Why Worry About Recession When Inflation Looms Ahead?
The deal is done. The government is going to spend no, drat, “invest” $8.5 trillion, no wait, that’s not right, the total potential bill could be as much as $9.7 trillion according to Bloomberg News, to bailout, oops, darn, nope, to rescue Wall Street, oh my, that’s not it either, I mean “Main Street” and fix the mortgage, oh no, not again, the “subprime” crisis….
Whew. life is so complicated these days.
Let’s talk about something simple, say the the London Interbank Offered Rate, or LIBOR.
Late in September the LIBOR rate for overnight borrowing among banks rose from 2.57 percent to 6.88 percent — in a day.
The overnight rate later fell back but it raises an issue which ought to concern everyone and that’s not what will happen in a few days or weeks, but what will happen in 2009.
A lot of folks are worried about recession. Some, going further, are concerned that for the first time since 1929 we may actually have a depression. Not a depression just in the U.S. but a worldwide slowdown that will impoverish billions of people.
After passage of the bailout bill in Washington the Dow Jones Industrial Average was down 26.59 percent from the yearly high. Sounds awful, but we’re doing vastly-better than some other markets. For instance, Italy’s Mibtel was down 38.15 percent, Scandanavia’s OMX Nordic 40 had dropped 40.80% and Russia’s Micex — after being stopped several times this year — was off 48.71%.
It’s not just Europe. China has a booming economy, but the Shanghai Composite was down 58.69%. The Nikkei 225 in Japan was off 36.01 percent at 10,938.14. If that number seems low consider that the Nikkei reached 38,915 on December 29, 1989.
If you look at these markets and others you get the sense that people who worry about declines and depressions are not illogical. There are real reasons to worry.
But there’s another worry, the thought that rather than a slowdown the looming issue is different, that it’s inflation.
One sure way to impoverish vast numbers of people is to devalue the currency. On a trip to Romania several years ago I paid 500,000 old lei for a very nice dinner — soup, salad, bear, dessert and wine as an exceptional quartet played in the background. The restaurant was beautiful. Not to worry, 500,000 old lei was then the equivalent of about $13.
After four straight years of surpluses under Clinton we have now had eight years of deficits which have added at least $4 trillion to the federal deficit. The real figure is much higher because it does not count such costs as re-stocking equipment for the military, health benefits for veterans or any costs from the bailout/rescue package.
Meanwhile, we continue to lose about $2 billion a day purchasing foreign goods — that’s how folks overseas are getting many of our dollars.
Federal deficits and vast balance-of-payments shortfalls are sure signs of rising prices to come. The reason is that we value goods and services on the basis of cash. If a dollar buys less it follows that we need more dollars to buy a given item. A gallon of gas refined in 2008 is the exact same size as a gallon of gas from 2000 but the price today is higher because the value of the dollar has eroded.
In the same way that home values cannot eternally rise, it’s equally true that mortgage rates are not perpetually planted at today’s levels. Mortgage rates will rise. They must rise. If they only rise to 7 percent or 8 percent we will be lucky. Remember there have been a number of years when mortgages rates have been above 10 percent.
Rising mortgage rates are one sure way to reduce existing home sales. Higher rates slash affordability which shrinks the pool of potential buyers. At the same time, those who have financed with adjustable-rate mortgages will see steeper monthly payments. New and higher rates will tip some homeowners into foreclosure, perhaps many homeowners.
The good news is that you don’t have to be passive about the threat of inflation. The trick? Go out and finance and refinance with fixed-rate mortgages. Do this now. Lenders are standing by. (And if we have a recession, that’s fine — you can always refinance if rates drop significantly.)
A fixed-rate mortgage is a great inflation hedge. Each month you repay the lender with cheaper and cheaper dollars and your cost never rises. Each month your lender will send you bigger and bigger gift offers if only you will refinance into an ARM.
Given the higher rates which no doubt lurk in our future I’m amazed that lenders continue to offer fixed-rate loans. But then again, these are the same clever folks who alertly brought us “affordability” mortgage products and the widespread use of stated-income loan applications. They could not possibly be wrong, er, incorrect, oh um….
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Published originally by The Real Estate Professional and posted with permission.
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