Hedging Hyperinflation With Fixed Rate Mortgages

by on June 10, 2010 in Blog, Economy, Investing, Manhattan Beach

Now is the time for patriotism and embracing the American dream of becoming overly indebted! Consumer debt won’t cut it. If you think modern patriotism is heading to the mall and furiously swiping plastic for big screen TVs, iPods, iPads, iPhones, and other iJunk (not a hit on AAPL, just got a little too poetic), then you’re way too old fashioned. Think bigger…

The US dollar is in a death spiral. Sure, we have had temporary respite from USD declines relative to other currencies, but relative to gold and general purchasing power, the dollar is doomed. Since 1920, the dollar is down 94% in purchasing power:

dollar purchasing power Hedging Hyperinflation With Fixed Rate Mortgages

That’s just the start. As of March, 2010 the revised 2009 federal budget deficit measured in GAAP accrual accounting methods reached $4.3 trillion. Total GAAP-based obligations for the federal government (at the end of 2009) totaled $71 trillion. ShadowStats estimates a looming $9 trillion real federal deficit in 2010. For how much longer can the government spend trillions of dollars they don’t have? The only future recourse will be to create lots and lots of new dollars to pay the bills.

There are far more eloquent advocates of hyperinflation than I, so that’s as far as I head down that path. Rather, let me merely suggest that its risk is sufficient to consider hedging.

Traditional inflation hedges include gold, silver, commodities, Treasury Inflation Protected Securities (TIPS), and corporate equities. I briefly touched on each of these in an earlier article: What If You Don’t Trust The Government With Your Portfolio?

While advising a client this week on whether or not to buy an investment property in the South Bay, I caught myself explaining the benefits of a fixed rate mortgage as a hyperinflation hedge. The light bulb in my head clicked and I quickly realized that everyone who can afford it should take on a good amount of fixed rate debt while rates are low. Despite real estate prices in Manhattan Beach continuing a prolonged downward trend, the asset diversification and hyperinflation hedging potential of a tax-subsidized, income producing property in a high demand rental location has its merits.

Depending on how badly the government and Federal Reserve mess up the dollar, borrowing large quantities at fixed, historically low rates now might be the bet of the century! There’s a significantly increasing probability that the $500,000 you borrow today at a fixed 4.75% rate might be equivalent to the cost of a loaf of bread in 10 years. You might one day find yourself wandering down the bread isle of your local grocery store and stop yourself to think, “Should I stock up on another loaf of bread, or pay off my mortgage today?”

The benefit of real estate debt versus other forms is that it is the most readily and abundantly available for the average person. Try to get a $500,000 loan to buy a car, or an case of iPads…it’s not going to happen. But anyone with a decent credit score, a job, and proven ability and desire to make payments can buy a house with a mortgage. Income properties buy down even more risk in that a cash flow stream is generated to offset debt service and operating expenses. Finally, real estate is (theoretically, and in the long haul) an appreciating asset. iPads have a much smaller and finite lifespan-they depreciate over time. If inflation gets bad, nominal real estate prices will go up.

It is sad that one of the best reasons I can come up with to buy real estate now is to protect yourself from the scourges of Keynesian-Kool-Aid-Drinking politicians and they’re collaborators heading up central banks around the world! While they destroy the world’s major fiat currencies (and our savings) one of the best protections is to hold a fixed rate mortgage that can one day be paid off for the price of a loaf of bread.

DISCLAIMER: Make sure you can afford the mortgage! I am not advocating the assumption of quantities of debt that will bankrupt you as soon as the payments begin. Rather, prudently consider your financial condition: income, risk of income disruption, current liabilities, and comfort levels with servicing debt.

7 Responses to “Hedging Hyperinflation With Fixed Rate Mortgages”

  1. I looked at the math it does not work. June 4, 2011 at 2:20 pm #

    If my $1,000 a month payment can buy a
    $200,000 mortgage at 4.25% paying $983.88 monthly or
    $110,000 mortgage at 10% paying $965.33 monthly or
    $_47,000 mortgage at 25% paying $979.75 monthly explain again how inflation with interest rate changes drive house prices upward as they appear to be driven further down.

    House prices are determined by how much money can be borrowed to buy a house. Interest rates change that amount to a very large degree.

    Incomes are not going to rise by such massive amounts. We have to much international competition for that to happen. Buying thinking inflation will be a friend is foolish at best. Hyperinflation will only push house prices much lower. There is no way it can happen until such hyperinflation ends. Then perhaps house prices could be much higher but only because money is worth so much less than it is now.

    Saving up cash and buying when inflation is at its worst then selling when interest rates drop down after hyperinflation ends is the only way to win big in this game.

    Reply
    • Rob Viglione June 4, 2011 at 2:51 pm #

      You’re absolutely right, given a range of interest rates and currency value. During anything resembling “normal” economic conditions, inflation drives interest rates higher with increased lender risks, which decreases housing demand due to decreased capability of market participants to obtain acquisition capital.

      Hyperinflation, however, changes the ballgame entirely. Hyperinflation comes when a currency’s value is utterly annihilated. Everything priced in that currency snaps exponentially higher in nominal price. Demand will plummet because only a fraction of the population will be able to buy at the inflated prices, so transactional volume will fall off a cliff. But that translates into “real” price declines, coupled with “nominal” price increases. The math works more like this:

      Time 1 (pre-hyperinflation), money supply = X, housing price index = 100

      Time 2 (post-hyperinflation), money supply = Xe^n*t, housing price index = 100*m*e^n*t, m being a decrement factor since housing prices will not likely follow 1:1 linear increase wrt money supply.

      Nonetheless, nominal housing prices will see a comparable, but likely, less efficient exponential increase.

      Nominal price growth is only one benefit of holding real estate during hyperinflation; the real benefit comes by holding fixed rate debt, the value of which will be obliterated by currency destruction. You’ll be left with title to property that’s higher in nominal price without any mortgage encumbrance.

      And finally, as you stated, wages will not keep anywhere near pace with hyperinflation, so people will suffer. Wages will grow, though. There will be economic activity, albeit at significantly reduced levels.

      Reply
  2. Torrey December 20, 2010 at 6:55 pm #

    Great post. I never thought of it that way. But the question I ask is, if hyperinflation becomes the case, income levels will stay the same. So the only thing hyperinflation will do is make the average American poorer. Because they won’t even be able to afford a loaf of bread, better yet a mortgage.

    Reply

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