The Real-World Ravages Of Inflation
Our town is experiencing unprecedented turmoil. Schools are closed. Parents are angry. The kids are bored and sad.
Our town is experiencing unprecedented turmoil. Schools are closed. Parents are angry. The kids are bored and sad.
A little over a week ago, the local teachers’ union called a strike. Teachers’ strikes are illegal in Massachusetts. Nonetheless, an overwhelming majority of the union voted to shut down the schools as part of their collective bargaining with the City for a new contract.
Parents are seething. Some are calling on the union to end the illegal strike and return to teaching while they negotiate the contract. Others are calling on the mayor to find the funds to pay the teachers what they are asking. The longer this has gone on the more people have started to take sides and assign blame.
Except, ironically, I have not heard a single parent place blame at the feet of the main culprit: inflation.
Allow me to provide some background. By law, our local property taxes can’t increase by more than 2.5% per year. Additional taxes can come from new real estate development, but in an old city that’s not a big contributor to the growth in tax revenue. All told, the city’s revenues go up in the 3% to 4% range per year.
The cost of the local public school system comprises well over half of the budget. The prior contract with the local teachers’ union had an annual cost of living adjustment (COLA) of around 1%. That was just fine – before 2020 that is.
Since the end of 2019 inflation, as measured by the Consumer Price Index (CPI-U), increased by a cumulative 19%. That’s substantially more than the cumulative increase in the teachers’ COLA. Put simply, the teachers lost 10%+ of the purchasing power of their salaries between the end of 2019 and today.
Now, if someone comes up to you and takes 10%+ of your pay away for no reason, you are probably going to get pretty angry. Rightly so – after all, you didn’t do anything to deserve that. With inflation it takes people longer to catch on to what’s going on. However, eventually they realize that the pay they are getting is no longer sufficient to buy the things it used to buy them.
So as much as I would like to have our kids back in school where they belong, I have to admit that much of what the teachers are asking for is not unreasonable.
What about the mayor? Why not just quickly settle with the teachers by making them whole for what they have lost due to inflation? Is she the villain who doesn’t value education or our schools as the critics allege?
Well, let’s think about it from the city’s point of view. Revenues have grown at less than inflation, in large part due to the legal limit on increases in property taxes mentioned earlier. The supplementary override which would have allowed the city to circumvent that rule to pay extra for education did not pass. However, many costs that the city faces to provide its services have increased at a faster rate than the revenue – due to inflation.
Where is the city supposed to get the extra money in a way that’s sustainable for the long-term? That’s far from clear.
So when some people choose to portray either side as unreasonable – either greedy and asking for too much or miserly and not valuing education by offering too little, they are missing the point. Inflation is to blame, not unreasonable demands on either side of the negotiations.
Teachers rightly feel they shouldn’t bear the brunt of inflation and effectively make less than they had been for the same work. The city rightly can’t pay what it doesn’t have. There are no winners here – only losers. Starting with our kids, who are sitting at home while the adults engage in increasingly acrimonious public debate.
I won’t go into a treatise on the causes of inflation. Many have far greater expertise on this topic than I do. The simple, and I believe correct, explanation however is that it’s politically convenient for the Federal government and our politicians, and so over time the government systematically lacks the discipline to do the right thing consistently enough to avoid inflation or at least contain it.
Since the end of World War 2, U.S. inflation has averaged about 3.5% per year. That’s about twice the high end of the official 0% to 2% target range. That range itself was a compromise, and some economists believe a weakening of standards, as originally the goal was 0%.
Furthermore, I struggle to find any multi-decade period in the last 75 years when inflation actually averaged below 2%. If you find some, please leave a comment – I would like to know.
Why should you care about any of this? Your kids probably don’t go to our schools, after all.
Well, consider that right now the 10-year market-implied inflation expectation is just slightly above 2%. You can calculate it yourself – take the normal U.S. 10-year treasury bond yield and subtract from that the inflation-adjusted yield on the 10 year TIPS.
Is that possible? Sure. Is that likely? Not according to long-term history.
This is a great example of the inside view bias. In it, we ignore the historical base rates of events and think that our own estimate is so much better. Like a contractor telling you that he will deliver the project on time and on budget when he never has in the past. Or someone telling themselves that this year they will finally lose that weight while ignoring all their previous failed attempts.
Possible, but unlikely.
The investment conclusion is straightforward. If it’s in the Federal government’s interest to have higher inflation and they have a history of allowing it to occur, assume it’s likely to happen again. So, you should avoid investments that:
Have a low and fixed rate of return.
Have an inability to offset rising costs with higher prices.
Otherwise, you will be in the same situation that my city is in: wondering what to do when stuck between escalating costs and insufficient revenues.
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About the author
Gary Mishuris, CFA is the Managing Partner and Chief Investment Officer of Silver Ring Value Partners, an investment firm that seeks to apply its intrinsic value approach to safely compound capital over the long-term. He also teaches the Value Investing Seminar at the F.W. Olin Graduate School of Business.
Inflation is definitely a factor here, but it's a factor everywhere. Costs have gone up across the board for every household and business. The difference is that *almost* everywhere else the costs are worked into the price mechanism in a free market. Here, we are dealing with a very different beast--the public unions.
That makes this actually more of a political problem with a veneer of economics. Public finance in Newton has the same problems as it does in Chicago or Dallas. Huge underfunded pensions liabilities, massive political interest groups, a full AUM play on the local real estate. That last piece is the golden goose.
The economic value of the teachers are being dangled over the balcony here, but in reality we all know there is more than enough money in the system to give the teachers a raise to keep them happy and productive. Instead, the new money will be funneled into that black hole of public union bureaucracy. They can justify this demand for increase every few years. If we wanted to solve the problem we would slash administrator head count, give the teachers more freedom in plying their trade (more recess, ability to discipline kids, not teach only to the MCAS), and everyone would be happier.
It's a ratchet that only goes in one direction. They will be back to sheer the sheep many more times. None of this is about the amount of money required to properly educate school children because that's a pretty easy problem to solve that doesn't cost $270mm. Public schools have been declining since the 1950s and this is exactly why.