Monday, May 5, 2008

What will Inflation do to Housing Prices?

This is a question that many are asking and I wanted to share my thoughts with you on this subject. I have discussed this with various people in the debt markets because this has become a hot button question.

The answer is actually quite surprising. Housing prices will continue to fall if inflation continues to rise. In fact, the more inflation you see in commodities and imports, the more deflation you will see in housing prices.

Now you may ask if everything else is more expensive why wouldn't housing prices rise as well? The reason is because they are not connected with one another. Inflation is a dollar based issue while housing is a debt issue. The two are not connected. This is a very important distinction.

In fact, as a home buyer is hit with higher inflation on everyday goods, it reduces the amount of money thats available to be used for borrowing. Because a buyer has less availability for credit, the home buyer is forced to pay LESS for a house.

This is what makes the debt bubble bursting combined with rising inflation so lethal. Its forces a death spiral/feedback loop type effect. The worse inflation gets the less someone can borrow. The less buyers borrow, the heavier the debt bubble becomes because it needs to be supported by more and more lending. Doesn't this sound like a game Mr. Ponzi invented?

When people get to the end of the loop where they cannot afford or have no desire to lend anymore, and combine it with the fact that the banks don't want to lend to you anymore anyway, you have the perfect storm for a bursting debt bubble.

The only way the economy is going to be able to heal itself is by totally resetting to a level where housing prices are drastically lower and people can afford to borrow again.

As the Fed continues to try and slow this process down, they are only making the problem worse. The best comparison I can think is a band aid. When you rip it off quick and fast, it is much less painful.

I realize this sounds horrifying and I wish I saw another way that this scenario could play out. Unfortunately, housing and all other debt is going to have to implode through defaults and reset before our economy recovers. Anyone on Wall St. talking about a big recovery is full of it.

We are going to fall into a deep long recession as we leverage the price of everything down to to affordable levels. Its going to hurt, but we will all survive.

There is only one other way this could play out. The government could try to inflate out of this mess through hyperinflation.

This scenario is highly unlikely because it would shatter our whole economy and infrastructure. Imagine the riots if a gallon of milk cost you $100. The politicians would also risk the threat of a revolution and we all know what politicians are all about. Getting re-elected!

Bottom Line:

Don't worry about inflation if you are sitting on the sidelines waiting to buy a house. Its only going to make your house cheaper! Pay off your debt while you wait. Having debt is going to get very expensive as the banks try to recover losses by raising interest rates on credit card balances.

Check out the comments on this post for some things to watch today!


Jeff said...

Things to keep an eye on today.

ResCap may declare BK. This was the nations 8th largest lender in 2007 and 12th largest subprime lender.

UBS didn't let us down as it reported earnings this morning. $11 billion dollar loss for the quarter. $19 billion in writedowns. Amazing


Minton Mckarkquey said...

This is a very intelligent observation and runs counter to the opinions of many people I talk to.

Many people believe that inflation will make their debts "less valuable" and therefore easier to pay off, but this couldn't be further from the truth.

I don't see companies rushing out to give pay raises either, so the scissor-action of rampant inflation, rising debt costs and falling house prices is going to be brutal.

Oh, oil just hit $122/barrel and Goldman's saying it could spike to $200 within two years. Glad I don't drive a Hummer, but the market for 12MPG SUVs must be at an all-time low.

Yes, it's going to be the mother of all recessions...

Jeff said...

Thanks Minton

$200 whoaa! what will that do to the consumer!

I have heard the opposite from others as well.

Its mainly the inflationists who hold the opposite opinion. I initially had a hard time with this point as well until I understood the fundamentals.

The debt game is over.

opportunistic said...

"There is only one other way this could play out. The government could try to inflate out of this mess through hyperinflation."

I've been thinking about this alot lately. It is scary as it seems to be the only viable option. There will never be enough money under present coditions to keep the market from sinking. The only possible solution is to bring up the prices of everything else to equlibrium w/ housing. Granted this seems silly, but on a macro scale how else would those in power prevent a recession? Unless of course they are simply treading water until 2009.

Jeff said...


It would be nice of they could pull it off.

The problem is you don't have the incomes to support the inflated prices if you try to inflate out. Thats why I highly doubt that would happen.

If it did happen then no houses would sell because no one could afford them. Eventually the prices would collapse and you would end up in a deeper crisis.

Expect the system to reset back down versus resetting back up. Sadly, The recession looks unavoidable.