The best hedge against the inflation genie

[GIDDO]

Hello all,

I would like to hear some thoughts on the best way to cope with an inflationary environment.

I had always thought that hanging onto a hard asset real estate was the way to come out as close to even as possible.

I am supposing that cash would be the worst method of hedging against inflation.

There are a lot of experienced and wise investors here on s soft.

Any wise words on hedging against inflation. I am thinking we are in for inflationary times in 08 and 09.

 

[boomtown]

In inflationary times debt devalues in real terms. The winners are the owners of fixed assets (such as real property) whose debt declines relative to the value of the asset.

 

[alexlee]

Cash does receive higher interest in times of high inflation. More importantly, in hard economic times other sources of money (such as loans against property, for example) may be harder to get. At that point, cash becomes much more important.

Alex

 

[GIDDO]

So you are saying that prices of goods rise and pay packets increase to compensate. With those increased paypackets it is easier to pay off the debt. The debt becomes tinier with time and inflation.

What about inflation and property prices? One would imagine that as the cost of replacing a house increases, the prices of existing places gets dragged in an upward direction.?

 

[boomtown]

So you are saying that prices of goods rise and pay packets increase to compensate. With those increased paypackets it is easier to pay off the debt. The debt becomes tinier with time and inflation.

What about inflation and property prices? One would imagine that as the cost of replacing a house increases, the prices of existing places gets dragged in an upward direction.?

Yes but.

If inflation drives interest rates too high then house prices may collapse for the short term.

 

[GIDDO]

Aw gee; I was looking for an easier way, a less painful way.

So the hedge against inflation is debt. Is that right?

Well good news, I've got debt; truckloads of it!

 

[alexlee]

Easier way: get a big pay rise every year. Easy enough?
Alex

 

[units4me]

I reckon that cash in the bank will grow at a much faster rate than property over the next few years.

But i can't bring myself to sell any of my IPs. But i will be buying when the a$$ falls out of the market.

 

[Sunfish]

So the hedge against inflation is debt. Is that right?

You seem to be answering your own question. Sure, Boomtown said this:

In inflationary times debt devalues in real terms.

but if interest rates remain above the rate of inflation, how does your debt fall if your repayments remain static? If you have a useful level of equity in your investment then your equity can increase as a percentage but if you were 95% geared on IO inflation has V little to offer you. High inflation caused by runaway input costs (oil etc) will not necessarily give a compensatory general pay rise.

I doubt inflation is our friend.

 

[alexlee]

but if interest rates remain above the rate of inflation,

Interest rates are almost always above the rate of inflation, though. -ve real interest rates usually happen when something is really wrong with the economy.

how does your debt fall if your repayments remain static? If you have a useful level of equity in your investment then your equity can increase as a percentage but if you were 95% geared on IO inflation has V little to offer you.

The debt falls in REAL terms, not in nominal terms. Depends whether you believe inflation 'inflates' the nominal value of the property.

100% LVR. $200k property. 7.2% inflation for 10 years. IF you believe that the property rises with inflation, in 10 years the nominal value of the property is $400k and the nominal amount of debt is $200k. So where previously you had no equity, you now have $200k equity, and the equity has increased from 0% to 50%.
Alex

 

[GIDDO]

I reckon that cash in the bank will grow at a much faster rate than property over the next few years.

.

But what if you are 50% leveraged?

Surely $1 m worth of property would grow more than $500k in the bank.

Leveraging would help in times of inflation, provided the inteest rates don't kill you.?

 

[grossreal]

hi GIDDO
seed capital into enities that will list or are capital raising and those companies that benefit from rising prices.
so as there profit increases
yours does also but magnified as you have a magnifer by being part of the seed capital.
as with any hedge fund the risks are higher
but the returns are also
a hedge fund is used on the opposite side of a ledger
so you use them to balance a position so if you are looking at inflation costing you money you invest in something that makes money out of that loss.
if that makes sense.
and seed capital for me does this.

 

[Sunfish]

100% LVR. $200k property. 7.2% inflation for 10 years. IF you believe that the property rises with inflation, in 10 years the nominal value of the property is $400k and the nominal amount of debt is $200k. So where previously you had no equity, you now have $200k equity, and the equity has increased from 0% to 50%.
Alex

But if interest rates were 10% (we agree that in "normal" times rates are above inflation) you will have paid $200k in interest, so you haven't gained a penny in nominal terms. Your actual rates are more likely to be 12%.

Had you put your $20k/a (your interest) into a bank account you would have more'n $200k at the end of the period unless we get into hyper-inflation, and you believe in a continuum so we will discount that possibility.

I have not debated the value of your investment in other ways, I am merely saying inflation does not eat away your debt.

 

[ruroshin]

But if interest rates were 10% (we agree that in "normal" times rates are above inflation) you will have paid $200k in interest, so you haven't gained a penny in nominal terms. Your actual rates are more likely to be 12%.

Had you put your $20k/a (your interest) into a bank account you would have more'n $200k at the end of the period unless we get into hyper-inflation, and you believe in a continuum so we will discount that possibility.

I have not debated the value of your investment in other ways, I am merely saying inflation does not eat away your debt.

but the rent you would of received on the property would be more than the interest on the $20k in the bank?

 

[plusnq]

But if interest rates were 10% (we agree that in "normal" times rates are above inflation) you will have paid $200k in interest, so you haven't gained a penny in nominal terms. Your actual rates are more likely to be 12%.

Had you put your $20k/a (your interest) into a bank account you would have more'n $200k at the end of the period unless we get into hyper-inflation, and you believe in a continuum so we will discount that possibility.

I have not debated the value of your investment in other ways, I am merely saying inflation does not eat away your debt.

Hi

The cash will depreciate in real terms in the bank even with interest rates at say 10% due to inflation dependent upon your tax bracket.

20K @ 10% =2K interest received
Tax @ 46% = $920
Inflation is 7% therefore our $21080 (20K plus $1080 interest after tax) is now worth in inflation adjusted terms $19604.40 so we go backwards every year with money in the bank. This is because inflation at 7% is higher than the interest received after tax (inflation 7%, interest after tax is 5.4%)

Cheers

Shane

 

[Sunfish]

but the rent you would of received on the property would be more than the interest on the $20k in the bank?

Note that I said: I have not debated the value of your investment in other ways, I am merely saying inflation does not eat away your debt.

 

[Sunfish]

Hi

The cash will depreciate in real terms in the bank even with interest rates at say 10% due to inflation dependent upon your tax bracket.

20K @ 10% =2K interest received
Tax @ 46% = $920
Inflation is 7% therefore our $21080 (20K plus $1080 interest after tax) is now worth in inflation adjusted terms $19604.40 so we go backwards every year with money in the bank. This is because inflation at 7% is higher than the interest received after tax (inflation 7%, interest after tax is 5.4%)

Cheers

Shane

Alex's $200k in equity will have suffered the same deflationary effect. Again I say I am debating the statement "Inflation reduces your debt!" not the merits of savings accounts.

 

[alexlee]

Alex's $200k in equity will have suffered the same deflationary effect. Again I say I am debating the statement "Inflation reduces your debt!" not the merits of savings accounts.

Agree, but since in my example I started with ZERO equity, ANY equity that is created solely as a result of inflation (I didn't include all the numbers on the actual investment itself such as depreciation, increasing rent and so on) would be a gain as a result of inflation, no?
Alex

 

[Sunfish]

Agree, but since in my example I started with ZERO equity, ANY equity that is created solely as a result of inflation (I didn't include all the numbers on the actual investment itself such as depreciation, increasing rent and so on) would be a gain as a result of inflation, no?
Alex

No. You only have that equity because you paid more than that to service the loan. You will have "saved" only 75c in every dollar you put in. You may be mining tax lurks but that is a separate matter.

But I was rebutting the argument that only cash deflates.

Should we do this exercise where assets are valued in ozs of gold?

 

[alexlee]

No. You only have that equity because you paid more than that to service the loan. You will have "saved" only 75c in every dollar you put in. You may be mining tax lurks but that is a separate matter.

If you include the servicing costs you would also have to include rent received, and that increases with time too.

But I was rebutting the argument that only cash deflates.

Isn't debt the reverse of cash?

Should we do this exercise where assets are valued in ozs of gold?

Nah, I'll let you have this field and I'll go onto something else.
Alex