Deflation has arrived but inflation could be flaring up in a couple

years. The latest March consumer price index showed the first decline

over a 12 month period since the Eisenhower administration. With rising

unemployment and excess factory capacity there is virtually no pressure

for wages or prices to rise. The first order of business – from the

Federal Reserve point of view – is to stop the deflation from spiraling

down, which could lead to years of a Japanese-style economic

stagnation. The mindset in this situation would be one of ‘why buy now

if I can buy just about every consumer product at a cheaper price

later?’ But postponing purchases freezes economic activity.

The Fed has, therefore, been madly pumping out money to help kick

start the economy and to help ease the credit crisis. The Fed’s balance

sheet has grown exponentially in the past year to now more than $2

trillion. This money is essentially off the printing press. Over the

short term, more money into the system and easier borrowing standards

will inevitably stimulate the economy. However, too much money for too

long in the system will spark inflation. Prices of just about

everything – from hamburgers and airfares to tuition and wages - will

rise. And if (or perhaps I should say ‘when’) inflation does rise – say

5 percent or even closer to double-digits – there will be distinct

winners and losers.

The big winners will be property owners. Paper money will lose its

purchasing power, but real tangible assets will rise in value. Property

is imbedded with commodities and is sitting on land, which cannot be

printed off a printing press. As it has happened around the world

throughout history and more specifically during the 1970s and early

1980s in the United States, property values rise with consumer price

inflation.

The big losers will be those who need to borrow money. High

inflation automatically brings high interest rates. Lenders will charge

a higher rate to compensate for the loss in purchasing power. Be it a

home buyer or small business owner or even the government, those who

need to borrow at that time will face burdensome interest payments.

It is possible that we may not see inflation when the economy gets

back on track. The Fed may be able to quickly mop up the cash that was

distributed. But some of the money printed, without being too technical

or using jargon-like acronyms such as TALF (Term Asset-Backed

Securities Loan Facility), was for the longer-term where the Fed cannot

automatically soak up the cash. That leaves a distinct possibility of

inflation picking up due to too much money chasing around the economy.

The economy, though growing, will also be operating sub-optimally

because high inflation introduces unnecessary uncertainty for business

start-ups and entrepreneurs.

What is the bottom line? Yes, inflation could be contained. But it

is also possible for it to get out of hand. If that happens, property

owners will be in the winner’s circle. Those property owners who

locked-in low mortgage rates will further benefit from constant loan

payments independent of future inflation. However, home buyers and

other borrowers at the time of high inflation will be shut out of the

market because of exorbitantly high interest rates.

Inflation