WATCH OUT! MASSIVE INFLATION IS COMING...

June 16th 2009

Deflation Now

Currently, we have been experiencing, serious deflation, although you wouldn’t know it if you just paid attention to the statistics published by the Government. For example, during the past three years housing prices have dropped in many areas of the country by 30-50%, if not more. Take the average annual American family income of around $50,000. If the family paid $150,000 rather than $250,000 for their home, due to declining home prices, the annual savings could be as much as $8,000-$9,000 (not a small amount considering the average net take home pay). Of course, people who already own their homes and can’t renegotiate their loans won’t gain these savings unless they walk away from their existing homes and acquire a new one. However, there are plenty of other deflation savings available.

With the problems in the automotive industry, huge discounts are available to buyers of autos, both new and used. And, how about the retail industry; can you find a major retailer that does not have big discounts available on most items.

Inflation is coming

Enjoy the deflation pricing while you can because we won’t have it for long. When the economy starts turning around, as it will, expect some of the assets that have deflated, like housing, to have significant price increases fairly quickly (prices tend to overshoot in each direction).

Many economists say that our economy has slowed down because we changed from being a nation of spenders, centered on the use of Credit Cards, to a nation of savers. I disagree. The primary reason why we’ve become savers is fear. Fear has been created by the Government. We think about the fact that 9.4% of our work force is unemployed, and growing. If you add the people who are no longer looking for a job or are underemployed, most statistics indicate the affected part of our work force is around 16% and climbing. If you consider the number of fully employed people who are worried that they might not be fully employed shortly, the percentage goes much higher. Thus, the fear tactic is what is driving the market. Once a few positive statistics get published, the fear factor will decline and people will start spending more.

If you want to consider potential problems, consider the investors and institutions that hold portfolios of credit card debt. At least with mortgages there is some security. But, credit card debt is totally unsecured and generally owed by those least able to pay them off. Bank of America recently reported that 12.4% of their credit card portfolio is not likely to pay. Scary, isn’t it?

Although many Banks have received enormous contributions from the Government, cut dividends and sold equity, consider the new reserves they would have to create if the housing industry continued to decline. The residential mortgage market is about $14 Trillion. What if 30-40% of the mortgages had to be written down, or sold at 20% of face value? What would the effect be – probably a new Banking system.

Fueling inflation by itself, the only solution to protect the Banking industry is for home prices to be increased significantly by one means or another. In this way, the collateral securitizing the Banking and Investment industry would be increased in value. Future write offs could be eliminated and some Bank reserves could be reduced, thereby immediately adding both equity and additional profits to the Banking System’s bottom line.

Now, the Real Fuel for Inflation

The national debt is about $12 Trillion and is growing at the rate of $2 Trillion per year. The government not only has to refinance its debt on a continuing basis, but must also find investors to buy the additional debt. The Federal Reserve has even bought over $100 Billion in Treasury obligations. This means that the Government is loaning money to itself (a recipe for runaway inflation). This substantial new funding obligation means that interest rates will have to eventually rise as a means of attracting more foreign as well as domestic investors.

Other nations both in the EU and Far East have begun to question whether the Dollar should be the international reserve currency. The Group of 4 (Russia, China, Brazil and India) are meeting now to discuss among other issues, how they should invest their funds, including perhaps in each other as opposed to increasing dollar investments, and therefore dollar exposure. To add fuel to the fire, the Treasury could lose its credit rating status.

Obviously, with the Government competing more and more with industry for borrowed funds, including the Government’s ever increasing need to make more funds for borrowing, available to industry, precipitously rising interest rates have to be a given. Consider the cost to the Government and Taxpayers of every one percent (1%) increase in the overall interest rate, when the amount financed is $12 and soon to be $15 Trillion. This is $120-$150 billion alone (not a small amount when the Governments total revenue receipts are about $2.4Trillion annually). If this, by itself, was not a basis for massive inflation, what would be?

Rising interest rates mean the price of most all goods and services will also increase. Wages will also increase. Thus, a spiraling inflation factor is virtually assured.

What can we do?

We should position ourselves financially in order to take advantage of the coming inflation. The answer is to own fixed assets which have long term growth potential, and are financed by long term fixed rate borrowing. Thus the lenders will make a rate of return but will suffer from inflation exposure, while we will benefit from the exposure. Of course, these financed assets should produce sufficient cash flow to pay for the cost of carrying them.

I favor investing in new residential property, priced in the area where the vast majority of the population could afford to rent or purchase. Of course, critical to this type of investment is acquiring the property at a price which is protected against exposure to any negative short term price fluctuation.

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