Thunder and Lightning

posted on June 2nd, 2008 filed under: Real Estate News

What happens when negative real interest rates encounter overindebtedness?  Seems we’re in the midst of that very storm.

Negative real interest rates are inflationary.  People chase goods and services when it’s cheaper to buy now with borrowed money than to buy later when prices have risen.  The incentive to buy creates demand and drives prices up.  As you can see on the chart below, we spent a lot of time below the zero line on real interest rates back in the inflation-heavy ’70s.  Real rates turned mostly positive in the ’80s and ’90s.  For the ’00s, however, we’ve hit the skids again, hanging out at the cheap-money saloon.


Overindebtedness, by contrast, is eventually deflationary.  There’s only so much debt a person — or a people — can carry.  The housing sector, for example, boomed as rates fell and lending standards disappeared.  But when there was no way to cram any more debt onto buyers’ balance sheets, borrowing receded and prices followed.  This process has implications for the broader economy, where we’ve piled one debt binge upon another, far outpacing the growth of our economic output (see chart below).  When the limit is reached, it will seem like just another day.  But it won’t be.


Of course, these are two vastly different scenarios.  If high inflation lies ahead, then real assets are important.  Even real estate will look good again; home prices rose during the inflationary 1970s.  And debt will be desirable, as it becomes easier to repay with depreciating currency and inflated wages and assets.

In deflation, nothing beats cash safely held.  Except perhaps a job.  And nothing is more evil than debt, which is harder to repay in the face of lost jobs, tight wages and falling asset values.

If the thunder don’t getcha then the lightnin’ will.

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posted by // This entry was posted on Monday, June 2nd, 2008 at 9:36 pm and is filed under Real Estate News. You can follow any responses to this entry through the RSS 2.0 feed.

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