Thursday, April 23, 2009



Deflation has arrived but inflation could be flaring up in a couple years. The latest March consumer price index showed the first decline over a 12-month period since the Eisenhower administration. With rising unemployment and excess industrial capacity there is virtually no pressure for wages or prices to rise. The first order of business – from the Federal Reserve point of view – is to stop the deflation from spiraling down, which could lead to years of a Japanese-style economic stagnation. The mindset in this situation would be one of ‘why buy now if I can buy just about every consumer product at a cheaper price later?’ However, postponing purchases freezes economic activity.

The Fed has been madly pumping out money to help kick-start the economy and to help ease the credit crisis. The Fed’s balance sheet has grown exponentially in the past year to now more than $2 trillion. This money is essentially off the printing press. Over the short term, more money into the system and easier borrowing standards will inevitably stimulate the economy. However, too much money for too long in the system will spark inflation. Prices of just about everything – from hamburgers and airfares to tuition and wages - will rise. In addition, if (or perhaps I should say ‘when’) inflation does rise – say 5 percent or even closer to double-digits – there will be distinct winners and losers.

The big winners will be property owners. Paper money will lose its purchasing power, but real tangible assets will rise in value. Real Estate, by nature, is imbedded with commodities, and is sitting on land, which cannot be printed off a printing press. As it has happened around the world throughout history and more specifically during the 1970s and early 1980s in the United States, property values rise with consumer price inflation.

The big losers will be those who need to borrow money. High inflation automatically brings high interest rates. Lenders will charge a higher rate to compensate for the loss in purchasing power. Be it a homebuyer or small business owner or even the government, those who need to borrow at that time will face burdensome interest payments.

It is possible that we will not see inflation when the economy gets back on track. The Fed may be able to mop up the cash that was distributed. However, some of the money printed, without being too technical or using jargon-like acronyms such as TALF (Term Asset-Backed Securities Loan Facility), was for the longer-term where the Fed cannot automatically soak up the cash. That leaves a distinct possibility of inflation picking up due to too much money chasing around the economy. The economy, though growing, will also be operating sub-optimally because high inflation introduces unnecessary uncertainty for business start-ups and entrepreneurs.

What is the bottom line? Yes, inflation could be contained. However, it is also possible for it to get out of hand. If that happens, property owners will be in the winner’s circle. Those property owners who locked-in low mortgage rates will further benefit from constant loan payments independent of future inflation. However, homebuyers, property owners, and other borrowers at the time of high inflation will be shut out of the market because of exorbitantly high interest rates.

Todd G. McKissick, CRE, CFA, CCIM, FRICS
McKissick & Company, Inc.
Real Estate Economics


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