Interest Rates and Inflation

Yesterday we discussed the recent movement in the Mortgage Backed Securities market in relation to currently offered interest rates. Many people understand what inflation is, but they do not understand the full ramifications of inflation on markets and their lives.

A simple definition of inflation is an increase in the cost of goods and services. Another way to look at it is, the value of every dollar you have drops so it takes more of those dollars to buy the goods or services you are looking to buy. This is something everyone for the most part understands, but also where their knowledge stops. Ultimately inflation is a result of poor monetary policy.

There is a single entity responsible for our printing presses and controlling monetary policy in our Country. This is a private entity despite the illusions that shroud it, and the politicians that ogle over it. This entity is the Federal Reserve. The Federal Reserve is ultimately responsible for monetary policy in our Country. They control the printing presses set the discount lending rates, and the federal funds rate... the Federal Reserve is a very powerful entity, some even consider its chairman to be the second most important person in Country behind only the President of the United States.

Understanding that it is the Federal Reserve that is ultimately responsible for our monetary policy, they are who we look to for signs of inflation. Not what they necessarily say in their released minutes but rather the actions they take around their comments. For instance, over the last couple of years the Federal Reserve has printed 13 trillion new dollars, but continue to stress inflation is not an immediate concern of theirs. Because most of us think short term, we read this and think no problem without focusing on the operative word "immediate." So it is a concern, just not a concern right now. This is the thought process to follow. We know they printed 13,000,000,000,000 new dollars and have been keeping the discount and funds rates very low making money more available than they would normally like. Hmmmm.... low rates mean easy money for those that need to borrow (banks, insurance companies etc,) which means more money in the system. Hmmmm... wonder why the Fed is saying not an "immediate concern" .... well there are a lot of people out of work which curbs spending in our economy which means less consumption... Less consumption infers demand on goods is currently low, and with low demand comes low pressure. Low or no pressure means no influence/pressure to force the selling point up for that good. So the price of goods and services for now stays relatively the same.

But that is not the whole story.... we continue our analysis looking at other indicators... The stock market was down in the 7,000s now back in the 10,000s. Gold's value is increasing steadily. The cost of oil is rising.

These are all indicators suggesting inflation is here it just has not hit the open market yet and the individual consumer yet because our economy is suffering so badly. What does this suggest.... simply that when our economy does turn around it will do so accompanied with rising prices and inflation which will send prices up. How high they will go is anyone's guess.

Once inflation begins we must to worry about something called hyperinflation which is simply inflation on steriods. Imagine minimum wage at 30 dollars an hour.... sounds great right??? Well also imagine a gallon of gasoline costsing 14 dollars. This is the power of hyperinflation. It should also be noted that inflation is somewhat controllable - hyperinflation is a beast out of its cage. Those that think they can tame it are usually bitten.

So understanding these points we begin to understand how inflation effects us.What we have not discussed is how inflation will affect the real estate market, and financing. The nice thing about inflation is the value of your home if you are a homeower should rise. That is you will be able to sell you home for more dollars albeit those dollars will be worth less due to inflation. Regardless inflation will pull people out from underwater and or return a nice equity position to them. On the other hand interest rates for home loans are going to go up in concert with inflation. This means if you seek financing the rate of interest you will be offered is going to be higher than it is today. Why? For the simple reason that the note you are issued is an investment vehicle for someone else. Moreover it is a long term investment. Since it is long term, and because they are looking to profit off of their investment, they have to make sure they beat future inflation, if they don't the investment will lose them money. So to combat current inflation they must offer an interest rate higher than inflation rates, so as inflation takes hold rates go up. How high depends completely on the rate of inflation.

The nice news is you should be making more dollars due to inflation to pay for the higher payments and rate of interest, however imagine for a moment your not needing to pay more. Imagine locking in a 30 year fixed with a rate of 5.000%. You will be making more money, but your loan still costs you the same. This is a good formula.

But let us digress.... you are currently renting. Guess what is going to happen to the cost of rent as inflation hits. The rent you pay will go up... in concert. Now what if you owned your own home with a 30 year fixed rate of interest. Your monthly payment is never going up. That's security.

Are we starting to understand how inflation plays a role in each of our lives. Point in fact, you can prepare for inflation and profit from it, or you can be caught unprepared and be a victim. People currently renting are going to experience higher rent. Those with adjustable rate mortgages set to adjust in the coming months and years will be subjected to a higher rate of interest. The people immune to inflation in the real estate market and are in a position to potentially profit, are homeowners with fixed programs.

These people are guaranteed the same payment month after month after month. When inflation hits this will not change even though the amount of money they have will. With inflation comes larger pools of capital which makes paying off their home loan that much easier.

We are happy to discuss you options without any obligation. Now is the time to begin planning.