Working Both Sides of the Balance Sheet, Part II
by Richard
Picking up on our theme of intelligent debt applications, it might help if we examined the ramifications from being a borrower in a world about to be engulfed in inflation.We have just this past year concluded a remarkable bull run in the bond markets, that began in the early 1980s, and finally reached bottom when the Fed funds rate was reduced to zero, and the bellwether 10-year government bond fell to the rock bottom yield of just over 2% at year end.
If rates can’t go any lower, they can certainly go much higher.
And then the inverse relationship once again manifests itself. As bond yields go down, prices go up…the back story on our 28 year bond bull market.
Just as prices will drop when yields once again start climbing.
At a time when wages are stagnant, and employers are cutting back on even the basic forty hour work week, inflation may seem to be a tamed beast.
Don’t bet on it. Not with the tsunami of money working its way through the stimulus and bailout pipeline.
We’ve already talked about why real estate is the premier inflation hedge. Unlike other hard assets, not only does its tangible aspect translate into inflation hedging, but the stream of rental income (or imputed rental income, for homeowners) also rises with inflation.
But in addition to the rising asset value and increasing income stream…
There is another huge benefit…when the real estate is leveraged with prudent and ultra low cost debt.
Because just as borrowers are rewarded during inflation, lenders are punished. The lenders put real dollars in the deal at closing, but they are repaid with steadily and stealthily shrinking currency, with only a fraction of its original buying power.
Look at it this way. If you are bullish on an asset, you go long. You buy it.
If you are negative on an asset, you dump it.
And if you are both negative and daring…you sell something that you don’t even own…i.e. you sell the borrowed asset short.
For in the final analysis, the bond issuer/holder is long the bond. By definition. They hold a depreciating asset in an inflationary environment, and must wait 15-30 long years for the money to trickle in.
A different story for the borrower. Owing on a mortgage is exactly like selling the bond market short. The preferred position in that bilateral exchange.
A brilliant strategy for an era marked by total economic amnesia…. and a hyper-activist administration with a veto proof majority…. determined to spend our way back to prosperity.
