AMA - Inflation and Debt Crisis, part 2

This is part 2, a continuation from yesterday's show. Braxton from New Orleans asks:

It feels like we are certainly departing from the status quo of the past 10-20 years. I have taken cash out of some of my small rental properties but struggle to re-deploy in more investment properties because prices continue to be pushed upward. There is a mountain of liquidity and increasing competition for investment at low yield. My personal view is we may see near term inflation, but I am concerned we could also be at the doorstep of another debt crisis like in 2008. It appears as though speculative mania has taken over in many markets. How do you view the inflation vs deflation risk and balance you near term investment decisions? If there is inflation it would make sense to buy assets as the housing rents should keep pace with prices, however if there is deflation retaining cash may make more sense. I would like to know how you are thinking through this scenario as each path will likely have very different outcomes.

I think we are going to experience a period of stagflation, a combination of economic stagnation combined with inflation. Stagflation is caused when something artificial causes economic contraction. Efforts to stimulate the economy are held back because the artificial cause is still present. The result is an economy that is flooded with cash, but nowhere to go. The result is inflationary despite the economic contraction. That means prices will fall in some sectors of the economy, but not all.  The artificial event of course is the pandemic this time around. Governments the world over are ordering businesses to close and to not conduct business in order to protect human life and the healthcare system.

 Keynsian economists believe that stimulus will  be inflationary and that retrenchment is deflationary. But that’s not necessarily true as we saw in the late 1970’s after the OPEC oil embargo.

Any talk of deflation is of short term deflation. Nobody’s talking of a protracted depression like we saw in the 1930’s. I have no doubt that we are in a long term inflationary trend. This has been true since the early 1970’s. So the question is really whether a deflationary interlude would be devastating for you as an investor or not.

The key to positioning your portfolio to handle a deflationary period is to make sure you have sufficient covering equity, and that you have sufficient monthly cash flow, or ample cash reserves.

Your third question is whether we’re going to experience another debt crisis. A 2008 style residential real estate crash is possible, but not very likely in my view. The banks are much better capitalized and the Fed has basically told their member banks that they will buy up the toxic debt if it appears. It would take a big rise in interest rates in order for loan rates to become unaffordable, which would trigger a drop in real estate prices. For now, the Federal Reserve has issued guidance for the next couple of years that rates would remain low. When you do the math on the excess reserves that the banks have on deposit at the Fed, there’s more than enough cash there to handle a massive default on real estate.

As of earlier this week, the new Treasury Secretary Janet Yellen who was previously Chair of the Federal Reserve has been the cheerleader for even more aggressive printing of money. We may be facing a sovereign debt crisis at some point in the future, but not a real estate debt crisis.

I believe the US government is going to print money until the population or the rest of the world loses confidence in the dollar. At that point, we will experience rising interest rates in order for the US to sell its bonds. 

If the US doesn’t succeed in restoring confidence in the dollar, then the US will lose its position as the global reserve currency and will get reset into some other monetary system.