The Lottery: Payments or Lump Sum?

I see that the Mega Millions Lottery  is offering (a) $359 million now or (b) $19.2 a year for 26 years.  The gross value of the payment stream is of course 19.2x26=$499.2 million.  Hey, do the math and you'll see that $499.2 tops $359 so take the deferred payments, right?

Well,   I gather that's that what the grownups want us to think.  Don't take it now or you'll blow it. Take the payments, you'll do better in the long run.

But of course it's not right.  Time is money and the present value of the payment stream is the nominal value discounted at the appropriate interest rate.

Anyway, try this.  Assume you get your first payment today and subsequent payments at the beginning of each of 25 more years.  So if you take the payments you are "paying"  $339.8 ($359-$19.2) million.  What is the implied discount rate (internal rate of return)?  Excel says 2.85* percent per year.

So, what is your discount rate?  If your rate is lower than 2.85percent, then the implied present value of the payment stream is higher than 339.8.  If lower, higher.  Such is the conventional wisdom.

And is this right?  Well, there's taxes.  Not really my department, though I think you have to pay tax on the lump sum payment at the front end, but on the payments only as they come in, which seems to tilt the advantage towards payments.  And I suppose with this kind of money, you may be able to get some Mitt Romney action.

Oh, wait--the "I" word, "inflation."  I gather that discount rate is based on the long-term treasury rate.  The rate is supposed to "impound" inflation.  But it looks to me like the inflation rate is already running  close to 3 percent--low by historical standards but still high enough to eat up all of the implied discount rate.  And what are the chances that inflation in the future will stay that low, huh?   Huh?

Short answer: take the money and run.  What say you?

[h/t: Buce's friend Bruce.]  

*See comments.

The Two-for-one Play

I was telling the Wichita Bureau just now that for all its meteoric rise, the price of gold has been outstripped over the past decade by both lead and copper.

Go for the two-for-one play, Wichita advised. Buy ammo. Copper-plated ammo.

Or could it be that the reason for the runup is that all of Wichita's neighbors are buying ammo?


JPH Adds: As Wichita falls, so falls Wichita Falls.  When you figure it out, explain it to me.

And I am Right, and You are Right,And Everything is Quite Alright

We're not for inflation, we're not for deflation: we're for flation.

Gold bugs are buying bullion for the understandable reason that central banks appear committed to printing more money: they fear that eventually this will lead to inflation. Stockmarkets are buoyant on the grounds that QE will eventually work to revive the economy and head off the prospect of a double-dip recession. Meanwhile government-bond yields have fallen because central banks seem to spend most of the QE money buying their own country’s debt. Traders see the central banks as putting a floor under bond prices.

Link.

--Wait a minute, your honor, they can't all be right!
--That's right!

The Inflation Lobby and its Enemies

I've been mulling over for a long time the fact that there is a huge "inflation lobby" in this economy--folks who have an incentive to promote inflationary policies because they have a lot to gain from impairing the value of money. That would be, in particular, all those underwater homeowners who would love to pay back their mortgage debt in little teeny inflated dollars. We've seen it before: my generation bought our homes in the 60s. Through the 70s we howled about inflation. But the fact was that our salaries usually grew with inflation while our mortgage payments did not--which is to say, in purchasing power terms, our mortgage payment shrank every month.

Reading Leo Kolivakis' horrific account of the looming pension crisis, my first thought was: there is only one feasible way to solve this problem, and that is to inflate the currency so completely as to destroy the value of all that fixed-income wealth. Hey, it's happened before--think of all those 16-stone babushkas selling Mars bars outside Moscow subway stations (and recall these folks).

But then it struck me: no, it just might work the other way around. The cohort of pensioners, aggrieved and soon-to-be-aggrieved, may prove to be an anti-inflation (a deflation?) lobby, ready scratch and grab to prevent the currency from depreciating, to preserve precisely the (unfunded) advantage they (= we) enjoy so far.

David on the Economics of Lunch

My cousin David (who is old enough to remember) has his knickers in a twist remembering prices from the 1950 menu at the FW Woolworth Company (or maybe he has is just from sitting on one of those high stools). "Thanks a lot!" growls David. "Those were the days!"

Sure enough, but it would be important first to play the inflation game. Using the CPI calculator from the Bureau of Labor Statistics website (link), I find that the appropriate pricing factor is about niine—in the sense that it would take you $9 today to buy what $1 bought then (actually 9.08, but I’ll round off so I can do the math in my head). So, a ham (or egg, or cheese) sandwich is $2.70 (30 x 9); a slice of cake or pie is $1.35 (15 x 9) and so forth.

But there are problems here. First, what is the right point of comparison? I There are no Woolworth’s any more; maybe the right point of comparison would be Denny’s. One threshold difficulty with this comparison is that the Denny’s website lists ten different menus (link)—almost as if you could say that the range of choices has expanded even faster than the CPI. There is a “kiddies” an “all-night” and, perhaps most relevant for our purposes, the menu for “seniors” (defined as “55 and over”) so you can qualify as a “senior” even if your age in 1950 was negative three.

But if you look at the senior menu at the Denny website, you run head-on into another perplexity: the website listing doesn’t seem to track with the offerings at the 1950s Woolworth. No “ham sandwich;” instead, w e have a “Senior Bacon Cheddar Burger,” defined as “a delicious, juicy hamburger with crisp bacon, Cheddar cheese, lettuce and tomato.” Or a “Senior Club Sandwich,” said to contain “thinly sliced turkey breast, crisp bacon, lettuce, tomato and mayonnaise on toasted white bread.”

Perhaps the closest comparison is the “Senior Grilled Cheese Deluxe Sandwich,” which turns out to be “melted American cheese with tomato on grilled sourdough bread.” I suppose if you were the patron saint of old geezers, you could get her to leave the tomato off, but it’s a question.

Prices are not listed for these items—apparently the folks in marketing have advised that web shoppers are not price-sensitive. We do, ,however, find a “Flatjack Sizzzlin’ Skillet,” on offer for $5.99, containing “a traditional breakfast delivered sizzlin’ hot on a casts iron skillet. On the side, sit some warm flatjacks. Thin, sweet pancakes ready to be rolled up with scrambled eggs, sausage, bacon and hash browns. Pour syrup on top, if you know what’s good. It’s up to you to customize every delicious bite.”

Flatjacks? Ah, let it pass. A more puzzling question is—whose “tradition”? Somebody at the bar at Woolworth’s in 1950 would surely have told you that if he asked his wife for the “traditional skillet breakfast,” she would have hurled it at him (idle thought: does Denny serve this Mount Rushmore of breakfast treats with a complimentary chest spreader, for emergency care until the paramedics arrive?).

Still I have to admit I am a bit baffled by all this: on the one hand, the basic “factor of nine” prices sound pretty cheap. On the other, it is not obvious that you can get anything that compares to the 1950 breakfast any more—and if you buy one of the monster specials, you actually get a kind of a bargain.

There is also the problem of quality, and that is almost too depressing to contemplate.. The1950s menu offers “plain bread,” which might not be a selling point today. I’d speculate that the 1950 chicken just might be superior today’s factory specials (and note—relatively speaking, on the 1950 menu, the chicken is the most expensive offering). For sheer ambiance, I don’t think either has much to offer. I don’t suppose anybody ever actually goes to Denny’s, any more than you would have gone to Woolworth’s—if you wind up at either place, then something has gone bad wrong with your day. On the other hand, I don’t suppose anybody ever will duplicate that inimitable Woolworth basement smell.

Perhaps the most interesting comparison, though, would be in terms of earning capacity. Forget about straight CPI numbers, on which I would concede that Woolworth does look fairly cheap. Instead ask: how much of the average weekly paycheck would an Woolworth lunch cost? My suspicion is that even at 1950 prices, lunch out was more of a big deal than it would be today. So even though Denny serves up a lunch fit for an angry rhino, the customer is likely to go home with less of a dent in his wallet than his grandfather at Woolworth’s so long ago.

You Want Inflation? I'll Show You Inflation!

(Cross-posted from CreditSlips)

Followup on yesterday (link)--you want inflation? I’ll show you inflation. Here’s a piece I put together a few months back to introduce inflation to some law students:

==

The Thomas Mann story I mentioned this morning is “Disorder and Early Sorrow,” published in 1925, situated in the great German Hyperinflation that peaked in 1923. The story revolves around Professor Cornelius and his family, particularly his new-age children. The first two sentences are:

The principal dish at dinner had been croquettes made of turnip greens. So there follows a trifle concocted out of one of those dessert powders we use nowadays, that taste like almond soap.

Not the kind of life a senior professor wants to lead, I can assure you. Later we get this sketch of domestic life as the family organizes a party:

Many people had to give up their telephones the last time the price rose, but so far the Corneliuses have been able to keep theirs, just as they have kept their villa, which was built before the wear, by dint of the salary Cornelius draws as a professor history—a million marks, and more or less adequate to the changes and conditions of post-war life. The house is comfortable, even elegant, though sadly in need of repairs that cannot be made for lack of materials, and at present disfigured by iron stoves with long pipes. Even so, it is still the proper setting of the upper middle class, though they themselves look odd enough in it, with their worn and turned clothing and altered way of life. The children, of course, know nothing else; to them it is normal and regular, they belong by birth to the ‘villa proletariat.’ The problem of clothing troubles them not at all. They and their like have evolved a costume to fit the time, by poverty and out of taste for innovation: in summer it consists of scarcely more than a belted linen smock and sandals. The middle-class parents find things rather more difficult.

Later still, Frau Cornelius

speaks of what is uppermost in her mind: the eggs, they simply must be bought today. Six thousand marks apiece they are, and just so many are to be had on this one day of the week at one single shop fifteen minute’s journey away. Whatever else they do, the big folks must go and fetch them immediately after luncheon; and Xavier Kleinsgutl [the house-servant] will don civilian garb and attend his young master and mistress. For no single household is allowed more than five eggs a week; therefore the young people will enter the shop singly, one after another, under assumed names, and thus wring twenty eggs from the shopkeeper for the Cornelius family. This enterprise is the sporting event of the week…

Let’s do some computation here. Eggs cost six thousand marks, so 20 eggs cost 120,000 marks. The professor gets a slary of a million marks a month. So 20 eggs cost 12 percent of his monthly salary. In our world, 20 eggs cost—what, maybe $3, give or take. If eggs cost 12 percent of your salary, you’d be earning $25 a week…

Finally, here’s a good non-technical non-fiction account of the German experience (link).

And here’s a neat little graph of the German hyperinflation (link). Note that it is “log scale,” which means that each horizontal line represents a number ten times the last horizontal line.

Postscript: Taxmom, a premium-content subscriber to Buce/Underbelly, asks:

On the subject of literature and insolvency, what do you think of Arthur R. G. Solmssen? I came across his book "A Princess in Berlin" about a year ago. While it's not deathless prose (somewhat contrived plot) his description of the inflation in Berlin in the 20's is awesome. I just googled him and come to find he is a Philadelphia lawyer.

That can be easily answered: never heard of either one. Looks like one more item for the inbox, and near the top, too. Thanks again, Taxmom.

"Too Much Capital (Again?)?"

(Cross-posted from CreditSlips)

I guess I have been one of those pushing the meme that there is just “too much” capital sloshing around out there, chasing too few deals, and with no completely obvious reason (aliens?). I am therefore happy to introduce Thomas Palley, proprietor of “Economics for Democratic and Open Societies,” who offers no fewer than eight alternate explanations for asset price levels. The whole piece is superb reading, a marvel of concision and exposition (link). But here are the takeaway points:

Factor #1: increased income inequality. ...

Factor #2: increased profit shares. …

Factor #3: taxation policy. … [B]etween 1978 and 1999 top marginal tax rates fell significantly in every OECD country for which statistics are available. …

Factor #4: export-led growth. It is now widely recognized that China and much of East Asia have adopted export-led growth, a key ingredient of which is undervalued exchange rates. To keep their exchange rates under-valued, East Asian governments have been accumulating U.S. and European bonds, resulting in lower interest rates that have in turn fostered higher equity and real estate prices.

Factor #5: lower central bank interest rates. …

Factor #6: credit market innovations. The last twenty years have also witnessed tremendous credit market innovation. In the corporate sector, the 1980s saw the introduction of junk bonds, and such financing is now the favored vehicle of leveraged buyouts that bid up asset prices. Additionally, the emergence of private-equity funds allows the super-rich to pool their funds and leverage them. …

Household credit markets have also changed as evidenced by home equity loans and the advent of interest-only mortgages. These innovations have liquefied homes and increased the volume of money chasing real estate assets.

Factor #7: demographic trends. Another widely recognized development is the aging of the baby boom generation, which is now in the second half of its work life. That places baby boomers in their period of heaviest saving for retirement, which has increased asset demand. …

Factor #8: mania.…

(Hat tip: Economist’s View, your one-stop shopping site for good econ reading (link))

Is There An Inflation Lobby?

(Cross-posted from CreditSlips)

Here’s one that is way above my pay grade but this has never stopped me before. I write about the inflation lobby, if there is one.

Anybody out there old enough to remember when Adlai Stevenson was president? Okay, how about Jimmy Carter? Remember the great kidney stone of a year, 1980, when the inflation rate veered toward 14 percent per year? Not exactly Germany 1923, but enough to –inflict a lot of pain: “people on fixed incomes,” we were told, and it was true—if inflation went to 14 percent while your monthly social security check stayed just the same, you just had a 14-percent pay cut. It was throw an awful lot of small (and some big) businesses under the bus: try keeping up with a your monthly revolving when your (floating) rate goes up by a factor of, say, three.

But where you stand depends on where you sit. If you are not on a fixed income—if your paycheck goes up—and if your debt is fixed—then congratulations, bucky, you just got yourself a big chunk of relief. From your point of view, the more inflation the better.

In the 70s and 80s, we saw the inflation lobby hard at work—no, strike that, not hard at work, but sitting on the furnace eating chocolates while the pensioners and others did the work. In particular, I’m thinking of all the people who bought their homes on 30-year fixed mortgages in, say, 1967, just in time to enjoy the jolts and disruptions of the next two decades.

Clearly, there are political implications here. If we truly have a nation full of people with fixed-rate debt (and floating incomes), then there is no incentive to control inflation. Quite the contrary: you want all the inflation you can. Ironically, this is true even if the subjects don’t see it that way themselves: way I remember it, some of the loudest grousing about inflation came from people who were its biggest beneficiaries.

This is the point where you would expect me to write about how the inflation is coming back again, with the inflation lobby in tow. In truth, I believe the first part of that proposition. I’m one of those who believes that we are behaving like Donald Duck in the cartoon, suspended in mid-air, having run off the diving board and not yet having noticed that he’s ready for a fall. But what about the inflation lobby? Recall what I said before: “if your debt is fixed.” Back then, the mainstay of the loan market was the fixed-rate loan. Consumer installment loans were fixed-rate. So also credit card debt (if you had any). And the system thrived on the 20-year (or 30-year) fixed rate real estate loan.

You can see where I am going with this one. I’m not smart enough or well informed enough to say anything conclusive about the loan market today. But I do know that a lot of our debt is floating-rate. Translated, that means we have shifted the risk of rate fluctuation from lenders (where it lay in the 70s/80s, and since time immemorial) to borrowers. If I’m right, then inflation may be far more painful for the mass of borrowers next time than it was last. Indeed, this may be one reason why there hasn’t been as much worry about the risk of inflation as you might expect—it may be that the people most like to suffer from it belong to a class that has no memory of any such pain. Keep this in mind as you try to figure out what will happen when payday comes on all the borrowing and spending of the last few years.