Inflation

[spurner]

Can someone explain to me why inflation is bad for us as individuals?

I am more of a "doer", and don't usually try to understand the more technical aspects of the economy. So in my uneducated opinion: If petrol is up 25%, cheese is up 37%, and wages are up 6%, then a property investor might be paying another $100 per week for their living costs and business expenses, which is bad. But if rental inflation is 8% then they might get another $1000 per week in rent if they have a good sized portfolio, so they're $900 better off, so actually inflation is good, no? And if you start considering capital gains then some very very serious money can be made. (All figures are random, for illustrative purposes only).

It seems that wealth is effectively transferred from people on fixed and low incomes (generally less wealthy people), to people who have income and assets which are influenced by inflation (generally more wealthy people)? And if you are leveraged then you can do exponentially better?

Even if absolutely everything in NZ increased by exactly 4% pa, then surely we (people with above the median assets/income influenced by inflation) are better off, as our biggest expense is interest which is not subject to inflation, our net income increases, and so does our net worth.

Am I wrong in my assumptions, or is this just a selfish way of assessing the situation? Any input would be appreciated.

New Zealand's inflation rate will probably accelerate to 4.9% in the year ending Sept. 30, the fastest pace since 1990, the Reserve Bank said today.
Annual inflation will be 4.5% by March 2009 but will slow to 2.8% a year later, he said. In June, the central bank expected inflation would stay above 3% until mid- 2010.

"We remain mindful of the risks to inflation,'' said Bollard. The extent of the decline will depend on the responses of wage inflation and inflation expectations, he said. A weaker exchange rate will underpin the price of imports, he said.

[exnzpat]

Yes inflation is not just bad – but very bad.

Companies start laying off employees.

People stop spending.

Banks stop lending.

And Governments begin fighting inflation with interest rate hikes. Just watch and see. The current rate drop will do nothing to jumpstart the housing market or the economy at large (as the experts hope). By the end of summer interest rates will be where they were last month (if we are lucky).

Inflation can ravage an economy – it makes everyone poorer – even the rich.

[dandan]

I dont think inflation will cause active property investors and problems.

[tricky]

You're quite right, spurner.
Inflation is the friend of us property investors.
I'm no economist but the simple view is high inflation is the same as 'fast forwarding' into the future. You can get the gains from property faster.
Embrace it.
You may as well because you're not the one who's causing it.

[watchful]

Yes inflation is not just bad – but very bad.

Companies start laying off employees.

People stop spending.

Banks stop lending.

And Governments begin fighting inflation with interest rate hikes. Just watch and see. The current rate drop will do nothing to jumpstart the housing market or the economy at large (as the experts hope). By the end of summer interest rates will be where they were last month (if we are lucky).

Inflation can ravage an economy – it makes everyone poorer – even the rich.

But expat you have in a sense completely contradicted yourself. The primary reason for OCR rises over the last two years by the RBNZ were due to the pressure that rampant house prices were placing on inflation. Realising that many kiwis would curb spending when their mortgages were re-fixed at much higher levels, the RBNZ successful checked inflation by dampening the housing market. On the other hand they have witnessed first-hand the dire implications of an out-of-control lack of confidence in the housing sector.

Therefore, if as you say,

The current rate drop will do nothing to jumpstart the housing market or the economy at large (as the experts hope).

then why would the RBNZ feel the need to do the following?

By the end of summer interest rates will be where they were last month (if we are lucky).

I am guessing some of the considerations for the RBNZ are this. Check the level of property price rises and remove the greatest risk of rampant inflation. DONE. Seek to re-establish the NZD at levels that will promote export earnings (DOING and for most part DONE). Now, encourage growth of the economy while minimising the effect of a currency collapse (DOING), and as they can have little impact on the INT commodity market, finally do their best to ensure confidence is retained in the property sector and NZ equity markets (DOING).

Agree 100% that high inflation is bad, but a serious period of economic demise is far worse than inflation rising to 5% for now.

[watchful]

You're quite right, spurner.
Inflation is the friend of us property investors.
I'm no economist but the simple view is high inflation is the same as 'fast forwarding' into the future. You can get the gains from property faster.
Embrace it.
You may as well because you're not the one who's causing it.

But you also have to factor in that people may not be able to afford to pay you rent and certainly that interest rates will rise and invariably what has happened here in the last year (falling property prices) will occur again.

All-in-all there are very few people that it is good for. Ask a Zimbabwean PI if rampant inflation has been positive for them.

[mlkmnz]

Am I wrong in my assumptions, or is this just a selfish way of assessing the situation? Any input would be appreciated.

Well you've cherry picked the possible advantages to yourself as a property investor. Inflationary times may be good for capital gains, however rampant inflation is often followed by a bust, where all your gains can vanish and rents decrease. Inflation pushes interest rates up so your holding costs increase and your rental yield goes down.

Times of high inflation may be a good opportunity to make a quick buck, but the risks are relative. In fact inflation probably hurts a PI more than most members of the public.

[exnzpat]

I dont think inflation will cause active property investors and problems.

Wow!

Let’s just agree to disagree, but let me assure you -- you are in for a rude awakening!

I haven’t seen denial like this since I visited Egypt.

[exnzpat]

But expat you have in a sense completely contradicted yourself. The primary reason for OCR rises over the last two years by the RBNZ were due to the pressure that rampant house prices were placing on inflation. Realising that many kiwis would curb spending when their mortgages were re-fixed at much higher levels, the RBNZ successful checked inflation by dampening the housing market. On the other hand they have witnessed first-hand the dire implications of an out-of-control lack of confidence in the housing sector.

Therefore, if as you say,

then why would the RBNZ feel the need to do the following?

I am guessing some of the considerations for the RBNZ are this. Check the level of property price rises and remove the greatest risk of rampant inflation. DONE. Seek to re-establish the NZD at levels that will promote export earnings (DOING and for most part DONE). Now, encourage growth of the economy while minimising the effect of a currency collapse (DOING), and as they can have little impact on the INT commodity market, finally do their best to ensure confidence is retained in the property sector and NZ equity markets (DOING).

Agree 100% that high inflation is bad, but a serious period of economic demise is far worse than inflation rising to 5% for now.

Monkey see -- monkey do.

The US tried the same thing in early 2007 (and twice more throughout the year). Nothing happened. The reason – well that’s anybody’s guess, but since early 2007 foreclosures have risen in the US to levels not seen since the Great Depression. And things are just getting worse.

The government takeover of Fanny Mae and Freddie Mac (quasi government agencies) was designed, not to protect investors, but stop the destabilization of the world’s economies (all of them). These two organizations lend money to the people who lend money. The situation these lenders found themselves in speaks volumes to those who listen.

Why anyone would think New Zealand is immune to this coming train-wreck is beyond me!

Lastly, inflation and the exchange rate are not the same thing.

[Matt Gilligan]

Inflation is not your friend

Can someone explain to me why inflation is bad for us as individuals?

I am more of a "doer", and don't usually try to understand the more technical aspects of the economy. So in my uneducated opinion: If petrol is up 25%, cheese is up 37%, and wages are up 6%, then a property investor might be paying another $100 per week for their living costs and business expenses, which is bad. But if rental inflation is 8% then they might get another $1000 per week in rent if they have a good sized portfolio, so they're $900 better off, so actually inflation is good, no? And if you start considering capital gains then some very very serious money can be made. (All figures are random, for illustrative purposes only).

Good out of the box thinking Spurner. I like it, but don't think you have your logic quite right here.

Why would rents rise with inflation ? Rents are a function of supply and demand are they not ? ie: are there more people looking for accommodation, and are there more properties being introduced into the housing stock by developers. ( Demand v supply)

Inflationary times do not determine if there is a supply imbalance.

Immigration trends and housing supply determines the imbalance, which in turn determines if rents are going up or down and ditto for house prices.

Therefore would it not be more likely in your stated scenario that you are spending more on your stable goods ( food, oil, cost of living) and have poorer tenants that cannot afford to pay their rents. You will get more bad debt, more hassles, and your income will buy less.

And the inflationary environment may drive the mobile part of the population out of town, so you get less demand for housing and therefore rents could soften. ie: Your tenants may flee to Aussie where incomes are 30% up on NZ.

Inflation is not your friend.

What you want is immigration. Immigrants soak up the surplus housing stock in the economy, competing up rents and house prices.

Inflation is eroding your wealth, cos every dollar you earn buys less and hurts everyone in the economy, making them want to tighten the belt and spend less, as we have seen this year in NZ.

[Commercial Dan]

Inflation is getting worse and will mature over the next 2 years to take a real hold on the economy. I think it will be great for the property investor who can leverage himself up to the hilt and make a fortune.

Hold a bit of gold and silver which will go up as well, a great inflation hedge for the next 2-3 years.

I still think fix rates for 3-5 years, they ain't comin' down to 6.50-7% levels again for a long time.

[exnzpat]

...I think it will be great for the property investor who can leverage himself up to the hilt and make a fortune....

I don’t know about that.

Last week (here in the US) I put an offer on a house. It was in pretty bad shape, but I made a fair offer based on the current market conditions. The seller refused because he owed $30,000 more than I offered. This meant that he would need to pay $30,000 to sell his house to me. The problem the guy has is that two years ago he refinanced, with intent on fixing the house up, but pocketed the money instead (probably all gone by now). Anyway, this guy is only months from foreclosure. No one in his or her right mind will pay him what he wants (needs) for this house. This guy also knows that he’s better off having the bank foreclose on the house and declaring bankruptcy than selling to me or someone like me. Which, from a financial point of view, is actually correct.

The trick to buying foreclosed properties is speed and cash. Two weeks ago I put an offer on a foreclosed property but lost it to 4 other offers, because I waited a day before making my move (the house had asbestos shingle siding – I needed to do some research – hence my delay).

This, I think, will be a difficult time for all.

[Matt Gilligan]

Interest rates

And Governments begin fighting inflation with interest rate hikes. Just watch and see.
REPLY Garbage - they are looking through tradeable ( imported) inflation and reacting to the recession. See below discussion.

The current rate drop will do nothing to jumpstart the housing market or the economy at large (as the experts hope).

REPLY More garbage - it is greatly appreciated, but diluted by the impact of imported credit cost / wholesale rates.

By the end of summer interest rates will be where they were last month (if we are lucky).

REPLY I strongly disagree

.

I think interest rates are going to drop in NZ.

The government is looking through the tradeable component of inflation ( oil and imported costs). Therefore looking at the total inflation rate, is misleading in Australasia cos the Reserve Banks are looking through the tradeable component, and seeing that we have recession, ie no growth, therefore no need to dampen demand and raise interest rates. Completely the opposite to what you are saying Expat, is what the Govt are doing. ( A bit of local knowledge for you.).

We have reverse conditions to what we had at the start of the year, creating some deflationary pressure.

Oil prices are dropping, the panic is passing in the US with Fannie and Freddie being nationalized, and improving the money supply over there ( in the USA), as structural intervention is being actioned. This should reduce the imported cost of capital from America to Australasia, easing the credit squeeze.

A drop in the OCR plus a drop in offshore cost of funds must be likely to push down interest rates.

Of course if the situation in America worsens, then wholesale rates will rise and this will put pressure on rates for sure.

All and all, my pick is it is stabilizing over there, wholesale rates will drop, inflation has peaked and will fall in NZ, and the OCR is down.

Interest rates are therefore more likely to go down than up, IMHO.

Consider breaking fixed interest contracts NOW, before the rates fall and float. Then re-fix in a low interest environment.

Keep an eye on it, if it turns to custard in America, re-fix again.

[watchful]

Monkey see -- monkey do.

The US tried the same thing in early 2007 (and twice more throughout the year). Nothing happened. The reason – well that’s anybody’s guess, but since early 2007 foreclosures have risen in the US to levels not seen since the Great Depression. And things are just getting worse.

The government takeover of Fanny Mae and Freddie Mac (quasi government agencies) was designed, not to protect investors, but stop the destabilization of the world’s economies (all of them). These two organizations lend money to the people who lend money. The situation these lenders found themselves in speaks volumes to those who listen.

Why anyone would think New Zealand is immune to this coming train-wreck is beyond me!

Lastly, inflation and the exchange rate are not the same thing.

Yes the Fed did cut rates in 2007, however it was widely fore-warned and was heavily criticised for not acting sooner and more aggressively. The RBNZ decide to be aggressive and yet some fools bleat that they 'didn't see it coming' and that they have fuelled the fire.

Re FM and FM, yes you could say that the objective is to 'stop the destabilization of the world’s economies' but moreso it is to try to stabilise the US housing shambles. That is their immediate goal. Yes, you and the rest of the US got themselves into some sub-prime sh#t and are now trying to tread water in it while wearing gumboots.

Back here in NZ, Expat, this decision by the RBNZ has been a significant and decisive one that people will long remember. It will both restore confidence and ease a lot of pain.

Not sure where you got the last part from. I'm not trying to state that inflation and the exchange rate are one-in-the-same thing, so sorry but no idea what you are on about there.

[MikeO]

One advantage of inflation

Inflation definitely has tax advantages for the leveraged property investor. Why? Because the same level of borrowing is more affordable if prices, wages, rents, etc go up in nominal terms. Sure interest rates might go up if the RBNZ tries to clamp down but that's tax deductable anyway...