This post is mainly a link to a discussion of inflation.

The link is to Musings on Markets, a blog by Aswath Damodaran, a finance professor at NYU. It’s pretty long but thorough, and well worth reading. Personally, I don’t think the chances of interest rate rises to nip incipient inflation in the bud are as high as Prof. Damodaran seems to think, but on the other hand I’m always too optimistic.

My two big reservations about the post concern real estate and gold as inflation hedges. On gold, it was money a generation ago but in my view is now just a special kind of dirt, except for in places like India, where, in effect, burying your savings in the back yard is preferable to deposits in banks no one trusts. The gold price is also subject to the ebbs and flows of pricing based on the large scale and long lead times inherent in any mining operation. Sort of like urban office buildings, there’s often either a glut or acute shortage. Gold did spike in the late 1970s on inflation fears, but added capacity produced fifteen years of no price movement. In short, there may be high correlation between gold and inflation but I don’t think there’s causation any more.

Real estate’s another funny one. The price data Prof. Damodaran cites show that house prices almost never seem to go down. My two issues:

–real estate can be highly illiquid, particularly in recession (typically caused by high interest rates). It becomes harder to get a mortgage and potential sellers withdraw because the price they would receive in a forced sale would be so low. So I’m suspicious of the price data.

–typically in the past in the US, housing has been financed through fixed-rate mortgages covering, say, 80% of the purchase price. Arguably, in times of high interest rates, the loss in value of the house is offset in large part by an increase in the now-below-market value of the loan. Today, however, many home loans are at least partially variable rate, so this offset is less than it once was.

tomorrow the deflation side