Back to Bogle Basics, The argument for and against inflation



Inflation. It is the backbone of nearly every long-term value investment philosopher from Buffett to John Bogle. John Bogle, the famed ex CEO of Vanguard and creator of the modern day index fund was particularly passionate about the subject and covered inflation extensively in many of his writings. He likened inflation to a galloping steed, it starts out slow, but then it picks up speed and momentum before finally getting up to a sprinting pace. As the price of commodities increases, others line up to buy the commodities in fear of shortage and price inflation. This drives up the price of commodities even more. The net effect is a salient impact on cost of goods sold for any company and an upward pressure on prices of nearly every common product in the consumer price index. The same effect occurs with real estate and the overall stock market in general, price inflation is based on fear.

Therefore, it is logical in the mind of the long-term investor to buy stocks that represent physical assets as a hedge against inflation because the value of those assets will go up over time. It’s still only part of the equation though, as assets are only valuable if they produce income, or are liquidated in receivership. In steps the FED. The control over interest rates has enormous effects on inflation, the initial thought is that at low interest rates, companies will create more jobs and spurn a higher demand for goods overall, the net effect will be more money for individuals to spend in the economy and a minimal effect on cost of goods sold (inputs) as long as borrowing remains affordable.

Bogle argues that this is usually a fallacy, as the decrease in interest rates leads to deflation when companies go all out to improve existing capacity through R&D capital expenditures, the net effect on higher efficiency is a drop in consumer good prices. The job creation is good when new projects are created in research and development, but I would argue in this day and age, the cheap money is making matters worse for wages and worse for added employment.

Walmart’s recent acquisition of for a few billion is a good example of this. In the old days, an improvement to R&D would naturally be an increase in manufacturing or service capacity using a logical amount of money to purchase, create or improve the capacity. Now, companies like do employ a good amount of individuals, but nowhere near as many individuals as a standard $3 billion investment in property plant and equipment would. No way. In the current age, technology is so mystifying to large hard asset companies that they’re being held hostage to figure out the equation of Amazon and others. Unfortunately, that equation doesn’t usually make money (just take a look at Amazon’s eps, if you can ever find one in a given quarter). Increasing the interest rates will make companies think long and hard about where to distribute that money, instead of throwing it at every Silicon valley kid with an idea, give it to 1,000 new workers that can put your investment in the black.

It may be time for the FED to start raising rates.



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