Inflation on its head?

People ask me about inflation in the 70s and 80s, usually because they want to position themselves advantageously for the inflation they now anticipate. “The only solution to all the debt is to have inflation” they say.

But the inflation of the 70’s felt like deflation. Although retail prices and incomes were rising fast, real and nominal prices of investment assets were falling.  Most residential and commercial property prices were (as they are now) determined by people’s capacity to borrow. As interest rates climbed, their ability to service a constant loan size declined faster than inflation lagging incomes and rents could boost their capacity to service it. The same pressures lowered equity valuations, earnings yields ratcheted upwards and prices plummeted.

However for residential property buyers actual net borrowing rates were generally lower than inflation. With the tax relief available to owner occupiers in the 1970s, it was possible to pay a net annual interest rate on your mortgage of less than the annual rate of inflation.

Trouble was, there was loan rationing everywhere, even from building societies, and the building societies were only lenders to owner-occupiers High street banks wouldn’t lend on property for investment at all, and rarely for occupation.  In 1976 I was offered a detached freehold house in Finchley (NW London) arranged as four flats yielding £4,500 per annum, for £16,500 .

It was desperately cheap but I couldn’t find finance, which was of course the main reason residential property investments were so cheap.  Residential investment property prices were falling because there was credit deflation.  In those days I had three credit cards maxed out up to my combined credit limit then, of £6,500, for the purpose of buying residential property investments.

London auctions were stacked with properties yielding 25% but no buyers. Most auction rooms had rows of empty seats in 1976.

But it was standing room only by 1979.

So my advice is counter intuitive. Liquidate everything for cash. In the coming inflation, market rates of interest will overwhelm central bank interest fixing (look at Italian bond yields last week for an example of markets setting yields against central bank diktat), and rise to levels which force holders of assets bought with borrowed money, to release them into a falling market.

And cash, ie real, folding money, will be king again for a while.