Inflation Fears and a Coin Flip

Steve Waldman has a new post up on why rich people, and not so rich people, might prefer hard money over greater wealth. This post was a response to Paul Krugman, and Cullen adds some good thoughts too.

Here’s Steve:

““Full employment” means ungrateful job receivers have the capacity to make demands that could blunt equity returns. And even if that doesn’t happen, even if the rich do get richer in aggregate, there will be winners and losers among them, each wealthy individual will face risks they otherwise need not have faced. Regression to the mean is a bitch. You have managed to put yourself in the 99.9th percentile, once. If you are forced to play again in anything close to a fair contest, the odds are stacked against your repeating the trick. It is always good advice in a casino to walk away with ones winnings rather than double down and play again. “The rich” as a political aggregate is smart enough to understand this.”

Steve says the richest are trading “full employment” for stable prices, because that suits their best interests, and that they believe getting back into the .1% is very difficult, so difficult they do not think they can do it again.

Hard money is the ultimate risk free asset. It is far superior to any real world asset, because it cannot materially degrade. It is a mark in a cloud based accounting ledger, and destroying the ledger doesn’t take away the money.

I’ve pointed out (with prodding from Steve W.) the reason we have such fears of inflation today despite record low actual inflation is almost certainly due to the loss of purchasing power in real money terms after accounting for both inflation AND interest rates.  Inflation is actually reducing purchasing power for people holding cash money after accounting for interest rates. Looking at this, we can see why rich people are howling about inflation even when inflation is below 2%. They are losing money for the first time in a generation after taking into account interest. 

One thought experiment which may help in understanding why some people fear inflation so much is a simple coin flip wager.

In this wager, it’s a standard “head you win, tails you lose” wager. You have to risk your entire net worth on this wager, but you get to set the odds you get when you win. So, if you lose, you lose everything. If you win, you get some multiple of your entire net worth.

It’s pretty clear higher net worth will result in exponentially higher demands for a winners multiplier. At low levels of net worth, you might take a 2:1 payout, because you know you can get the money back pretty easily.  If your net worth is $100, you might take a 2:1 pay out.

But as your net worth gets higher, anyone will almost certainly demand higher and higher multipliers to play. If your net worth is $1m, there is no way you’ll take a 2:1 payout – you’ll hold out for something higher, like a 7:1 payout, or maybe a 10:1.

If your net worth is $100,000,000 – is there some multiplier which is high enough for you to play? How about $1 billion? Is there any multiplier which is worth risking $1bn on a coin flip?

 

 

 

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Expert in business development, product development, and direct marketing. Developed strategic sales plans, product innovations, and business plans for multiple companies. Conceived the patent pending Spot Equivalent Futures (SEF) mechanism, which allows true replication of spot and swap like products in the futures space.

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21 Comments on "Inflation Fears and a Coin Flip"

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JKH
2 years 9 months ago

Waldman –

“Some of that higher return will be distributed to groups of people who are, under the present stability, hungry and eager to work, and there is no guarantee that the gain to the wealthy from excess aggregate return will be greater than the loss derived from a broader sharing of the pie.”

right

its about expected elasticity in that sense

the rich simply have more to lose in aggregate

but the issue of fear of inflation in general when inflation is a credible risk should really be separated from the issue of rationalizing a fear of inflation in the current environment – those are two distinct questions

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Philip Diehl
2 years 9 months ago

Do the rich and ultra-rich really care about CPI inflation? Aren’t they passing up fixed income investments and reaching for returns spurred by low interest rates and the inflation of asset prices thanks to obstruction of fiscal policy and exclusive reliance on monetary policy? Seems like they’re the ones primarily benefiting from the current economic policies they decry.

I suspect their apparent obsession with inflation reflects adoption of GOP talking points to mobilize middle income voters and focus their attention on the threat inflation poses to retirement income instead of the greater benefit inflation offers in easing their debt burden. It advances their political agenda of electing Republicans and strangling domestic spending.

No doubt some believe the BS. I’ve scratched my head about why people who hold a significant share of their wealth in precious metals don’t support policies they think will cause high inflation. Maybe some of them are pumping and dumping. Gold ETFs are a good vehicle for that strategy.

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beowulf
2 years 9 months ago

“I suspect their apparent obsession with inflation reflects adoption of GOP talking points to mobilize middle income voters… It advances their political agenda of electing Republicans and strangling domestic spending”

What’s amazing is how spectacularly against interest this is for the GOP politically. When the average family is doing well financially they vote for a Republican president and when they’re hurting, they vote for a Democratic one. What’s curious is this dynamic holds regardless of which party is in power. The Republican George H.W. Bush was tossed out in 1992 because of a weak economy, with unemployment was 7.5% that year; Democrat Barack Obama was reelected when the 2012 unemployment rate was 8.1%. Bad times are good for the Democrats.

On the other side of the coin– 1952, 1968 and 2000 were general election years with a Democratic-held White House and economy that really couldn’t do much better. In each case unemployment was under 4.0%. If you think that was good news for the incumbent party, you’re not paying attention– GOP nominees won all three elections. Good times are good for Republicans.

That’s why the GOP reaction ever since Obama’s inauguration has been nuts. McConnell and Co don’t seem to get that the faster the economy recovers, the sooner the GOP gets back in the White House. Strangling domestic spending in Obama’s first term probably cost Romney the White House in 2012. If they keep strangling it, its gong to cost the GOP 2016 as well.

Guest
2 years 9 months ago

Have you floated this notion past the Nate Silvers, Sam Wangs, Andrew Gelmans, Larry Bartells of this world? Any research addressing it?

It arguably explains the Dems’ superior economic performance: they get voted in at bottoms, so they get credit for the ups.

Sort of gives a much deeper meaning to Carville’s “It’s the Economy, Stupid.”

Guest
beowulf
2 years 9 months ago

Thanks for the kind word Steve. Haven’t floated the idea past anyone other than the readers of this thread. I leave it to the world to beat a path to my door. : o)
I’ll have to think more about it and write a longer post.
I suppose Harry Truman was making a similar point with his “if you want to live like a Republican, vote Democratic”.

Guest
2 years 9 months ago

Beo: “When the average family is doing well financially they vote for a Republican president and when they’re hurting, they vote for a Democratic one.”

Damn, that’s an amazing insight that I hadn’t realized. Will be spending some time with that…

Guest
beowulf
2 years 9 months ago

“Outside, of course, for rising healthcare costs, rising university tuition, and housing prices in Blue, coastal cities, where the complaints have some merits. BTW, what do those 3 have in common?”

Its like Bill Vickrey said:
“Inflation occurs when sellers raise prices; they can do this profitably when the forces of competition are weakened by the differentiation of products, real and factitious, misleading advertising, obfuscating sales gimmicks and package deals, mergers and takeovers, and the increasing importance of ancillary services, trade secrets, patents, copyrights, economies of scale, overheads, and start-up costs. Inflation can and does occur in the midst of underutilized resources, and need not occur even if we were to consume our capital by failure to maintain and replace it, consuming more than we produce.”
http://www.columbia.edu/dlc/wp/econ/vickrey.html

Guest
2 years 9 months ago

I haven’t seen any rich people howling about inflation. I’ve seen govt officials be nervous about inflation because the “money supply” is so large, and I’ve seen politically motivated people who want “sound finance” instead of “functional finance” complain about inflation being around the corner, but I have not seen any credible complaint about inflation right now.

Outside, of course, for rising healthcare costs, rising university tuition, and housing prices in Blue, coastal cities, where the complaints have some merits. BTW, what do those 3 have in common?

I don’t think that Steve is correct in interpreting pushback on his redistribution-centric policies as mere “wanting to keep an unfair advantage”.

Hard money, btw., is not even close to being the ultimate risk free asset.

Guest
Cullen Roche
2 years 9 months ago

I agree WS. I live in a bit of a bubble in my work and in my community where I tend to encounter lots of people in the top 5% of the wealth distribution. And I get a pretty good feel for how most of these people think. I don’t know too many rich people who are just coasting through life trying to maintain the status quo. In fact, most of them rely on disrupting the status quo in some form or another.

Most of the wealthy people I know think the exact opposite way of how SRW describes them. They’re all super type A and fairly progressive (even if they wouldn’t label themselves that way). Rich people tend to be OCD disruptors – the type of people who can’t stop being productive and want to take market share from other people in any way possible (usually by overthrowing someone else’s business model).

Sure, there are the crotchety old people and the ones who just inherit lots of money, but I don’t think that describes the majority of the wealthy. The majority of the wealthy are people who have achieved something (which could be the result of luck or skill or both) who tend to feel entitled to keeping what they earn. That’s why they tend to be conservatives. They don’t like the sense of unfairness in sharing what they believe they rightfully earned just because the govt says they should. That’s the wealthy’s source of angst against redistributive policies. Not some maintaining the status quo mentality….

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