar with the phrase “wealthy percentile tiers”. You mean like how much wealth it takes to be in the top 1%? Lots of assets have risen in value faster than inflation in the last decades including US stocks, most real estate investments, and housing in general. Is that all you’re saying?
I think the house example in this article wasn’t to say that this IS how home prices rise (and ONLY how they rise). It was to illustrate a point with some solid numbers, where it looks like you are having appreciation, but you actually aren’t. You might have missed the point if you are saying the author thinks home appreciation is only ever commensurate with the CPI. The author has described average residential real estate growth rates in many other (RE targeted) articles.
the conclusion, however, that inflation (the ultimate cause of which is monetary debasement) doesn’t benefit wealthy people completely breaks down if the house price rise is greater. Add in the equity accounts rising in value. Own a lot of real assets and it’s easy for the pumped up nominal gains to overcome the negatives of inflation that one experiences on the expense side
Agreed. Inflation is not good for the wealthy or the poor in aggregate. It IS good, however, for specific groups from each of these categories.
In the case of the wealthy, those with closest access to the money printer get the most benefit (Cantillon Effect). Ie. If the government chooses YOUR defense contractor company to buy missiles from and prints money to buy them, you get that money before everyone else and you benefit first from it before it spreads to the rest of the economy and causes inflation.
In the case of the poor, if you’re getting food stamps or housing aid or any other government benefit and the government is printing money to give this to you, you’re getting benefit from inflation.
In both cases, the government is choosing specific winners and losers. It’s the average Joe in the middle class that ends up being the real loser in all of this.
I’m not either of these examples benefit from inflation. Yes they benefit from receiving money, either from the defense contract, social security, SNAP or other. But the purchasing power of that money goes down with inflation. So like most of us, they lose from inflation. They government might benefit as mentioned in the article about being indebted during times of high inflation. They can purchase the missiles with today’s dollars by increasing the deficit and pay for that purchase in the future with dollars collected from tax, which have been devalued by inflation. But the purchasing power of social security benefits and SNAP go down with inflation. So unless those benefits get increased in parity with increased cost of living, inflation is bad for those people. If we do give cost of living adjustments for social security then at best you could argue those people come out even as it pertains to their social security benefits.
For SNAP, we would have to increase the threshold for eligibility in addition to increasing the dollar amount of the benefit. Otherwise with inflation their small income increase keeping up with inflation might put the over the eligibility threshold. Without the increased threshold they might really be harmed by inflation if they earn more income but can afford less.
Something that needs to be understood is the necessity of benign inflation for banks to work. The Fed’s targets are for the safety and soundness of banks, and thus profound incentives for it to prevent deflation (which it never says) and cause hopefully low inflation at its target. A good exercise for some quiet time over the holidays is to contemplate your own behavioral aspects of deflation, if you can bear it.
Nonsense. If deflation promotes savings and people keep their savings in the bank, how exactly would deflation hurt the banks?
The Fed was created so the government could print money, plain and simple, and so banks could get a bailout for reckless risks.
I took the advice to stay in the market through the post-COVID inflation based on the wisdom that being in stocks is better than being in cash. When the Fed started raising the interest rate like crazy, the stock market got killed and an amazing play would have been to be in cash and get 5+% guaranteed, no-risk in short-term treasuries.
The advice that stocks will be safe with inflation seems to overlook the hawkish response that the Fed will respond with to bring inflation back down.
there are always opportunities to make money trading, timing the market. The problem is that’s very hard to do repeatedly to beat the long term market return
this isn’t a trading website
the best way to combat inflation in long term investing is to buy and hold assets. An equity heavy portfolio has done great through the recent period of high inflation
If you stayed in the market, then you’ve done very well during that period. Way better than 5% in money markets
I work in a tech-related field, and while I make decent enough money, I’ve lost ground. My income didn’t go up much during the inflationary periods. The COLA raises we got were ‘matched to other tech peers’ and not inflation. One would think it was collusion in how so many big companies gave traditional COLA increases.
From the people I know, and from stats I’ve seen, many people didn’t increase their salary along with inflation. So yeah, it was a little painful for me, and a very painful for others lower down on the income list.
Personally when I hear inflation benefits the wealthy I assume they mean because the assets the wealthy own rise much higher than inflation making them richer while others have to spend more of their money if things that don’t increase wealth like rents and food. Not sure if there’s actually a high correlation though between higher inflation and the larger increases in those asset values though.
Yes, exactly. It’s never perfect correlation especially in near term but you can pretty easily see this just looking at a chart showing SP500 and M2 money supply (since money supply increase is the ultimate driver of inflation over the long term)
Since this is a doctor-centric website, I think it bears mentioning that doctors and healthcare systems in the US are likely a “wealthy” group particularly negatively impacted as costs go up with inflation but insurance reimbursements don’t keep pace.
I’ve noticed a lot of discussions about inflation assume that wages will be rising with inflation (paying off debt with higher nominal dollars that are less valuable, etc) but that’s not true for docs.
except that same inflation pumps the value of your assets especially equities and real estate. So if you hold a lot of assets it’s easily a net gain
Your take on inflation is so convoluted it’s nots even funny. Even Arnold Schwartzeneggar says inflation absolutely benefits the rich in his documentary. Stop trying to fool people with this nonsense.
Nots funny at all. “Schwartzeneggar” is definitely my go to for economic analysis as well.