– Inflation, Hyperinflation and Real Estate (or, The Lessons of The Great Hernán P.) (Gonzalo Lira, February 12, 2011):
“Hyperinflation accompanied by a housing collapse is simply impossible—by definition.”
– None-too-clever financial blogger.
Most people in the advanced economies—including most economists—really don’t have any idea what inflation and hyperinflation is. They don’t have a clue because they haven’t lived through it, or were children when it happened in the States and in Europe during the Seventies.
They think it’s nothing more complicated than a rise in prices that ripples through the economy—like a spectator in a football stadium who stands up, obliging the people sitting behind him to also stand up, so that they too can see the action on the pitch, which in turn forces the people behind them to stand up too, until finally, the whole stadium is up on its feet.
That’s what these people seem to think: Inflation—and the more severe hyperinflation—affects all goods and services and asset classes equally, in a rippling effect. Sort of like a rising tide.
Because of this very foolish fallacy, many economists and interested observers think that real assets—commodities, land, buildings, factories & machinery—all rise in price equally during an inflationary spell, whereas financial assets—bonds, stocks—uniformly fall.
But this is wrong: It is at best sloppy thinking, at worst dangerously stupid.
Inflation—and hyperinflation—affects two things immediately: Near-term necessities (such as food and fuel), and credit.
The effects on basic necessities is obvious—but the effects on credit are more subtle and complex.
How does inflation and hyperinflation affect credit? By driving up interest rates—obviously. But what is the effects of rising interest rates in an inflationary/hyperinflationary environment?
Real estate price collapse.
Lenders—on seeing prices rising and purchasing power deteriorating in an inflationary economy—naturally raise the interest rate they charge, on the future expectation of inflation during the period of their loan. Obvious: If I lend money for a year, and expect the inflation rate to be 10% for that year, I’ll naturally lend out my money at 15% interest—or more, if I think inflation is accelerating.
Borrowers on the other hand—on seeing interest rates rise, while their wages and salaries are at best playing catch-up to rising prices—curtail their borrowing: They either borrow less, or don’t borrow at all.
Therefore, real estate sellers—who depend on lenders to provide their buyers with credit in order to sell their properties—are forced to lower their prices, in order to attract buyers. Law of supply and demand: They cannot force up the price of their real estate to match the pace of inflation, because if they do, they will simply not have any buyers.
Thus, in an inflationary environment, real estate prices either remain static or indeed fall on a nominal basis, even as inflation is debasing the currency, because real estate sellers will not find buyers willing to take on usurious debt in order to buy the property.
This is how real estate prices fall, even as prices for near-term necessities—food, fuel—rise. This is how you have a real estate collapse, even as you have inflation.
Don’t believe me? Well, I can empirically prove this. During the 1979–‘83 inflationary recession, this is exactly what happened in the United States: Nominal real estate prices were essentially flat, even as inflation peaked at 15%. The same in the UK during the early Seventies, in fact the same in every advanced economy that experienced low-double-digit inflation in the post-War period: Real estate prices remained nominally flat or even fell, as inflation rose and the currency was debased.
What about real estate in a hyperinflationary environment?
The same—only magnified: In a hyperinflationary environment, interest rates are so high that essentially, there is no lending. There’s no point to it: Most lenders will decide not to lend out their excess cash, and instead park that cash in assets which will resist inflation—they will certainly not lend out their cash to a borrower, and watch it become worthless on their books.
Therefore, since real estate buyers cannot get a mortgage loan, real estate sellers are forced to reduce their prices in a hyperinflationary episode—drastically.
Of course, there are fewer sellers in a hyperinflationary period: Many sellers will decide not to put their real estate assets on the market during such a period, precisely because they do not want to receive a lower price for their holdings. They’ll choose to ride out this rough patch, or hold out for the price they want for as long as they can.
But that doesn’t mean that there are no sellers—obviously. The ones who remain in the market during a hyperinflationary period—for whatever reason—will lower their prices in order to attract a buyer. And as buyers dry up, sellers will either exit the market—that is, take their property off the market—or else lower their prices even further.
This is why the windbag blogger above who claimed that “Hyperinflation accompanied by a housing collapse is simply impossible—by definition” simply does not know what he’s talking about.
The exact opposite is in fact the case: When there is severe inflation, real estate prices are either nominally flat or falling, like in the United States during the abovementioned ‘79–‘83 inflationary recession.
And when there is hyperinflation, real estate prices of all sorts—residential, commercial, industrial—go into a free-fall: Their prices crash and burn, completely and utterly.
This situation—crazy though it may sound—is exactly what happened in Argentina, in 2001: The Argentine peso went into a hyperinflationary breakdown, the causes of which are irrelevant to the present discussion. But because of this, no bank would lend money to purchase any real estate.
Thus, real estate prices plunged in Argentina.
I have a family friend here in Chile, an attorney named Hernán P., who made one of the shrewdest investments ever: At the height of the Argentine crisis in 2001, he bought an apartment in one of the most fashionable neighborhoods in Buenos Aires: A lovely and luxurious full-floor apartment, across the street from the Four Seasons.
It’s price before the crisis? $650,000. The price Hernán P. paid at the height of the crisis? Less than $90,000. Here’s the kicker: He was the only buyer. Of course, he had to pay in cash—no mortgage loans were available. In fact, he had to pay in cash cash: He was required by the seller to close the transaction with actual physical dollars.
At the time, I thought he was crazy—and told him so. But he replied, “Back in Chile in ‘73, during the hyperinflation brought about by Allende, I had the same opportunity—and didn’t take it. I’m not going to make the same mistake twice.”
I thought Hernán P. was a fool—then realized that I was the fool, when the Argentine crisis passed, real estate prices rebounded, and the apartment he had purchased was now worth several times what he paid for it.
The Great Hernán P.’s story is far from unique.
In fact, this situation was not unique to Argentina in 2001 either: Every hyperinflationary period in history—Weimar Germany, Chile under Allende, Brazil in the ‘90’s, Zimbabwe—results in the same situation: Rising prices for food and fuel, but collapsed real estate prices.
In other words, in an inflationary/hyperinflationary period, real assets do not all rise in tandem, like a tide lifting all boats. On the contrary, think of it as a pool table sitting on a gimbal: Some pockets rise, while other pockets fall.
The Great Hernán P.’s example is exactly what any sensible investor should do, in an inflationary or hyperinflationary period: Preserve capital at all costs, via commodities, while keeping a sharp eye out for real estate opportunities. As inflation rises and real estate prices collapse, be prepared to trade the commodities you own for real estate assets selling at depressed prices.
Here endeth the lesson of The Great Hernán P.