The silent tax

Dear Gala,

Most of the losses you will take in life announce themselves. A bad year in the market has a date. A business that fails has a last day. This letter is about the one loss that has no date, that no statement shows you, and that took more from more families in the country where I was born than every crash put together.

First grade

In 1991 I was in first grade. I did not know what inflation was, but I knew that the candy at the kiosk near school cost more almost every day. Not every week. Almost every day. The money my mother gave me in the morning bought less by the afternoon, and the man behind the counter had stopped writing prices on things, because there was no point. That was the tail of it. In 1989 prices in Argentina had risen by more than three thousand percent, and in 1990 by more than two thousand. A family that had saved for ten years in pesos had, at the end, about enough for a week. It stopped that year, when the government tied the peso to the dollar one to one, and for a while people believed it was over.

From a distance

Thirty years later I watched it happen again, from outside. I left Argentina in 2019, the year prices rose by about half. Three years later they doubled. The year after that they tripled. From a distance you see things that are hard to see from inside. You see people spend their salary the day they receive it, because holding it costs money. You see savings turn into dollars under a mattress, and then into a car, and then into an apartment nobody needs, because anything is better than cash. You see a whole country turn into traders of their own wages. And you see who pays. The person with land, or a building, or a business that can raise its prices, comes through bruised. The person with a salary and a savings account is the one who is quietly emptied out, and she finds out years later, counting what is left.

That is why I call it a tax. Nobody votes on it. Nobody collects it in person. It takes a little every day, and by the time you add up the days, it has taken most of what you had.

The slow version

You will probably never see three thousand percent. I hope you never see fifty. But the slow version is everywhere, and it is the one that catches careful people. Three percent a year sounds like nothing. At three percent a year, money left in a drawer loses half its value in about twenty-four years. At seven percent, in ten. That is the arithmetic of the sentence you will hear all your life, “I have it saved,” said by someone who is losing half of it and cannot feel it, because no single month hurts.

Fisher, 1930

Irving Fisher wrote the book on this the year after the great crash. The Theory of Interest says something that now seems obvious and was not: the interest rate you see is two things added together. There is the real reward for waiting, and on top of it there is what the lender expects to lose to rising prices. When people expect inflation, rates go up to cover it. When inflation surprises them, the lender loses and the borrower wins. Fisher himself believed that owning shares protected you, because companies could raise their prices with everything else. He was a brilliant man but he was wrong about that, and it took the next forty years to show it.

Lintner, 1975

In 1975 John Lintner, a Harvard professor, stood up in front of the American Finance Association and gave the speech that ended the idea. He looked at the decades after the war and found that when inflation rose, stocks did not rise with it. They fell. The years with the worst inflation were also the years with the worst real returns on shares. Prices in America roughly doubled during the seventies, and a person who bought the stock market in 1966 had, sixteen years later, about the same purchasing power she started with. Sixteen years of owning good companies, for nothing. Fisher’s hedge did not hold.

Brixton and colleagues, 2023

The best modern explanation of why comes from a paper by six researchers at AQR, Brixton, Brooks, Hecht, Ilmanen, Maloney and McQuinn. Their question was simpler than it sounds: when do stocks and bonds protect each other, and when do they fall together? The answer is that it depends on what the world is worried about. When the worry is growth, a recession, a crash, stocks fall and bonds rise, and a portfolio of both is calmer than either. When the worry is inflation, both fall at once, because both are promises of future money and rising prices shrink the value of every promise. For most of the twentieth century that was the normal state. The twenty years from 2000 to 2020, when bonds reliably cushioned stocks, were the exception, and a generation of investors grew up thinking the exception was the rule. Then 2022 arrived, inflation surprised everyone, and stocks and bonds had their worst year together in decades. One year proves nothing on its own. It did confirm what the paper said should happen.

The paper’s practical point is the one I want you to keep. Both stocks and bonds lose when inflation surprises. Commodities gain. Wheat, oil, copper, cattle are part of what inflation is made of, so if you own none of them, nothing in your portfolio protects you from inflation.

What I do

I own three things against inflation: farmland, some commodities, and real estate. I chose them before I read the paper, because I had already lived through the alternative twice. Each one holds its value for a simple reason. The land grows the crop, and the crop is priced in the same money as bread. The building’s rent gets rewritten every year. The commodities are the very things whose prices are rising.

But I want to be honest with you about the limits. These hedges help some of the time. None of them helps all of the time. In the seventies, the worst decade for this in living memory, land and real estate carried better than shares, and they still had years when everything fell together, and there were months when nothing you could own looked safe. When inflation comes with a bad economy at the same time, what people call stagflation, almost everything loses at once. There is no asset that saves you. You hold the ones that lose least, you owe nothing that can be called in, and you wait. The storm passes. It always has. The families that came through 1989 in one piece did not find a clever asset. They had real assets, they owed nothing, and they did not sell them.

With love,
Papá