What Happens To Debt After Hyper-Inflation?

[ngn]

Ok. Tin hats on....

Assume there is some massive "unexpected" black swan moment and inflation goes to 1000% or more.

What happens to all those beloved, over leveraged, home owners? now that their £400k morgague can be swapped for a tank of petrol?

NGN

[Mr Yogi]

Ok. Tin hats on....

Assume there is some massive "unexpected" black swan moment and inflation goes to 1000% or more.

What happens to all those beloved, over leveraged, home owners? now that their £400k morgague can be swapped for a tank of petrol?

NGN

They pay their mortgage off and live in their (nearly) free house feeling rather smug, I guess...

I remember 25% inflation in the 1970s making big mortgages a rather good idea. I still think deflation is more likely over the coming years, however.

Edited August 24, 2010 by Mr Yogi

[Saberu]

They pay their mortgage off and live in their (nearly) free house feeling rather smug, I guess...

Or the banks put up interest rates to compensate and anyone with a mortgage is then owned by the bank.

Besides it's gonna be inflation without wage inflation to match, stagflation so basically everyone is screwed

Edited August 24, 2010 by Saberu

[bomberbrown]

Or the banks put up interest rates to compensate and anyone with a mortgage is then owned by the bank.

Besides it's gonna be inflation without wage inflation to match, stagflation so basically everyone is screwed

Exactly! This is the bit I can never understand with the hyper-inflation argument, why on earth would the banks let their loans get inflated away without putting up rates to compensate. It's not in the banks interest to be paid back with worthless paper is it?

[Odakyu-sen]

They pay their mortgage off and live in their (nearly) free house feeling rather smug, I guess...

I remember 25% inflation in the 1970s making big mortgages a rather good idea. I still think deflation is more likely over the coming years, however.

It only works if you get wage inflation. Inflation without wage inflation (everything getting more expense but less money in the hand to buy stuff) = stagflation.

[Frank Hovis]

And another trolling bull goes back to the drawing-board

[Bloo Loo]

They issue some more based on their newly acquired housing assets.

Banks sell food.

Which you cant buy as the shops cant restock with the cash received in their sellout in the morning.

[fluffy666]

They pay their mortgage off and live in their (nearly) free house feeling rather smug, I guess...

I remember 25% inflation in the 1970s making big mortgages a rather good idea. I still think deflation is more likely over the coming years, however.

This is where the 'folk wisdom' of 'Always buy the biggest place you can afford' comes from - when you have an ongoing wage/price spiral, it makes sense to borrow to the hilt.

Now, when you have low inflation, wage stagnation and a huge house price bubble it is suicide, of course.

[Richelieu]

Ok. Tin hats on....

Assume there is some massive "unexpected" black swan moment and inflation goes to 1000% or more.

What happens to all those beloved, over leveraged, home owners? now that their £400k morgague can be swapped for a tank of petrol?

Based on what happened in historical hyperinflation event, they fail to pay their mortgage and the bank take ownership of the house.

Hyperinflation will make credit expensive, not cheap. In the UK, where a significant part of the mortgage market is on adjustable rates, it will be very easy, but if you refer to other counties, first and foremost the infamous Weimar hyperinflation, to protect the banking sector and keep a little liquidity, fixed-rates lending was converted by law to adjustable-rate. With the loss of faith in the money, what little credit stays will happen in the form of foreign currency-denominated lending (like the dollar lending in Argentina) or converted to an amount of gold (Weimar again, because gold was a common currency standard at the time, it didn't feel odd).

Moreover, home owners, like everyone else, will struggle to keep their jobs,as hyperinflation comes with a collapse of the broader economy... So it's not even guaranteed they'll be able to pay their (now little) mortgage payments, as most wealth will be used to buy the necessary (food, and maybe gas for the car if you're lucky enough to retain your job).

The common misconception about hyperinflation is that real estate is considered safe in an hyperinflation period. That's true, provided you enter the market after the credit crunch. It didn't cause a lot of problem in the Weimar Republic because home ownership was extremely rare among the working class.

If you consider not hyperinflation but strong inflation (like in the 70s), then basically nothing happens : consumer prices increase, wages stay flat, so they can make their payments but have to consume less. As borrowing rates increase for new borrowers (in the 15% range), there is a strong possibility that the price crash as people won't be able to borrow as much based on their salary... Basically, the winner ares cash-rich buyers entering after the high inflation has set in, but who managed to maintain the real value of their cash.

[ngn]

I agree with the point that high price inflation with low wage inflation leads to a major problem. But, what is different this time vs the 1970's?

Even before 2007 I was saying we (the West) are headed for a major reduction in wages and then house prices due to the adding of 2,000,000,000 extra people to job market. Why would I pay an IT person here £30,000 when I can get 5 IT people with PHDs in India for the same money...?

Same with any "professional" that sits behind a computer, lawyer, accountant, insurance broker, website designer, mortgage advisors :-))), the list is ENDLESS.

(P.S. I'm no BULL TROLL)

Richelieu welcome, glad I got you registered :-)

Edited August 24, 2010 by ngn

[Injin]

They pay their mortgage off and live in their (nearly) free house feeling rather smug, I guess...

Until the council tax bill lands on the doorstep and the wife has to suck someone off down the council to get the cash to pay it.

I remember 25% inflation in the 1970s making big mortgages a rather good idea. I still think deflation is more likely over the coming years, however.

After the hyper, deflation follows.

[Injin]

I agree with the point that high price inflation with low wage inflation leads to a major problem. But, what is different this time vs the 1970's?

Even before 2007 I was saying we (the West) are headed for a major reduction in wages and then house prices due to the adding of 2,000,000,000 extra people to job market. Why would I pay an IT person here £30,000 when I can get 5 IT people with PHDs in India for the same money...?

Same with any "professional" that sits behind a computer, lawyer, accountant, insurance broker, website designer, mortgage advisors :-))), the list is ENDLESS.

(P.S. I'm no BULL TROLL)

There is no iron clad law that says you, me or anyone has to be able to afford to live.

[Richelieu]

I agree with the point that high price inflation with low wage inflation leads to a major problem. But, what is different this time vs the 1970's?

Mostly, and this is a worldwide trend, the damages caused by the "vicious circle" of linking (legally) wages to CPI was broken. Nowadays, existing wages are only inflation-adjusted in very few countries, Belgium coming to my mind but there might be a few others. So the chances of high inflation degenerating into hyperinflation are lowered.

Basically, as you stated, wages increase are unlikely because of high unemployment. High inflation would sink the GBP, so there would be less competition from abroad and less incentive to send job overseas. On the other hand, there would be very few pressure to increase wages as high unemployment would allow employers to find cheap manpower. In the 70s, the government tried to impose a wage cap to stop the hyperinflation spiral that was looming, but massive strikes followed, prompting a softening of this measures. In the 2010 era, I don't think the trade unions could bring the country to an halt like they did during the winter of discontent.

Basically, the labor market is totally unlike what it was in the 70s. And the economy has shifted to a service based economy, also, which could be partly delocalized easily... The bonus tax was enough to prompt a few banked to relocate in Switzerland, I guess massive strikes paralyzing the country would, also, make them consider it. In the 70, coal-mining was still an important part of the activity, and you can't really relocate a coal mine (and it used to be difficult to relocate a factory, too...)

Edited August 24, 2010 by Richelieu

[PopGun]

Exactly! This is the bit I can never understand with the hyper-inflation argument, why on earth would the banks let their loans get inflated away without putting up rates to compensate. It's not in the banks interest to be paid back with worthless paper is it?

They should of thought about that then before...oh yes silly me they did.

Edited August 24, 2010 by PopGun

[abaxas]

Two options

1) people on fixed - laughing all the way

2) people on variable - unable to meet payments = reposession.

[Traktion]

You would have to have a fixed rate deal to benefit, otherwise your mortgage rates would be jacked even higher than the inflation rate (banks want a profit, remember).

Of course, as the taxpayer gets the bill for any liabilities which the banks can't cover, we would all end up paying for the defaulting loans too.

Unless you have a fixed rate throughout the hyperinflating period, you will get crushed by high interest. As business doesn't flourish in such an environment (too unpredictable), it would get harder and harder to get the money to pay for your bills too (as the real value of the economy would be contracting).

In short, it would be devastating for most people, but a few would get cheap houses if they survived. Likewise, those who didn't hold cash (gold, silver etc), would also be able to buy a house for peanuts after the crisis.

P.S. BTLs would be wiped out too, as the average person would be struggling to pay for food, let alone their landlord for rent. They would just squat where they could and try to survive.

[Richelieu]

Two options

1) people on fixed - laughing all the way

That's assuming they stay on fixed. Historical precedents shows that the governments transformed the contract to adjust for inflation in order to protect that banking system from collapsing. We can't be sure of course but the current governments of the UK seem quite keen on protecting the banking system.

It happened in some form in the Weimar Republic (conversion to gold), in Argentina (conversion of the money to dollar, and basically if you owe a fixed amount of dollar, you're not in a better position to pay it back, as the sterling collapse vs the dollar as part of the hyperinflating process). It's difficult to find precedents in Zimbabwe, because the lending activity was already mainly in a foreign currency for those concerned.

The big difference here is that a lot more people are holding mortgage now than in past comparable situations, so popular revolts and riots could prevent the government from converting existing mortgages. As a result, most UK banks collapse, and the homeowner isn't really better off. OK, he becomes the full owner of his abode, paid by a wheelbarrow full of pounds. But to whom exactly will he sell it to? There is no banking system anymore, and the country is operating on a barter system. He's an owner, ok, but his property can't be easily split to buy things, and the real value of his home has dropped a lot. He's basically in the same position than a renter, who'll probably, by this time, just stop paying his rent, who will be either suspended/fixed by law (as in France between the two world wars) or inexigible (public order has a strong tendancy to collapse when money collapse) or simply worthless (with 1000% inflation and wage following inflation, you pay your rent in the same monkey money as the BTL'er pays his mortgage).

[Injin]

That's assuming they stay on fixed. Historical precedents shows that the governments transformed the contract to adjust for inflation in order to protect that banking system from collapsing. We can't be sure of course but the current governments of the UK seem quite keen on protecting the banking system.

It happened in some form in the Weimar Republic (conversion to gold), in Argentina (conversion of the money to dollar, and basically if you owe a fixed amount of dollar, you're not in a better position to pay it back, as the sterling collapse vs the dollar as part of the hyperinflating process). It's difficult to find precedents in Zimbabwe, because the lending activity was already mainly in a foreign currency for those concerned.

The big difference here is that a lot more people are holding mortgage now than in past comparable situations, so popular revolts and riots could prevent the government from converting existing mortgages. As a result, most UK banks collapse, and the homeowner isn't really better off. OK, he becomes the full owner of his abode, paid by a wheelbarrow full of pounds. But to whom exactly will he sell it to? There is no banking system anymore, and the country is operating on a barter system. He's an owner, ok, but his property can't be easily split to buy things, and the real value of his home has dropped a lot. He's basically in the same position than a renter, who'll probably, by this time, just stop paying his rent, who will be either suspended/fixed by law (as in France between the two world wars) or inexigible (public order has a strong tendancy to collapse when money collapse) or simply worthless (with 1000% inflation and wage following inflation, you pay your rent in the same monkey money as the BTL'er pays his mortgage).

Also.

No banking system = smashed state = your property is yours if you can hold onto it and invest your own time into keeping it free and clear.

Much reliance on private thuggery and local gangsterism ro compensate, with all that goes with it.

[Richelieu]

Unless you have a fixed rate throughout the hyperinflating period, you will get crushed by high interest. As business doesn't flourish in such an environment (too unpredictable), it would get harder and harder to get the money to pay for your bills too (as the real value of the economy would be contracting).

Actually, it's not the problem with predictability, it's a problem of money flow. Most businesses rely on the money having an almost constant value. If you have 15% monthly inflation, getting paid with a 3-month lag incurs a massive net loss for the seller. Even the traditionnal benefiters, supermarkets, who get money as soon as they sell and pay their own suppliers with a lag, will suffer as the inflation rate is so high that they need to push up prices several times a day to pick up... Remember Argetnina, where prices where no longer printed on items but announced over a loudspeaker... Basically, you have to revert to bartering as money becomes worthless in hyperinflation, and that's why companies suffer. Of course, both lending and investment plummet.

This is one of the reason (the other being riots) that makes government avoid hyperinflation.

In short, it would be devastating for most people, but a few would get cheap houses if they survived. Likewise, those who didn't hold cash (gold, silver etc), would also be able to buy a house for peanuts after the crisis.

A few could get away with a "free" house, that would be worth not a lot of real money. That's a little benefit.

P.S. BTLs would be wiped out too, as the average person would be struggling to pay for food, let alone their landlord for rent. They would just squat where they could and try to survive.

Yeah, that means that renting could prove a little more beneficial than entering the property market too soon.

Edited August 24, 2010 by Richelieu

[Richelieu]

Much reliance on private thuggery and local gangsterism ro compensate, with all that goes with it.

Zimbabwe comes to mind, but really that's a little extreme, as in most case, hyperinflation came with a collapsing central authority, but wasn't necessarily the cause of it. Strong governments could maintain autority : in Hungary, the world record for hyperinflation, crime remained at a manageable level as the Red Army took care of the eventual profiteering criminals. Black market was huge, though.

Basically, strong/efficient governments can act to prevent large inflation to degenerate into hyperinflation, will weaker ones can't. In the odd event of hyperinflation in the UK, the government would have take measures to prevent it, including rent cap (which amount to rent nixing with enough inflation). So event non-defaulting honest tenants wouldn't bring a lot of real income to the landlord. There would be a huge incentive to pay the rent late, also. No court would prosecute a tenant who is late a few days in his rent... but in a context where price/wage are doubling every 24h (Yougoslavian inflation), that's a huge discount to renters.

I guess most people thinking of hyperinflation (or, worse, wishing hyperinflation) don't realize what it means to live through it as we've grown used to a relative monetary stability. Even the 70's (a period most of us don't remember well) were mild compared to hyperinflation.

[RufflesTheGuineaPig]

Were getting Bi-Flation, not inflation.

Costs up, assets and wages down.

[Injin]

Zimbabwe comes to mind, but really that's a little extreme, as in most case, hyperinflation came with a collapsing central authority, but wasn't necessarily the cause of it. Strong governments could maintain autority : in Hungary, the world record for hyperinflation, crime remained at a manageable level as the Red Army took care of the eventual profiteering criminals. Black market was huge, though.

The problem with saying this sort of thing of course is that you are discounting the actions of the red army, which are factually criminal. it's a bit like saying the murder rate during the second world war was low.

Basically, strong/efficient governments can act to prevent large inflation to degenerate into hyperinflation, will weaker ones can't. In the odd event of hyperinflation in the UK, the government would have take measures to prevent it, including rent cap (which amount to rent nixing with enough inflation). So event non-defaulting honest tenants wouldn't bring a lot of real income to the landlord. There would be a huge incentive to pay the rent late, also. No court would prosecute a tenant who is late a few days in his rent... but in a context where price/wage are doubling every 24h (Yougoslavian inflation), that's a huge discount to renters.

Yes, which is where the LL opts for local gangsterism.

I guess most people thinking of hyperinflation (or, worse, wishing hyperinflation) don't realize what it means to live through it as we've grown used to a relative monetary stability. Even the 70's (a period most of us don't remember well) were mild compared to hyperinflation.

Relative.

Monetary.

Stability.

[Bloo Loo]

Were getting Bi-Flation, not inflation.

Costs up, assets and wages down.

sounds like crap to me. prices and wages ALWAYS vary against each other in different directions

[SMAC67]

Au contraire Monsieur Injin, as the chaos engulfs everyones lives they will demand strong centralised government and scapegoats.

The fundamental point about the experiences of the Weimar Republic is that it shows what happens when you base your economy on "deficit financing", [hint: what we and the rest of the world are currently doing]. The difference is that it was primarily the losing sides of the Austro-Hungarian Empire that were persuing this policy (along with France), and the only way you can succeed is by invading another country and nicking all their stuff!!

At first everyone is very excited, manufacturing is very competitive, house prices and other assets increase in price, the shops are full, restaurants packed, the locals go on excursions, the foreigners arrive en-masse due to the favourable exchange rate, cars purchased, loans taken out, wages rise, taxation remains much lower that needed, roads, railways, and airports get built, everyone is happy, prosperity seems to be never ending, house prices can only go up..................a few Cassandra's point out the illogicality of what is happening and are summarily dismissed as "cranks and weirdo's".

But then a funny thing happens, people completely misread the situation, none of them understand the principles of economics or basic finance, the working man, the middle classes, the industrialists, and intelligencia. The government, the local banks, and the central banks all descend into a consensus trance. Representatives of other governments complain that you cannot maintain stability and long term viability of any economy by systematically devaluing your currency.

But devaluation brought so many good things and besides it's not the weakness of our currency that is the problem, rather the strength of everyone elses. But what worked in past must surely work again. OK, the foreigners don't want to loan us any money and we have had to sell a substantial proportion of our gold reserves but growth must be maintained at all costs, new injections of liquidity to keep the game going.

In the end of course your money reverts to what it is actually worth, nothing.

Trade stops, factories close, farms keep the food they grow, transport becomes unreliable, central government issues more decrees which are promptly ignored, tax evasion becomes the national sport, a once honest society is reduced to bribery and corruption at all levels. Homelessness increases, renters are thrown out their properties, owners barter their furniture and valuables until eventually the house is swapped for a years supply of potato's.

Unemployment is endemic, the remaining unionised workers are permanently on strike, the remainder do what they can for some quick cash, credit is impossible to get unless you are part of the crooked banking industry. Society shuts down, violence and crime are endemic, the police and soldiers kill and injure many in the local population before resorting to extortion and robbery to survive. Town people and country people are busy fighting each other, cruelty becomes the norm.

Despite all the evidence around them, people are convinced that "green shoots" are just around the corner, if only we could borrow some money!!!!

The only people who do well are the capitalists who buy up the country with loans they know will be worthless in a month's time. Only they can get the loan's because they have their contacts in the banks who they bribe handsomely. Government ceases to function and other's come in to replace them. The people want security, they want a strong man in power, they want a scapegoat. They don't want democracy and they certainly don't want capitalism. They will settle for anyone who can provide stability and will punish the wrong doers. War is the inevitable consequence, the enemy doesn't matter, someone will pay.

In a nutshell, it's not good, the mechanics of the situation might be slightly different but the most pertinent similarity is government debt. Deficit financing always ends in even bigger problems than the ones they claimed to solve.

Anyone with a mortgage will be wiped out!!!!

Edited August 24, 2010 by SMAC67

[Bloo Loo]

Actually, it's not the problem with predictability, it's a problem of money flow. Most businesses rely on the money having an almost constant value. If you have 15% monthly inflation, getting paid with a 3-month lag incurs a massive net loss for the seller. Even the traditionnal benefiters, supermarkets, who get money as soon as they sell and pay their own suppliers with a lag, will suffer as the inflation rate is so high that they need to push up prices several times a day to pick up... Remember Argetnina, where prices where no longer printed on items but announced over a loudspeaker... Basically, you have to revert to bartering as money becomes worthless in hyperinflation, and that's why companies suffer. Of course, both lending and investment plummet.

This is one of the reason (the other being riots) that makes government avoid hyperinflation.

A few could get away with a "free" house, that would be worth not a lot of real money. That's a little benefit.

Yeah, that means that renting could prove a little more beneficial than entering the property market too soon.

Having debt is bad. Yep, its a good point about the fixes...course, most fixed mortgages are fixed for a short term, and the hyperinflation could last much longer than the term.

course, not having a job could make paying even a fixed difficult.

and hyperinflation could be small, say only 100% per year...not that there are any real definitions.