Economists' Outlook

Housing stats and analysis from NAR's research experts.

Inflation is Picking Up

Inflation is creeping up everywhere.  Officially, prices as measured by the Consumer Price Index are up by 3.1 percent as of April compared to one year ago.  Officially, this increase is said to be of little concern, because this data is not that important.  What matters is the core prices, after subtracting food and energy prices, which have barely risen.  Focusing on the core price index makes sense in times of volatile price swings in energy and food.  To report that prices rose 5 percent one month and then say prices fell 5  percent in the next month and on and on in a swinging cycle does not provide a real meaning to the price trend.  Yet, when food and energy prices just keep going up and up and rarely down, then the inclusion of food and energy prices make more sense in an inflation calculation.  Hence, the focus should perhaps be more on the broad figure and not just the core.  After all, Americans are visibly suffering at the gas stations and at grocery stores.

Before the summer ends, I expect the broad official inflation rate will reach 4 percent.  It will also mean that Social Security checks and other payments that follow cost-of-living adjustments (COLA) will get a 4 percent bump next year.  Recall that Social Security checks saw no increase in the past two years because inflation was said to be non-existent.  For those working without a COLA clause, you’re unfortunately out of luck: there is no protection against higher prices.  Oil prices have shown a stabilizing trend of late.  But if they were to spike again, then a 5 or 6 percent rise is possible – into the territory of uncomfortably high inflation rates resembling the 1970s.

One reason for accelerating the inflation trend outlook at least for the near term is that all pipeline inflationary pressure is pointing that way.  Today’s import prices should be an eye-opener because they rose 12.5 percent from one year ago.  It’s almost certain that the goods sold at Wal-Mart and shopping malls will soon have a higher price tag.  Producer prices, the prices that companies pay to buy their products, have also been rising fast, which inevitably means some of the increases will be passed along to consumers.  Note that producer prices tend to be more volatile than consumer prices, so if producer prices were to retreat quickly then there may not be any pass-along cost to consumers.  Also note that consumer prices include services such as haircuts and landscape work,  and are minimally related to producer prices.

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Only real estate prices do not appear to be rising.  In calculating the consumer price index, real estate price is excluded because it is considered as an asset.  Stock and gold prices are excluded in inflation calculations for that reason as well.  Included from the real estate arena, however, are rent payments.  If rent is rising, then it reflects a higher cost of living for renters and is presumed to be the same for homeowners.  And rents have been rising of late, with most economists calling for about a 2 to 4 percent rent increase this year and the next.  So the renter’s rent component will also begin to add to inflation pressure.

Without an automatic cost of living adjustment, most people will face a lower standard of living unless they can properly hedge.  One way to protect against high inflation, historically, has been to acquire hard tangible assets, and not paper assets.  Rising gold and silver prices reflect some investors’ desire to hedge against potentially high inflation.  Another good inflation hedge, as demonstrated in the past, has been real estate.  Many Germans after the First World War lost everything to hyperinflation.  The only Germans who had some semblance of financial stability were those with gold or real estate.  (For some who remember from their school days a picture like the one below, it is said that thieves stole wheelbarrows like these after dumping the useless money to lighten the weight.)

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America will never face hyperinflation.  However, some high inflation is certainly a possibility.  Real estate is not a good hedge if property prices contain a bubble.  With the bubble removed in the harsh housing market downturn, however, some may buy real estate for inflation protection.  It is not surprising to see some investors getting into real estate even to protect against modestly high inflation.  Because investors are having a near impossible time getting a mortgage (for a non-owner occupied home), they are buying investment homes all-cash.  Investor activity is heavy in some deeply discounted markets like Miami and Las Vegas, to the point that first-time home buyers who do not have all-cash offers are getting shut out.  That is the nature of cycles, both economic and in real estate.  Things rise and fall, sometimes to extreme points, but the continuing rise and fall eventually comes to an end and the trend reverses.  This time around, rising inflation pressure may be just that catalyst to reverse the trend.

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