Is deflation a real threat?

Question

How will deflation affect the property market and what should an investor do if it does brew its ugly head?

Why are economists talking about deflation when so much money is being printed by governments all over the world in order to revive the world economy?

The burst of the housing bubble has created wealth effect in reverse. People can no longer use their homes equity as ATMs by taking out lines of credit or refinances their homes to fuel consumption. The reduction in equity is destroying wealth at a much faster rate than any money supply that governments are pumping into the economy. This is creating a very powerful deflationary pressure.

Deflation is much worse than inflation for property investors. I will appreciate some views on the subject as it is very current.

Praveen Kumar

Bill Gulley · Answer

The culprit is the velocity of money, not the supply.

Bryan Hancock · Answer

For those that are really interested in this stuff John Mauldin puts out a weekly newsletter about global economic thoughts.  His work is unparalleled in the industry and the letter is free.  You can Google, "Outside The Box" and "John Mauldin" to sign up.

Mitch's post hits a lot of the highlights well. It doesn't matter if there is a lot of currency if it doesn't circulate through the system because it is stuck at one place in the cycle.  There is no money velocity if it is stagnant.

Mitch Kronowit · Answer

First off, I really wish the media would stop using this cliche', especially in the U.S. Our money supply is not determined by how many "Greenbacks" the treasury prints. Think about it, when is the last time the government paid for anything with cash?

Our money supply is controlled by the Federal Reserve. All that "printed" money just sits there until the Fed "monetizes" it, i.e., turns it into legal tender. It might be more accurate to say the government is printing "debt" (selling treasury bonds) rather than printing "money". When the Fed purchases that debt from the open market, liquidity is added to the system. That would normally be inflationary, but nobody is spending anything, hence the deflation. IOW, the money is out there, but it's not changing hands.

Imagine you had $1 million in the bank and I was trying to sell you my house for $500k. Obviously, you have the money, you can afford it, but you just don't want to spend that much. After a year of runaway inflation, your bank balance grows to $1.5 million. I try to sell you my house again for $750k (adjusted for inflation). But you still won't budge. However, I really have to sell this house now, so I lower the price to $350k before you strike. There you have it: Deflation with an increasing money supply.

The moral of the story? All the money added to the economy won't result in inflation unless that money is making into the hands of the spenders. That's not occurring now. People are losing their jobs, losing their home's equity, losing their credit, etc. etc. How can they afford to pay more for thinngs? I believe most of the money is finding it's way into bank coffers, where it sits and collects dust. Instead of getting lent out to consumers and investors, it's used shore up the bank's balance sheet.

Praveen Kumar · Answer

I think deflation is a real possibility.

Deflation can result in property prices staying stagnant or even going down. Financial pressure on businesses and individual can result in increase in vacancy rates and will eventually result into reduced rentals. This is definitely not good news to property investors.

Eddie Ziv · Answer

I would agree with Bryan that deflation is not the worst... Stagflation is...

Bryan Hancock · Answer

Shadowstats (site) has a graph of the real inflation numbers...not the ones manufactured for consumption by the masses.  Deflation causes people to delay purchases, which is bad for the economy overall.  Why would you buy something now if you expect for it to cost less later on?  If it is something you really like and can get utility from now you will likely buy it.  Otherwise you will wait and get it at the discounted price later on.

Housing is just one component of the CPI.  As housing prices fall in different areas of the country those lenders with frothy pieces of the debt stack will be in severe risk of losing all of their money.  Homeowners will be stuck and not be able to move unless they had sizable equity cushions with large down payments.  Even if they could move they likely won't because they are anchored cerebrally to the amount of equity they had in the past.  The wealth effect in reverse!  If you feel poor because you just lost a lot of equity in your house you are much less likely to buy stuff anytime soon.

What is happening in the present time has a lot to do with other currencies.  The dollar is starting to look pretty strong relative to other rival currencies because of their massive entitlement programs and fiscal disarray.

This is an extremely complicated subject that relates not only to housing or our own economy.  It has a lot to do with the world economy and how we fit in with the whole system.  You could run some econometric models to try to predict what will happen with inflation in the future, but if you knew that you could easily make millions betting on currency futures instead of going through the REI brain damage exercise.

My personal opinion is that inflation will likely rise over time as the economy roars back.  We have several years of pent-up demand from this gnarly recession and banks will eventually start to come out of their shell and lend money again.  I don't think we are going to have massive swings in the CPI one way or the other.  The Fed does a reasonably good job of managing their cartel so as not to piss off the masses.

Is deflation a real threat?

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