Inflation worries and speculations are causing a messy debate amongst all market participants. We watch oil and food prices increase, and we see historic amounts of money pumped into the U.S. Economy through monetary policy. Both sides have valid arguments in the “will inflation remain or go?” discussion. Residential real estate has proven to be a safe haven in periods of high inflation. In the 1970s, economists in the United States studied the inflation rate and found that the home price increased continuously relative to the size the economy. Stock prices, however, fell. This meant that homeowners had a better financial situation than stockholders.
Most people have heard of inflation, but very few understand it. We’re in a period where consumer prices are increasing. December 2021 was the month with the highest since 1982.
The Bureau of Labor Statistics reported this week that consumer prices (CPI) rose.9% for all goods, including food and energy like gasoline. This is after a.6% increase in May.
Core inflation, which excludes volatile components such as food and energy, increased by 0.9% to 0.9% in June after 0.7% and 0.9% increases in May and April. Core inflation includes new cars, used vehicles, clothing, medical care and shelter.
The CPI increase was largely due to the price of used vehicles. Other factors such as hotel stays, car rental, and airfares, which are all associated with the opening up of the economy, also contributed.
Source : U.S. Bureau of Labor Statistics
What does it all mean? Continue reading.
What is inflation?
Inflation is defined in textbooks as a steady decline in the value money. Practically, this means that you can purchase fewer goods and services today with the same amount as you could yesterday. This happens day after day, month after month, and year after year.
Hyperinflation was the most extreme example of inflation in Brazil thirty years ago, when people bought everything they could at the opening of stores because inflation was rising 70% to 80% each month. Imagine if that happened here. You might buy a LED light bulb in January at IKEA, pay $2 in February for the same item, and then have it cost $1,000 by December. Yikes!
The U.S. thankfully has not experienced anything as extreme as Brazil’s hyperinflation. In the 1970s there was double-digit inflation, but not “hyperinflation”. The U.S.’s highest 12-month rate of 13.3% happened between 1978 and 1980, when food and oil prices rose due to supply problems and monetary policy that stimulated a higher demand. Inflation can still have a real impact on your wallet and the economy.
What is so frightening about inflation?
Civic Science statistics show that more than 75% American consumers are worried about inflation. It also affects the quality of life and cost of living.
It’s difficult for business owners when inflation is unpredictable to decide what to charge for products and services. The price discovery process, which is the process by which an asset’s value is determined, starts to add up. Imagine how much time and effort it takes a restaurant to print a new menu, and to research the price of every ingredient and dish.
Everyone is affected by the price distortions of goods and services that are caused by hyperinflation or even double-digit inflation. Many workers, investors and business owners try to predict inflation and its effect on the price of goods and services. Inflation expectations in the U.S. are high, especially for gasoline and rent.
A second scary effect of inflation can be the redistribution it creates in income, as it doesn’t affect all groups equally. Higher inflation will allow those with fixed-rate student loan debt to pay off their debts faster. This group has historically had a higher income compared to those without debt. High inflation therefore redistributes wealth from people with lower lifetime income to those who have higher lifetime income.
The pandemic can be exacerbated by inflation, which is a problem for both homeowners and tenants. People who were in forbearance (meaning they missed or reduced their debt payments under protection) during COVID-19, or lost their jobs and could not refinance their home with a lower rate of interest are at a great disadvantage. This is because raising interest rates can be a way to curb inflation. After COVID-19, the monthly housing costs of both renters and new homeowners (or those that couldn’t refinance at lower rates before) will be much higher.
What is COVID-19 and inflation?
Multiple lockdowns slowed global supply chains. Some sectors were more affected than others but they were all affected. In Q4 2020, for example (see the chart below), demand for some recreational activities grew as people were more concerned with their mental health. They also didn’t have to commute to work. As people spent more time at their homes, the demand for clothing decreased.
How spending changed by sector during COVID-19
Source: BEA World Data Lab and projections for Q4 of 2020
The cost of the product is influenced by factors such as currency appreciation and taxation, subsides, sanctions, supply chain disruptions, and subsidies. Changes in lifestyle due to pandemics, such as job losses or staying at home orders, can also affect disposable income and change spending habits.
The government’s stimulus money increased the amount of money that people had available to spend. When money supply increases, spending usually goes up. Only if the money supply is not able to keep up with the demand over the long term, or if the economy does not grow, can inflation be called such.
What is the inflation discussion about?
Price trends post-pandemic are difficult to analyze. From computer chips to wood, everything is in short supply. There aren’t sufficient goods and/or services when people demand more than the producers can produce. This problem can be solved by the market through higher prices. That’s exactly what is happening. Moreover, the stimulus money has increased people’s spending power.
Will the post-pandemic inflation rate last?
Long-term, the producers will usually find a way to boost supply in order to meet the demand. In a world after a pandemic, this inflation may be “transitory” or temporary until supply shortages subside. The rate of inflation is not uniform for all goods. Even if some prices drop (such as those items that are susceptible to disruption by technology), the overall price tends to stay higher. Prices remained the same, even though inflation increased on an annual basis, then decreased. This means that inflation was only temporary (or short-lived), but not in absolute terms.
Real estate can be a hedge against inflation
In an inflationary climate, the first and most significant characteristic of real estate is that it is a scarce resource. It’s a natural limited-supply asset that serves human needs. The fixed monthly mortgage payment for previously owned property remains the same as inflation increases and other costs rise. Rent payments can also be adjusted to reflect price increases, which is a great benefit for homeowners or investors who rent. This is why single-family rental operators spend billions on renting out properties. Hotel is the easiest concept to grasp. The hotel leases are based on a nightly basis. Hotels can adjust their rates immediately if inflation increases. Rent can be adjusted more slowly than a hotel night, but it still responds to market forces.
Does inflation continue or decline?
Why inflation may be temporary?
- The rapid recovery of the demand is a major cause of many supply shortages. Producers will figure out the supply bottlenecks.
- The demand is high and, by early July 2021 67% adult Americans will have received at minimum one dose of vaccine. They are now ready to return into the world.
- Demographics are a major factor in driving increased spending. As the economy opens, younger generations will be more eager to travel and purchase clothes.
Why inflation may be here to remain:
- Rising wages is a fact. After wages increase, employers cannot ask employees to accept pay cuts or hire workers at lower salaries. The result is higher prices for goods and services, which are then passed onto the consumer.
- The current administration has ambitious plans for fiscal stimuli, which could lead to a new level of demand.
- Inflation is self-fulfilling. Prices will be set based on inflation expectations. When people expect that prices will continue to rise, they may ask for a pay raise or start looking for higher paying jobs. Employers who raise wages must also increase the prices of goods and services to compensate for wage increases. This can cause inflation.