Yes- banana-republic style inflation could save the housing market. Of course, there would be other problems if this happened.

Not the sort of thing that you want to wish for…

The biggest monkey wrench IMO is that increased inflation could dampen the nominal drop in housing prices. There would still be real (adjusted for inflation) losses in home prices. Problem is that the accompanying interest rate increases would dampen the housing market. Who would be the winners in that scenario ? Historically in inflationary times it is best to own hard assets (e.g. property) and even better to have locked in a low interest rate to increase leverage in that investment. Not saying it’s gonna happen, but it’s a scenario that throws a monkey wrench in the plans of bubble sitters.

PD – I think that your piece captures the essence of this moment in SD real estate history. Bravo !

The Fed will try to pull another rabbit out of the hat. However, they’re running out of rabbits. Inflation will cause foreigners to loose on their investments; they’ll demand higher returns which will cause rates to go up. That might cause housing prices to drop while consumer prices increase. We are now too endebted to foreigners not to worry about the global repercussions.

The best course of action is to let the markets work and flush all the crap out of the system.

Things are never simple, they are all interrelated.

If we have inflation and cause the Chinese to loose a chunk of their Dollar holdings, they’ll be mad at us and thus will be less likely to cooperate where we need them (Korea, Afghanistan, Iran, etc..) They will need to make it up somehow even if they need to go against us (a big loss in the value of their Dollar holdings will cause them to think that we are not trustworthy and that we screwed them).

Same with the oil producing countries. They have large dollar holdings and they won’t be happy. They may then start trading their oil in Euros, Yens and Yuans. That will be a problem for us because that will reduce our ability to pay for oil in depreciating dollars.

Why are we in the Middle East? To assert our influence/relevance so that oil producing countries have confidence in our ability to shape events and continue the petrodollar regime.

Remember, we have it really good because of the dollar being the reserve currency. That is we pay with our own currency so we don’t have to “work” to earn foreign reserves. Foreigner sell us goods and we give them paper dollars. Those same dollars are then re-invested in our economy generating growth for us. Our standard of living is high because we can exchange paper dollars for all the stuff we fill our homes with.

Economists are talking about the beginning of “decoupling” that is Europe and Asia’s ability to sustain growth without America. America is still the biggest buyer of everything but “decoupling” will happen sooner of later — just like globalization cannot be stopped.

However we manage our economy we have to be mindful of how our lenders perceive us. Confidence in the US Dollar is critical to our national security. Remember, once you get bad credit you pay more for everything.

The Fed will try to pull

I agree, it’s time the fed stopped trying to postpone the inevitable and let the market(s) run their course which will be an Al Bundy size toilet flush. I just don’t have that much faith in the Fed to look farther forward than the next two to four quarters…

With each passing year, at current growth rates China is developing a huge consumer market in their own country. Within 5 years, they won’t be so dependent on U.S. trade to keep their economy humming. They’ll unload their dollars over time, and we’ll see inflation like in the 70’s (probably worse). The Fed’s job will be inflation control. Congress will offer emergency GSE home loans to anyone caught in foreclosure in order to save the housing market. While all this is going on, rents will continue to climb upward and onward.

Consider the rental market in Calif. today … if you make 40K per year, and spend 30% on housing cost – that enables you to pay $1000 per month on rent.

Rental prices today can’t justify the prices being paid for homes, but just try finding a decent apartment for $1000 per month … can’t be done.

R.E. prices have to drop 35-50% or rents have to double. Either way you go, it not going to be a pretty sight.