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Example 1:

Imagine a person making $50,000/year. Divide that by 12 and they earn $4,333/month. Back in July 2000, 22 years ago, the House Price to Income ratio was 4.5, so if you made $50,000 then a house would cost roughly $225,000. Average mortgage interest rates were 8.2%. Assuming you put down 20%, let’s run the numbers for a 30-year fixed rate mortgage. At an 8.2% interest rate, the monthly payment (principal and interest) is $1346. Assuming 1% annual taxes (so $2,250 per year, or $187 per month) and $750 per year for insurance, we are at $1597 for a monthly all-in. Is that affordable? Let’s look at what mortgage brokers use to qualify lenders: monthly housing expenses divided by gross (pretax) income. 1597 / 4333 = 36.8%. This is workable — lenders like to see this so-called “Debt-to-income” ratio as low as possible, but anything under 43% is allowed. If the person has any other debt to consider (student loans, car payment, credit card debt, other mortgages) that also has to be factored in.

Example 2:

Okay, so let’s zoom forward to November 2021 and run the same calculation. Interest rates on 30-year fixed rate mortgages are around 3.1%. Houses have increased in value, both in absolute terms and, more importantly for this calculation, compared to incomes. The Home Price to Income Ratio went up from 4.5 to 7.5, so at the same income of $50,000 the house is now $375,000 but we have the lower rate — so let’s see how it plays out. One note — we now need $75,000 to put down rather than $45,000 before, but let’s assume we find that $30,000 somewhere. Okay:

Hooray, the loan is only $1,281 (principle and interest) so actually cheaper than the other one. I kept the insurance the same, $750/year, and kept the property tax at 1% of value, so $3,750 per year or $312.50 per month. All-in we are at $1,657, so $60 higher than the first example with the lower house price and a higher interest rate. Great! All’s well in the world. Now our debt/income ratio is 38.2% instead of 36.8%, but we can still get a mortgage and get on with our lives.

Example 3:

And how does it look now, 8 months later, with rates at 5.73% (today’s average rate) and Home Price to Income Ratio at 8?

Our house now costs $400,000 and we need another $5,000 to put down (80K total), and just the loan costs $1,863. With taxes and insurance, our all-in is now above $2,000, at $2,259. This represents a 52.1% debt/income ratio, and it’s going to be nearly impossible to get a loan at this amount. Remember, this is pretax, and lenders want you to have some room in your budget for non-housing expenses, like, you know, food.

Links:

https://www.weforum.org/agenda/2019/04/50-years-of-us-wages-in-one-chart (mentioned)

https://www.numbeo.com/property-investment/rankings_by_country.jsp?title=2022-mid&displayColumn=0

https://www.longtermtrends.net/home-price-median-annual-income-ratio/

https://fred.stlouisfed.org/series/MORTGAGE30US

https://www.cnbc.com/2022/06/30/housing-shortage-starts-easing-as-listings-surge-in-june.html

Yesterday the Bureau of Labor Statistics issued the June CPI numbers.

We are now running at an annual inflation rate of 9.1%, up from 8.6% last month. This is the largest 12-month increase since November 1981. The BLS defined the increase as broad-based, with energy, shelter and food being the biggest contributors.

Energy

The energy index rose 7.5% overall after rising 3.9% in May. gasoline 11.2%, natural gas at 8.2%. Electricity index also rose 1.7%. The energy index overall rose 41.6% for the year, with gas rising

Shelter

The shelter index increased 0.6% in June, as it did in May. Rent index rose 0.8%, and owner’s equivalent rent rose 0.7%. Lodging away from home (hotels and such) actually fell 2.8% in June after a string of increases in recent months.

Food

The food index rose 1% in June, the sixth consecutive increase of at least 1% in that index. Food away from home rose 0.9%. The only major grocery group to decline in June was the index for meats, poultry, fish and eggs which fell 0.4%.

Overall, food at home rose 12.2% over the last 12 months.

CPI

To review, the bulk of the CPI is made up of Shelter (32%), Commodities (21.2%) like apparel, new/used vehicles, alcohol, tobacco, Food (13.4%), Energy (8.6%), Medical Services (6.8%) and transportation services (5.8%)

My main take away is that the longer this elevated inflation continues, the longer it will continue. Anyone not asking for a significant, 8-10% raise from their employer at this point is effectively getting a pay cut. Eventually people are going to take their financial lives in their own hands, and when they do, I think it’s going to lead to a wage-price spiral where people get raises, but everything becomes more expensive because everyone is getting raises just to keep up.

The Fed now knows it needs to act, and it needs to act quick. So what are the likely results from this higher-than-expected inflation print? It will likely lead the Fed to a 75-100 basis point (fancy way for saying .75% or 1%) federal funds rate hike in at the July FOMC (Federal Open Market Committee) meeting. This is pretty significant — the current federal funds rate is 1.5%-1.75% (it’s set as a range between an upper limit and a lower limit) so with an increase of 75-100 basis points it would go up to 2.25-2.5% or 2.5-2.75 depending on how aggressive they choose to be.

The popular viewpoint at the moment is that the fed will continue tightening until they “break something,” and then they will ease up. A bit of historical context here might be helpful.

For the last 20 years we have had both historically low interest rates and quite low inflation. Post financial crisis in 2008 they had many years of 0% rates (which was a first at the time), until 2015. When they tried to raise rates up to 2.5% in the period of time from 2015 to 2019, the hiking cycle was cut short when the economy was showing signs of stress.

The Fed has what they call a “dual mandate” which is 1. Stable Prices and 2. Full employment. They really shouldn’t be concerned about asset prices (real estate, the stock market, etc.) but they have started to be more and more influenced by the markets.

In the covid period, The Fed responded by moving rates back down to zero, by resuming Quantitative Easing, by sending out stimulus checks and increasing the amount of unemployment, pausing student loan payments, and that sort of thing.

Links:

BLS.gov news release

https://www.bls.gov/news.release/pdf/cpi.pdf

Reuters

https://www.reuters.com/business/past-fed-hiking-cycles-sanguine-severe-may-say-little-about-this-one-2022-03-17/

Brookings:

https://www.brookings.edu/research/fed-response-to-covid19/

You may have have heard the term Greedflation floating around lately. What is “Greedflation,” where did it come from, and are there merits to the idea? In this episode we will be looking at a NY times article by Linda DePillis called “Is Greedflation Rewriting Economics, or do Old Rules Still Apply?” A link to the article is in the show notes.

From the article:

Since prices started to escalate a year ago, politicians and economists have seized on inflation to tell their preferred story about what went wrong, and what policies would bring it back into line. Some say it’s very straightforward: Supply and demand, Economics 101.

The White House and progressive organizations, however, say wait a minute: This time is different.

In a time of extraordinary disruption, they contend, increasingly dominant corporations are taking the opportunity to jack up prices more than they otherwise could, which is squeezing consumers and supercharging inflation. Or “greedflation,” as the hypothesis has come to be known.

Robert Reich, former secretary of labor and Berkeley professor, just tweeted (and got 10K retweets):

“Let’s be clear: inflation is being driven in large part by monopolies that are driving up prices for the sake of profit.

On the other side, we have Lyn Alden, a prominent macro commentator and investment strategist with a finance and engineering background:

For people saying that “corporate greed” is the main cause of inflation… corporations are always greedy. They didn’t randomly get more greedy in 2022. A lot of broad currency was created in a short period of time while real supplies (commodities, infrastructure) were limited.

You can probably guess which side of the argument I land on. In my opinion, Whenever prices go up, there is always one or two unhappy people who say “we need to do something about “”Price Gouging”” with serious looks on their faces. But they never get very far with this argument, because the market sets prices and any effort to have the government set prices has always led to inefficiencies and shortages. When no one supports your policy or idea, it’s time to move on. And if you don’t want to move on, it’s time to change the name. I think that's what we're seeing here with Greedflation. But we have to give this argument a full chance, so I’ll read a portion of this article and analyze it.

Links:

1. Is "Greedflation" rewriting economics, or do the old rules still apply? https://www.nytimes.com/2022/06/03/business/economy/price-gouging-inflation.html?searchResultPosition=1

by Lydia DePillis, @lydiadepillis

2. https://twitter.com/RBReich/status/1538283894901862400?s=20&t=n_mCEoOPv-4bjzLDVv0XJQ

@RBReich

3. https://twitter.com/LynAldenContact/status/1533210428238614529?s=20&t=n_mCEoOPv-4bjzLDVv0XJQ

@LynAldenContact

4. Tyson Foods earnings call:

https://www.fool.com/earnings/call-transcripts/2022/02/07/tyson-foods-tsn-q1-2022-earnings-call-transcript/

5. "Corporate Profiteering" PDF with transcripts of earnings calls:

https://groundworkcollaborative.org/wp-content/uploads/2022/06/RESEARCH-Corporate-Profiteering-Findings-22.06.08.pdf

Other Mentions:

Michael Faulkender

John Zhang

Donnie King

Brett Briggs

Samim Bassul