Among the many pithy teachings of Mr. Averbach, my high school history teacher, was “Debtors love inflation, because existing debt is the only thing that doesn’t get more expensive.”
Obviously, there are some qualifications with this kind of statement. For starters, this doesn’t apply to new loans originated during rampant inflation—those obviously get more expensive. But the guy (or girl) who took his loan when inflation was 2% doesn’t owe more just because inflation spiked to 10%. In fact, as a general rule, that inflation is good for this person. Wages and income are likely rising (even if not keeping up with inflation), including any earned from the money borrowed (maybe it was for a college education, or an investment property), while the cost of his debt holds steady.
In fact, none other than the Federal Reserve Bank (St. Louis branch), has recently confirmed what others generally hold: that inflationary environments represent a transfer of wealth to borrowers.
But obviously, inflation does a good deal of harm, and it needs to be contained. Nobody likes watching the cost of gas and groceries and housing soar, and central banks exist in order to keep inflation in check. But as Mr. Averbach would agree, it’s not so bad for us debtors. Sure, some of our costs go up, but the biggest one—our debt service—holds steady. And since cash flows and asset prices increase in times of inflation, our bottom line tends to increase (or at least hold steady). So long and short of it, we’re on track for another healthy double-digit return for 2022 (for the record, the S&P 500 closed Q3 of 2022 down 25% year-to-date four days before I wrote this), and we’re confident that the existing debt portfolio will sustain that throughout this inflationary period.
Lest I get a bunch of hate mail, I’ll also acknowledge that our cost to borrow certainly will increase, and I don’t want to promise that returns on future investments will be as strong as on the ones we have now. But I’ll save that topic for another blog post….