Warren Buffett warns inflation is on the way

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Warren Buffett told shareholders at Berkshire Hathaway's annual meeting that while the government's response to the financial crisis has been appropriate, it will likely lead to some pretty serious inflation.

"I haven't had my taxes raised," said Buffett. "My guess is the ultimate price will be paid by a shrinkage of the value of the dollar."

Inflation will have the effect of penalizing people who have had the gall to save money, but will also serve as a bailout to people who have accumulated fixed-rate debt: As your income rises your debt payments won't, and you'll be paying off loans with money that is worth less than the cash you borrowed.

The best way to fight inflation for the average consumer is probably this: Buy real estate with 20% down and a 30-year fixed rate mortgage. If you don't already own a home, this means you will likely be able to take advantage of the $8,000 first-time homebuyer tax credit. If we get rampant inflation and you don't own a home, you will find your monthly rent obligations soaring. If you buy a home, your mortgage cost will remain the same as your salary increases, leaving you with more cash to save and invest.

The other nice thing about buying a home is that, even if property values appreciate slower than inflation, you can still end up ahead because of the power of leverage. For example:
  • Buy a home at $100,000 with $20,000 down. Property value appreciates 3%. Inflation clocks in at 6%. So your property value goes up $3,000, but since your down payment was only $20,000, your cash on cash return is 15% -- easily preserving your purchasing power in the face of 6% inflation.
And that's a worst-case scenario because on average, real estate appreciation tends to beat inflation by a couple percentage points. Leverage magnifies that gain, meaning that inflation is actually the friend of real estate investors.

In a column on RISMedia, one southwest Florida real estate broker (So yes, take it with a grain of salt: But the logic is still compelling) opines that "We will see our property values double from the highest time of the market in 2006, due to the inflation within the next five years."

And if you already own a home? If you have some cash in savings earning 2-3%, this might be a good time to look at investment properties (or well capitalized publicly-traded real estate investment trusts). Find something where the tenant will cover all your expenses and generate a little cash flow and then sit back and wait for inflation.
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