Inflation is essentially a the rate at which prices in the general economy rise on a year over year basis. It is often expressed with and without highly volatile components such as fuel. Inflation was running in the 10% range in the early 1980's which led to mortgage rates in the mid to high teens (for all of you new homeowners, ask your parents what that was like).
As global economies teetered, governments around the globe began to "create" economic stimulus packages and bailouts of sectors of their economies. Banking, auto, housing were the first in a stream of what is likely to become a "hey what about us" line of groups asking for help. How do governments solve these problems? By printing money and putting it into the economy. This comes with a price later as all that extra cash will tend to lead to inflationary pressures. Most economists agree that once global economies are on track, that interest rates will need to jump substantially to prevent hyper-inflation. How does a mortgage rate of 9% sound to all those who overextended themselves.
Stock markets have also lost their minds. Reading an economic commentary the other day, I saw two "highlights" that I had to read twice to make sure I read them correctly.
- In 2008, the number of days the S&P 500 rose or fell more than 5% in a day was twenty. That compares to eight days for the 10 year period between 1997 and 2007.
- In 2008, the S&P 500 lost 38.5%. The number of down days during the year was 126. The number of up days? Also 126.
One big problem lies in how deep rates go down. The more they go down now, the more they will likely need to increase in the future. The second problem (and more current one) is the fact that reductions have not been passed on to consumers. In Monday's Globe and Mail, it was predicted that rates would be reduced by another 50-75 basis points. What that translates into for consumers is unclear. Already banks are raising rates for loans and credit even though the Bank of Canada rates are at record lows and falling. Normally a cut of 50 basis points would be an economic "spur" but with most global economies cutting rates to such dramatic levels, it's expected to have little effect.
Once we fully emerge from this mess (likely 2011), expect the government to tighten monetary policy and interest rates to rise over a protracted period. This will hit the housing market again as existing homeowners who currently hold "variable rate" mortgages will look to lock in. As "fixed rate" mortgages come due, the owners will be forced to take cut costs elsewhere to afford their mortgages. Anyone who owned a home before 1993 knows exactly what I mean. Does this mean we face the same sort of extended decline in the housing markets we saw in the late 1980's and early 1990's. Most people would say no - I don't belong in that crowd. Too many people saw the housing market as a short term quick-cash solution to their problems. As a long term investment this approach is fine. What happens when people cannot find anyone to rent their condos to. They will be forced to sell in an already saturated market. In Vancouver, a developer has started slashing prices by $100,000 on new condos. Imagine you bought in that same building last spring for the "investment potential". It may take you ten years to simply recover your principal.
So what do we do? Pay your bills. Pay cash (credit is getting too expensive) whenever possible. Set aside money for a rainy day (or rainy week). If you have debts, focus on paying them off as soon as possible. For older clients (60 plus) with adult children, see if you can provide a little assistance if it's within your means. Everyone believes their job is safe - don't believe it. If you think your job could be in jeopardy then start looking now. You are far more attractive to a company if you already have a job. All that being said, we cannot forget about the future. Continue to save cash, put money into RRSP's, set aside money for a child's RESP. The people who stop at this time will miss out on the eventual economic bounce.