Inflation is Coming. Do You Know What to Do?

I have been saying for several months on this blog that Big Inflation is coming. And even several readers have commented back that everything seems deflationary, and wonder if I am seeing the same economy that they are. And I am, but I am looking out a few more months.

Inflation, essentially, is caused by a money supply that outweighs the goods and services being offered for those dollars.

So, I happened upon this article, by Adam Hamilton, in which the author makes a very compelling case for the reasons that the inflation that is coming is going to be big and ugly. He almost argues that the CPI numbers that measure inflation may be being under-reported, on purpose. Interesting, and if that is the case, then that under-reporting will not be possible once the inflationary causes begin to hit main street. Here is a quote:

Inflationary expectations hurt the stock markets, and weak stock markets hurt the economy as the stock panic abundantly proved. Scared citizens are not only harder to rule over, but they won’t vote for politicians’ reelections and they won’t be able to shoulder as big of tax burden to pay for politicians’ grand spending plans.

And inflation just around the corner is not good for a populus that has a slowing economy. We have all read about (and hopefully not experienced) the growing job losses, and an anecdotal phenomenon that I am seeing, is a growing number of employees taking pay cuts instead of incurring layoffs. Interesting.

Preparing for Big Inflation

The author of the article that I cited above suggests some things to do to prepare for and ride out the coming inflationary period. For those, just read the article. He is an investment advisor, so his suggestions are geared toward stocks, commodities and other investments.

I, of course, am not an investment advisor. If anything, I could be called a debt advisor, since that is what I deal in – helping people set up and manage the largest indebtedness that most people will take on in their lifetimes.

My advice, then. Take full advantage of these artificially low interest rates, and refinance the home. If you have unsecured debt such as credit cards, student loans or car loans, and you have the equity in your home to do so, then roll those debts into a new home loan in the high 4% to low 5% ranges, depending on how you qualify.

Then, get on that budget and savings plan that you have always talked about, even though it means cutting back a little on the nice things that you enjoy. And, if need be, do some things to bring in a little extra income.

But the refinance part, do it quickly. The reason is two-fold.

First, mortgage rates are artificially low right now, because the Fed is the main player buying Mortgage Backed Securities (MBS) – those bonds that drive the mortgage rates. They are planning on buying MBS through the end of June, 2009. Once they stop buying, watch for rates to take off like a missle.
And, second, when we do see inflation take hold, mortgage rates rise as bonds are shunned. The reason is that bonds and inflation mix like oil and water. They don’t. In fact they can’t, because by definition bonds offer a fixed rate of return on an investment. And that fixed rate, say 4%, is diluted more and more as inflation rises. If inflation is at 4%, then the real return on that 4% bond yield is…nothing. Right, inflation cancels the yield on the bond. So what if inflation hits 6%? Bonds are negative, and have to rise to compete.

So that’s it, two very real factors that will cause mortgage rates to rise in the near future. So if you want to see if you qualify to refinance your home, anywhere in Georgia, then call me or email me – jduffy at phoenixglobalmortgage.com, and let’s see what you can do.

Oh, and if you are in an adjustable rate mortgage (ARM) that will adjust in the next 12-24 months, you may be looking at the LIBOR (or other index your loan is tied to), and patting yourself on the back, looking at how much that rate is going to drop once it adjusts. You are right, for now.

But I suggest refinancing into a long-term fixed rate, now that rates are so low. The reason is that the most effective tool that the Fed has to combat inflation, once it takes hold, is to raise interest rates.

Although the LIBOR is not tied directly to the Fed Funds Rate, that will be rising, it does track that rate with a fair accuracy. Remember what Paul Voker did in the 70′s to reign in inflation? My parents’ generation is still talking about the double digit interest rates they bought their homes with. And we will have stories for our grandkids, before this is all over.