Is it time to worry about inflation?

Oh no, the “I” word is back. Inflation is now on the front burner, an actual worry in some quarters. But is it a real concern or little more than a myth with great energy and lots of hype?

“Inflation is the decline of purchasing power of a given currency over time,” explains Investopedia. It adds that a rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.

“Inflation is not necessarily good or bad,” said Rick Sharga, Executive Vice President with RealtyTrac. “If you’re searching for a mortgage you don’t like inflation because it can push financing rates higher. If you’re a property owner you’re okay with modest amounts of inflation because it means sales prices and rents are likely to go up in cash terms.”

If you’re the Federal Reserve you like a little inflation. Speaking before the House Financial Services Committee, Fed Chairman Jerome Powell said in late February that “the pandemic has also left a significant imprint on inflation. Following large declines in the spring, consumer prices partially rebounded over the rest of last year. However, for some of the sectors that have been most adversely affected by the pandemic, prices remain particularly soft. Overall, on a 12-month basis, inflation remains below our 2 percent longer-run objective.”

If the Fed is aiming for a 2-percent inflation rate, and the inflation rate is lower, then what’s the big deal?

Inflation measures

It turns out that inflation does not apply universally. Some prices may go up at the same time that other prices go down. You need to look at a bundle of costs to realistically measure inflation, but some individual numbers are too curious to ignore.

Consider weekly mortgage rates. According to Freddie Mac, the rate for a 30-year mortgage was 2.97% at the end of February, down from 3.45% a year earlier. If inflation is an issue then why have mortgage rates declined? And how high can mortgage rates go when the world now has almost $15 trillion invested with negative interest levels, according to FXStreet ?

Does anyone really think that mortgage rates in the 3% range are somehow terrible? For context, the average mortgage rate between April 1971 and December 2020 was 7.9% according to Freddie Mac. If you’re a borrower which is more attractive, financing at 2.97% or 7.9%?

Look at home prices. The median existing home price was $303,900 in January according to the National Association of Realtors, up 14.1% from January 2019. If inflation is less than 2% then should not home prices be lower?

Should we worry about inflation if the rate has gone down? The annual inflation rate was 2.3% in 2019 and 1.4% in 2020. As Bloomberg headlined last week, “Weeks and Months of Negative Treasury Bill Yields Are Coming.” Does this sound like inflation gone wild?

Can the Fed handle inflation?

Despite all of its tools, it’s not clear that the Fed can manage inflation. Does the market control the Fed or does the Fed control the market?  As The New York Times wrote in 2017, “the Fed aims to keep inflation at an annual pace of about 2 percent, but it has undershot that goal consistently since the financial crisis, and the Fed says it expects to miss the target again this year.”

Gertrude Chavez-Dreyfuss, writing for Reuters, noted last week that “some investors may be getting ahead of themselves as they price in a move by the Federal Reserve to pivot away from an ultra-easy monetary policy sooner than most expected just weeks ago.”

Inflation and Negative Interest rates

Not only is it possible for low interest rates to exist during inflationary periods, it’s even possible to have negative interest rates.  If the inflation rate is 2% and the interest rate is 1.5% then – in terms of buying power – the borrower has real interest rate of -.5% and the lender is not earning enough to keep pace with the rate of inflation.

“The inflation-adjusted interest rate the United States Treasury must pay to borrow money for 30 years was negative for much of the last year,” reported The New York Times in late February, “meaning the government would pay investors back less in inflation-adjusted terms than it borrowed.”

Let the good times roll

It is now March and let’s consider a different thought regarding 2021 and inflation. Yes, prices are rising. But how much of the increase is the result of pent-up demand and interrupted supply chains created by the pandemic, and how much is the result of speculation, betting that inflation will come roaring back?

The great miracle for 2020 was that we avoided an outright depression in the midst of a pandemic. For 2021 there’s hope that the worst of the terrible costs created by COVID-19 — the deaths, hospitalizations, and long-term health impacts – will soon be behind us, that better days lie ahead.

If we are really beating the virus, if a strange and deadly mutant variant does not evolve, then a new economy can begin to emerge. There will likely be rising real estate prices increasing rental rates, and higher wages, but for your money you get a better world – one with a small dollop of inflation and a place where every surface and sneeze is not a threat to life and limb.

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