Is real estate a good hedge against inflation?

Given the size of the federal bailouts to prevent the U.S. economy from lurching into a full-blown Depression and a federal deficit that will rise to about 13% of GDP during the current fiscal year, the chorus of voices concerned with runaway inflation just down the road grows larger every day. So is that a good or bad thing for the housing market? It’s actually both.

Writing in an August op-ed piece for The New York Times, investment sage Warren Buffett, CEO of Berkshire Hathaway, argues that although he supported the financial intervention engineered by the federal government to prevent an economic collapse, the side effects from trillions of dollars sloshing around -- and still largely protected in the coffers of risk-averse banks -- will soon need to be monitored closely.

To be sure, finding buyers for U.S. government debt is a complicated process in the best of times. Even assuming that both foreigners and citizens continue to funnel all of their extra cash into Treasury bills, that still leaves another $900 billion needed to underwrite the $1.8 trillion in debt being issued this year alone -- $900 billion of which will most likely fall out of Washington’s money tree at the Federal Reserve.

With legislators not about to incur the wrath of voters already frustrated with lower home values and retirement accounts, it’s unlikely they’ll be serious about raising taxes or cutting spending to fill the void. Instead, they have a third option which requires no official vote, nor can it be easily used against them at election time: let inflation take care of it!

The problem is that inflation is a double-edged sword which can slowly yet deliberately eat away at the wealth of its citizens, especially if that wealth is directly tied to the value of the U.S. dollar. Yet for owners of ‘real’ assets – such as commodities, gold, and real estate – inflation can both boost the value of the asset while chipping away at the fixed-rate debt used to finance it.

In the case of real estate, the inflation hedge is really more about the type of debt used – preferably a long-term mortgage with a fixed interest rate – than anything else. But add in the impact of rising prices on rents, and suddenly investing in real estate for passive income and enjoying the various tax write-offs becomes a tried-and-true method (and one used extensively in the 1970s) to build wealth while paying off debt that becomes worth less and less each day.

Of course to address rising inflation, the Federal Reserve will eventually have little choice but to hike interest rates, which could counteract the advantage of real estate’s strength as an inflation hedge. Moreover, the housing inflation of the 1970s was made possible with concurrent increases in wages; given a global economy which has kept a tight lid on wage income, it’s also possible that we’ll see higher prices for oil, food and commodities as home prices continue to stagnate.

For now, the best advice for households is to conduct their own financial analyses and determine how to defend their assets in an inflationary environment while also looking out for advantageous investments, such as selling off bonds and converting variable-rate loans such as those used for credit cards, cars and home equity lines into fixed-rate alternatives.

For those with extra cash to spare, investing in exchange-traded funds specializing in gold and commodities, although more volatile, can be more profitable than the type of Treasury Inflation-Protected Securities which simply keep investors above water.

However, one group of potential homebuyers who might benefit the most from rising inflation are the baby boomers who will start retiring en masse just as interest rates on their CDs and savings accounts begin to rise. Add in the fact that Social Security payments are adjusted for inflation, and they might even forget that the actual dollars they’ve saved for a lifetime are worth just a bit less each day. And that’s where the ‘retirement home as inflation hedge’ discussion could very well have the most merit.

These federal deficits were years in the making

Lately, it seems to be the criticism du jour to pin the entire (rising) federal deficit at the feet of Barack Obama, who has only been in office since January.

Meanwhile, I continue to get somewhat unhinged email blasts from some of my more conservative friends who, quite frankly, don't know what they're talking about when they drone on about Obama's policies being the end of civilization as we know it (as well as the apparent end of baseball and apple pie). Of course I want to reply, "Perhaps you should get that pesky bankruptcy off your credit report before throwing stones at Obama's fiscal house!" but I'm simply too polite to do so.

And, while I'm certainly no fan of the entire array of the policy prescriptions of the Obama Administration (and think his lack of a business background is beginning to show), the truth is that these deficits took years to build up, and they won't disappear simply because Sarah Palin is now pulling a new string on her back that quacks, "I told you so!" From a New York Times story:

There are two basic truths about the enormous deficits that the federal government will run in the coming years.

The first is that President Obama’s agenda, ambitious as it may be, is responsible for only a sliver of the deficits, despite what many of his Republican critics are saying. The second is that Mr. Obama does not have a realistic plan for eliminating the deficit, despite what his advisers have suggested.

The New York Times analyzed Congressional Budget Office reports going back almost a decade, with the aim of understanding how the federal government came to be far deeper in debt than it has been since the years just after World War II. This debt will constrain the country’s choices for years and could end up doing serious economic damage if foreign lenders become unwilling to finance it...

The story of today’s deficits starts in January 2001, as President Bill Clinton was leaving office. The Congressional Budget Office estimated then that the government would run an average annual surplus of more than $800 billion a year from 2009 to 2012. Today, the government is expected to run a $1.2 trillion annual deficit in those years.

You can think of that roughly $2 trillion swing as coming from four broad categories: the business cycle, President George W. Bush’s policies, policies from the Bush years that are scheduled to expire but that Mr. Obama has chosen to extend, and new policies proposed by Mr. Obama.

The first category — the business cycle — accounts for 37 percent of the $2 trillion swing. It’s a reflection of the fact that both the 2001 recession and the current one reduced tax revenue, required more spending on safety-net programs and changed economists’ assumptions about how much in taxes the government would collect in future years.

About 33 percent of the swing stems from new legislation signed by Mr. Bush. That legislation, like his tax cuts and the Medicare prescription drug benefit, not only continue to cost the government but have also increased interest payments on the national debt.

Mr. Obama’s main contribution to the deficit is his extension of several Bush policies, like the Iraq war and tax cuts for households making less than $250,000. Such policies — together with the Wall Street bailout, which was signed by Mr. Bush and supported by Mr. Obama — account for 20 percent of the swing.

About 7 percent comes from the stimulus bill that Mr. Obama signed in February. And only 3 percent comes from Mr. Obama’s agenda on health care, education, energy and other areas...

The solution, though, is no mystery. It will involve some combination of tax increases and spending cuts. And it won’t be limited to pay-as-you-go rules, tax increases on somebody else, or a crackdown on waste, fraud and abuse. Your taxes will probably go up, and some government programs you favor will become less generous.

That is the legacy of our trillion-dollar deficits. Erasing them will be one of the great political issues of the coming decade.

And something that won't be addressed simply by "Drill, baby, drill!"

Is there a VAT in our future?

Worried about the rising federal debt? You should be, because even after the current stimulus plan has passed, future spending on entitlements such as Social Security and Medicare will continue to far exceed revenues. Since increasing income taxes on those making over $250,000 (and even below) will still not be enough to close the gap, some experts from both the left and right portions of the political spectrum are suggested that the U.S. might soon have the type of VAT tax that's long been standard in Europe. From a Fortune story:

The bill is far too big for only the rich to pick up. There aren't enough of them. America will have to lean on citizens far below the $250,000 income threshold: nurses, electricians, secretaries, and factory workers. Within a decade the average household that pays income tax will owe the equivalent of $155,000 in federal debt, about $90,000 more than last year. What the Obama administration isn't telling Americans is that the only practical solution is a giant tax increase aimed squarely at the middle class. The alternative, big cuts in spending, aren't part of the President's agenda...

The most likely levy: a European-style value-added tax (VAT) that would substantially raise the price of everything from autos to restaurant meals...

What will shock America into action is the prospect of fiscal collapse, which will grow more vivid each year. In 2008 federal borrowing accounted for 41% of GDP, about the postwar average. By 2019 the burden will double to 82% by the CBO's reckoning, reaching $17.3 trillion, nearly triple last year's level. By that point $1 of every six the U.S. spends will go to interest, compared with one in 12 last year. The U.S. trajectory points to the area that medieval maps labeled "Here Lie Dragons." After 2019 the debt rises with no ceiling in sight, according to all major forecasts, driven by the growth of interest and entitlements. The Government Accountability Office estimates that if current policies continue, interest will absorb 30% of all revenues by 2040 and entitlements will consume the rest, leaving nothing for defense, education, or veterans' benefits...

A VAT...would tax such a giant pool of purchases that a relatively low rate of 10% to 15% could generate the revenues needed to pay for Obama's agenda and balance the budget. The VAT, which would be imposed like a federal sales tax, is paid along the chain of production by wholesalers and retailers. The cost is passed to consumers in the form of higher prices. For the Democrats, the problem with the VAT is that it falls heavily on the middle class and low earners, who use a far higher portion of their incomes to buy things than the rich do. Some of the sting can be removed by exempting food and clothing from the VAT or sending rebates to lower-income households. But the middle class would be a big target in any event...

Click here for entire story.

"The Daily Bail" blog launches

Concerned about the mounting federal debt, the impact of pricey, pork-filled stimulus packages and what that could mean for your family and progeny? A new blog called The Daily Bail launched several weeks ago (I found it through Patrick.net) to provide regular updates and to assemble the masses to voice their concerns. From the site's About Us page:

The Daily Bail launched 3 weeks ago and we exist to fight the immoral transfer of trillions in debt from private banks onto the backs of future generations. If not stopped there will be $10 trillion of debt created by our government in the next five years, and most of it given to the banks. That amount is equal to our entire national debt for our first 232 years as a nation...

A special message to young people finding us through Twitter. This is your revolution and you need to help lead it. With respect, you need to wake the f up and understand that it is primarily your cash headed out the door and straight to the failed banks. And not to rub salt, but they just paid themselves over $18 billion in collective bonuses for their outstanding work in 2008, with your money.

We have a program building behind the scenes for letting Washington know what you think. But we have to achieve critical mass first. It's going to demand that a million of you, from teenagers to seniors call Congress and The White House on one day. It's one of the things we have in the works and we'll be announcing details soon in collaboration with partners...

My money (pun intended) is on eventually and deliberately inflating our way out of the debt because this country simply isn't ready for debt default, austerity measures, falling wages, chronic deflation and millions of foreclosed families. And what's been a decent hedge against inflation in the past (besides gold?): real estate. That is, after the current bust...

The real price of printing money for bailouts

I've been reading a lot lately about the impact of these bailouts to the economy, with many pundits predicting future inflation once the current round of deflation eases as inventories of homes, cars and other goods are absorbed and financial deleveraging continues. Eventually, a much higher level of dollars sloshing around the global economy will be chasing fewer goods and places in which to invest. From a New York Times story:

...it may seem perverse that in this new era of reckoning — with consumers finally tapped out, government coffers lean and banks paralyzed by fear — many economists have concluded that the appropriate medicine is a fresh dose of the very course that delivered the disarray: Spend without limit. Print money today, fret about the consequences tomorrow. Otherwise, invite a loss of jobs and business failures that could cripple the nation for years...

But where does all this money come from? And how can a country that got itself in peril by borrowing and spending without limit now borrow and spend its way back to safety?

In the case of the Fed, the money comes from its authority to print dollars from thin air. Since late August, the Fed has expanded its balance sheet from about $900 billion to more than $2.2 trillion, creating $1.3 trillion that did not exist to replace some of the trillions wiped out by falling house prices and vengeful stock markets. The Fed has taken troublesome assets off the hands of banks and simply credited them with having reserves they previously lacked.

In the case of the Treasury, the money comes from the same wellspring that has been financing American debt for decades: Investors in the United States and around the world — not least, the central banks of China, Japan and Saudi Arabia, which have parked national savings in the safety of American government bonds.

Americans have gotten accustomed to treating this well as bottomless, even as anxiety grows that it could one day run dry with potentially devastating consequences...

Since the Great Depression, the conventional prescription for such times is to have the government step in and create demand by cycling its dollars through the economy, generating jobs and business opportunities. That such dollars must be borrowed is hardly ideal, adding to the long-term strains on the nation. But the immediate risks of not spending them could be grave...

The most frequently voiced worry about the bailouts is that the Fed, by sending so much money sloshing through the system, risks generating a bad case of rising prices later on. That puts the onus on the Fed to reverse course and crimp economic activity by lifting interest rates and selling assets back to banks once growth resumes. But finding the appropriate point to act tends to be more art than science. The Fed might move too early and send the economy
back into a tailspin. It might wait too long and let too much money generate inflation...

But that, as most economists see it, is a worry for another day. Some policy makers are focused on staving off the opposite problem — deflation, or falling prices, as demand weakens to the point that goods pile up without buyers, sending prices down and reducing the incentive for businesses to invest. That could shrink demand further and perhaps even deliver the sort of downward spiral that pinned Japan in the weeds of stagnant growth during the 1990s.

Click here for full story.