This effects everyone differently. If you are trying to sell your house, you may be worried about a $10,000 or $100,000 price cut, but then again, you may not really care that the price of eggs just went up 10% or a few dollars. In other words, at this moment, some of us are worried about hundreds of thousands of dollars of deflation, and others about a few dollars of inflation.

In any case, the inflation of essentials such as food and electricity will not be so evident in the overall CPI statistics (inflation stat) because they are dwarfed by the super-large deflationary numbers of cars and houses. This is critical to keep in mind as the inflationary stats are reported. The stats create an economic mirage for every day producers and consumers trying to decipher the reality of inflation and/or deflation.

The human error or variable is the Fed. As they “play” with interest rates and/or print money; they can not change the supply and demand fundamentals of our credit, but can greatly distort price. For example, the house may finally sell for $300,000, but the value of the money is worth half as much since the Fed has doubled money supply. In other words, you can’t buy as many eggs (essentials) with your inflated money.

This excerpt from Jean-Baptiste Say, one of my favorite economists, explains on page 227 of Treatise on Political Economy:

“As a proof that this paper (money) has a peculiar and inherent value, when its credit was the same as at present, and its volume or nominal amount was enlarged, its value fell in proportion to the enlargement, just like that of any other commodity… No government has the power of increasing the total national money otherwise than nominally. The increased quantity of the whole reduces the value of every part; and vice versa.”

With the failure of Lehman and freezing of the credit markets the market has moved substantially. I believe that the extent of the change has not yet been understood since very few properties are trading. There exists a significant gap between sellers and buyers, and in this cash constrained market the buyers will win. This is because there will be significantly fewer buyers, and as demand goes so goes price. This will also create a widening between income producing and non-income producing properties.

In some respects this is very similar to the market during 1991, only more extreme. This will be compounded and magnified by two factors. First, $1.3 trillion of commercial mortgages are coming due during the next four years, most written at high valuation levels with no underwriting standards. Loans are now underwater and many owners who cannot refinance will be forced to sell, or their banks will sell for them. Both will need to offer higher return levels to attract a buyer. Second, many properties have current cash flow below levels they had at the time of origination, either the result of vacancies or rent concessions. These two realities will continue to put upward pressure on capitalization rates, and continue to depress the value of both income producing and development properties. Add to this the specter of inflation, and it looks to be a rough ride down.