Thirty years have passed since we’ve had a significant bout of inflation in this country.  At the peak of this inflation battle my money market account earned 21 percent interest!  That was the good side of inflation.  The bad side of inflation was banks pretty much stopped lending and the only lending getting done was seller financed or other creative forms of hard money lending.

For the past 30 years we’ve seen interest rates slowly decline on commercial real estate from 12 percent to now 4 percent or less.  I believe the days of ever lower interest rates are coming to an end.  In fact, I believe the days of double digit inflation is inevitable and I believe it’s just around the corner.

But before I go further on what I believe is in store for us as a nation, let’s review what inflation is and what causes it.

What is inflation?

Inflation is an increase in the price of goods and services not due to growing demand or shrinking supply for those goods and services (which also affects price) but due instead to the dollar losing its buying power.

There is a difference between real price increases and inflation.  The price of oil could be going up because we are running out of easy-to-find oil, or demand has gone up because China’s rapidly growing economy is demanding more oil.  That’s not inflation; that’s a real price increase due to the forces of supply and demand.

What causes the dollar to lose buying power?

The value of money is affected by supply and demand.  If there are too many dollars available their value falls.  When the money supply is dramatically expanded in an economy with no or slow growth, as is happening today, the value of the dollar will eventually decline.  In short, too many dollars (too much supply), relative to the slow growth of the economy (too little demand), leads to the falling value of the dollar, a.k.a, inflation.  Therefore, real cause of inflation is increasing the money supply beyond what is needed to keep up with economic growth. 

What is causing the money supply to expand so rapidly?

The Federal Reserve in an attempt to rescue the economy began in early 2009 purchasing $2 trillion in U.S. mortgage and treasury bonds with printed money.  The technical term for these big bond purchases is “quantitative easing” or QE. Then in November 2010 the Fed began more bond purchases (QE2), adding an additional $600 billion to the nation’s money supply over the next year.  Again the goal of the money printing is to stimulate the economy back to health.

How much has the money supply increased in recent years?

In 2008, before QE, the U.S. money supply totaled $800 billion.  Today, the money supply is $2.6 trillion or more than triple what it was in 2008.  This is a stunningly large increase.  Nothing like this has ever occurred before in the United States.

Why aren’t we experiencing inflation now?

A paper written in 1999 by Ben Bernanke, the Fed chairman,, examined past periods of inflation and determined there is about a two-year lag between increasing the money supply and the onset of inflation.  It can be delayed further if the Fed takes other actions to create more lag time, which I’m sure they are trying to do.  It can be delayed but it can’t be prevented. 

Exactly when will inflation begin?

Good question.  The truth is no one knows when it will begin in earnest.  The authors of Aftershock: Protect Yourself and Profit in the Next Global Financial Meltdown believe that significant inflation will begin in the 2013-2015 range.

What does this mean for commercial real estate?

We live in uncertain times.  Many factors lie outside of our control to influence. As property owners refinancing our real estate is one area of our lives that we can be proactive and take control of the situation by locking in low interest rate, long-term financing.  Those who do will be the big winners. 

Source: Aftershock: Protect Yourself and Profit in the Next Global Financial Meltdown by David Wiedemer, PhD, Robert Wiedemer & Cindy Spitzer; John Wiley & Sons, Inc., 2011.