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 factory 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?’ But postponing purchases freezes economic activity.
The Fed has, therefore, 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. And 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. Property
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
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
home buyer 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 may not see inflation when the economy gets
back on track. The Fed may be able to quickly mop up the cash that was
distributed. But 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. But 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, home buyers and
other borrowers at the time of high inflation will be shut out of the
market because of exorbitantly high interest rates.