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2011-03-10 17:46:50

Inflation Rears Its Ugly Head

            A news story caught my ear, and then I looked it up online. The basic truth is that every one cent increase in gasoline prices takes one billion dollars out of the economy. The full article is here:   The immediate point is that billion is no longer available for food, housing, clothing, entertainment, or any of the other things consumers need and want. The second point is that this will ripple through the economy, because petroleum products not only make lots of other things, but supply the fuels (diesel and gasoline) which bring products to market.  But we still have high unemployment, even though the rate dropped—at least it appeared to drop.  The talking heads still are concerned (and we should be, as well) about those no longer seeking employment (the discouraged workers), those who are underemployed (the person with the master’s degree who is working at Starbucks) and those working only part time who would prefer to work full time.

            I’ve seen this movie before, and it isn’t pretty. I was younger then—it happened under Presidents Ford and Carter—and what they call this is “stagflation”—inflation with stagnant job growth.  The cure for inflation (administered painfully by Volcker, Chairman of the Fed under Carter) was to raise interest rates again and again until inflation stopped. As I recall that worked—way better than the “WIN” buttons (Whip Inflation Now) President Ford wore.

            For housing, this is particularly ugly right now. We have a trifecta of unfortunate events, here and on the horizon: 1) a continued high supply of housing, in most markets; 2) lenders who sobered up after the excesses of the early 2000’s and now are sticking to sound underwriting guidelines, including debt to income ratios; 3) the specter of increasing interest rates.  I’ve harped on the math before; a 1/2 % increase in the interest rate raises the payment by 6%; a 2% increase amounts to over a 20% increase in the payment.  For those who don’t remember it, or didn’t live it, Volcker was appointed August 6, 1979 and increased federal funds rates from 9.6 to 19% within 8 months.  That’s an increase of 9.4%. Let’s round it down, to a mere 9%.  Mortgage rates are hovering between 5% and 5.5% right now (for a 30 year loan, without buy downs, or other incentives).  So $100,000 borrowed for 30 years at 5% results in a payment of $536.82 (principal and interest).  Raise that rate to 14% (a 9% increase; assuming the absolute worst, and we repeat the nasty medicine Volcker administered), and the payment goes to $1184.87—an increase of 121%.

            I can hear people saying: “Oh, that could never happen! The government knows how fragile housing is.” Yes, they do. But the other side of vise the government is in (inflation is one side) is our enormous debt.  If our creditors decide they want a better return on their investments, or they will stop buying our debt, we’ll have no choice but to increase the interest rate we pay on our debt—which will require all interest rates to rise.  These are tricky times to be in real estate.  Lest you think I’m not offering any good news, I am. It’s the same message I’ve been on for the past several months, and I can sum it up like this: people who don’t buy real estate now will live to regret it. The huge inventory and low interest rates are not going to last.  I can guarantee you this: within the next few years, you will hear from consumers who did not buy—and regret it.


Melanie McLane is a real estate broker, appraiser and educator. She covers this topic in her course: “Economics and Appraisal”. For a complete listing of courses, and other services, visit her website at or email her at:


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