Two Percent? Yeah Right!

While the world was distracted by a crippling pandemic, major economic shifts were underway and the headlines totally missed it.

Changes that affect the course of history happen slowly at first, then all of a sudden. I believe we’re in one of those phases again, right now as we speak. The last time this happened was 1971.

We’re still bearing the fallout of the damage that Richard Nixon did to the United States back in 1971 when he took the US dollar off the gold standard. I remember those days even though I was just a child. I was eight years old. We used to listen to a half hour news radio show every evening during dinner time at my house. I remember the news vividly. I watched the news conference when Nixon made the announcement.

I remember the OPEC oil embargo of the US. Naturally, the narrative on the news made the oil rich nations of the middle east to be the enemy. It was those nasty greedy oil Barrons in Saudi Arabia that were responsible for the long lines at the gas station, the unprecedented prices for a gallon of gasoline.

When in fact, the oil Barrons were quite right to be upset at the notion that they were being paid less for their oil with the illusion that the price remained the same.

What followed was a period of inflation, unlike what had been seen in the US in recent memory.

Inflation was out of control.

It started with oil, then spread to other commodities. Eventually the price increases trickled through the economy and spread to include rent, transportation, food, and eventually wages. It was a time of labour strife, of unions going on strike to protest declining purchasing power and the demand for higher wages.

There were strikes at car manufacturers, the post office, at airlines, the railways, the longshoremen unloading cargo ships. The culprits were the big bad corporations who were exploiting their workers. Or were they?

Perhaps the erosion of the purchasing power of their wage was really to blame. But since the government wasn’t paying the majority of pay checks in those days, you could only look to your employer for a raise, not the government.

So here we are in 2021, with commodity prices shooting up and yet inflation is still below the 2% target.

But wheat prices are up 33% of last year. Oil prices are triple what they were at this time last year. Copper prices are up 72.4% over this time last year. Lumber is up 260%. Corn prices are up 80% over last year. Real Estate prices for residential homes are up 16% nationwide. Yet somehow inflation is worryingly low, below 2%. Somehow there is either a disconnect, or the effect has yet to trickle through the system.

China is America’s largest trading partner. The tone of the talks this past week in Anchorage Alaska between the US and China have made it clear that China is taking the dominant role in the discussions.

OK. So what does this have to do with real estate? If you’re a real estate investor and you’re trying to underwrite deals based on flat market assumptions about inflation, it’s getting more and more difficult to create a financial model that reflects the reality we are now experiencing.

If prices are up, will rents follow suit?

Transportation costs are up dramatically. The balance of trade can be clearly seen in the cost of transportation. Shipping a container from California to Shanghai cost $445. But that same shipping contained coming from China to Long Beach California costs over $3,000, and if you want to ship to the US East Coast, add another $700.

The question is how long until China no longer accepts the devaluing US dollar as a means of payment?

When that happens, you will see a rapid drop in value of the US dollar. When that happens, you want to be holding real estate and as few dollars as humanly possible.