Whoa.. allow me to clarify!

DEBT and INFLATION, and how having debt during inflationary times is a good thing, because inflation destroys debt.  This is simply because debt is priced in today’s dollars, and as the value of the dollar goes down, asset values tend to rise .. but since the debt amount is fixed at a certain amount, it’s value relative to the asset’s value goes down (which is a good thing). To better illustrate, look at what happened to the real estate market almost everywhere in North America this decade.  In many areas, prices increased substantially.  This was due in part to the massive amount of (unreported) inflation in the system.  Even though the government tells us inflation is in the range of 2%, we know that it’s really around 7-10%, depending on where you are.  As a percentage of the value of a house, your mortgage on a property was eroded because of this inflation.  Housing prices were forced up partly because of inflation, never mind the softening of the U.S. dollar.  The result was that the debt you had on the property was a great tool to create more leverage and profit for yourself. Of course, this helped created part of the monster we have today, because the value increases allowed people to go back and crank the debt up even more.. but now that we’ve seen deflation of home prices, now debt is working against a lot of people.  By the way, why does the government lie about the inflation rate?  Well for one thing, a lot of government obligations are tied to the rate of inflation.  So if they purposely and deliberately under-report it, their obligations don’t cost them as much money.  For example, pension payments that are indexed to inflation.  There are lots of good reasons for the government to hide the real inflation rate, but that’s not the point of this post.  Maybe I’ll talk to that in a future post.  If you really want to see the actual inflation rates, go to www.shadowstats.com. Anyway, back to my point. Yesterday I said, during inflationary times, it’s a good idea to go and buy a solid asset that produces cash flow, and load it up with debt.  I gave the example of buying an income property.  What I meant to say, but wasn’t clear, is that you would do this ONLY if you thought you were in an inflationary period.  However, my post was ambiguous, and to some people, it sounded like I was saying “run out and buy real estate right now, and load up the debt”. That is not what I meant to say. My point was that doing this makes sense in an inflationary period.  The problem right now is that we’re seeing significant DEFLATIONARY effects, particularly in the housing market.  So does it make sense to do this RIGHT NOW?  In many markets, probably not. Because the other side of inflation is deflation, which is what the government is warning we’re in for.  IF this is true, then debt will have DEVASTATING effects on your wealth, because your debt doesn’t go down, even though the value of the asset does. My advice for the past several months has been to try and reduce your debt where you can, don’t take big risks, and anticipate that the financial crisis is definitely not going to be over soon. This has NOT changed. So, I did NOT mean to suggest to go out and buy lots of real estate right now and put lots of debt on it.  What I meant to suggest is that if and when we see significant inflationary signals, THAT may be the time to put debt to work for yourself.  The issue is I don’t think we are AT that point right this moment.. but I do think it’s coming. There IS a risk that we’re going to incur deflation in 2009.  My best estimate is that we may see some short-term deflationary pressures early on, but before the year’s out, you’re going to see evidence of major inflation taking hold, which will drive the value of hard assets up significantly.   IMPORTANT POINT:  Keep in mind that supply + demand fundamental will still apply, meaning that even if we’re in an inflationary environment, but there were 25,000 houses for sale in your market and there are only 1,500 sales happening each month, that imbalance between supply and demand will likely dampen prices, even in an inflationary environment.  So just because inflation comes doesn’t mean that all housing prices will immediately start jumping.  I believe you’ll see the impact of inflation move the price of gold and silver significantly and in higher proportion to real estate prices in most markets, until the major problem of inventory glut is resolved. Therefore, I believe we’ll see some deflation in early 2009, but we’ll move into inflation in the U.S. soon thereafter later in2009 — likely to be followed by hyper-inflation. The government will continue to deny that the inflation is there (and they’ll publish phony stats like the Consumer Price Index which are almost useless), but you’ll see it in continuing rising prices in food, gas, etc., just like what we witnessed earlier this year.  The difference will be that the U.S. will have dumped close to $10 TRILLION dollars into the system, and the inflation we’ve seen recently will pale in comparison to what waits ahead. If I am right about this, then you’d be best to wait to buy real estate until we see that the deflation is either temporary or non-existent, and that we see inflationary pressures starting to rebuild.  Until then, I suggest a conservative approach to debt, and eliminating consumer debt wherever possible (defined as any debt incurred for consumption and not investment). Hopefully that makes more sense to those that were confused about yesterday’s post! Whew .. don’t know about you, but my head hurts from talking all this economic stuff and financial stuff.  My next post is going to have a picture of our baby boy Cooper in it, so stay tuned!]]>