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How to Fight Deflation
The fact is, all the recent gains in home sales are all the result of direct government intervention. If interest rates were allowed to rise (as the would naturally) or if Congress withdrew its $8,000 first-time home-buyer subsidy, or if FHA tightened its loosey-goosey financing (which requires just 3.5% down payment and low FICO scores, the same as subprime!) home prices and sales would continue to drop at a 10 to 15 percent year-over-year rate. Housing has stopped plummeting for one reason alone; the Fed bought the market. The same rule applies to the stock market, where the Fed's quantitative easing (QE) and liquidity injections have sparked a 6-month bear market rally sending equities to the moon. It's all Fed intervention. A recent report by Egan-Jones Ratings And Analytics traces the Fed's lavish liquidity handouts pointing out the precise sectors of the market that have been most effected:
Let's summarize: The Fed is goosing the stock market and the housing market. Bernanke has slashed interest rates to zero percent, underwritten the entire financial system with $12.8 trillion in loans and guarantees, and flooded the financial system with liquidity. The Fed has also doubled its balance sheet to $2.08 trillion which is the equivalent of dropping the Fed Funds rate to -1 percent. As Mark Gongloff of the Wall Street Journal opines, "The Fed is essentially paying people to borrow money." Indeed, the Fed has done its level-best to keep the market from correcting, but isn't it a bit of a stretch to call it a "recovery"? In truth, Bernanke is in a pitch-battle with deflation and the outcome is still uncertain. Deflation has spread to every sector of the economy; retail, travel, luxury items, autos, building supplies, home furnishings, electronics. No business has been spared. The C.P.I. inflation-gauge has slipped into negative territory and is now at -2.1 percent. Prices are headed down and spending is falling fast. Unemployment is soaring, wages are dropping, and the average work-week has been sliced to just 33 hrs. And, as we noted, housing prices have flattened out, but only because of unprecedented government intervention into the market. Otherwise, real estate would still be stretched out on a marble slab. Most people think it should be easy to beat deflation. They think all the Fed has to do is flip a switch and print more money. But there's more to it than that, especially when trillions of dollars in credit suddenly vanishes in a poof of smoke. That's what happened last September when Lehman Bros imploded and reduced the financial system to rubble. Global stock markets crashed, interbank lending collapsed, capital flows stopped, and payrolls and inventories were slashed. The gigantic credit-purge thrust the economy into deflation, a condition which persists to this day. Economist Irving Fisher tackled the problem of deflation 76 years ago in his masterpiece "Debt-Deflation Theory of the Great Depression". Fisher showed how over-indebtedness eventually triggers a chain of events beginning with debt liquidation and ending in distress selling, huge capital losses, and violent economic contraction. This is the challenge that Bernanke faces today. Irving Fisher:
Clearly, Bernanke is following Fisher's advice and doing everything in his power to reflate asset prices and avoid an bigger crash. But it's still too soon to tell whether his strategy will work. We're still in the early innings of a humongous systemwide credit-implosion event. John Bellamy Foster: "But the real fear of deflation has to do with the enormously bloated financial structure and the huge debt load of the economy... In a deflationary economy, debt has to be paid back with bigger dollars (worth more over time). This then creates a debt-deflation spiral, enormously accelerating financial meltdown. As Fisher put it, "deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debt cannot keep up with the fall of prices which it causes." Stated differently, quoting from The Great Financial Crisis (p. 116), "prices fall as debtors sell assets to pay their debts, and as prices fall the remaining debts must be repaid in dollars more valuable than the ones borrowed, causing more defaults, leading to yet lower prices, and thus a deflationary spiral." It is this "deflationary spiral" that Bernanke is trying to avoid at all cost, even if he destroys the currency in the process. (Which he appears to be doing) Despite the Fed chairman's resolve, the economy has continued its historic nosedive. Consumer spending is falling and households have limited themselves to the bare essentials. (US households lost $14 trillion in wealth in the last year alone.) Families everywhere are paring back their credit, paying down their debts and rebuilding their nest eggs with what's left from their skimpy paychecks. Unfortunately, what's good for the family balance sheet is poison for the economy. From Bloomberg News:
US households and consumers have never been as strapped as they are today. They're dealing with recession the only way they can, by pulling back and hunkering down. That will make it even harder for Bernanke to resuscitate the economy. There's simply no way to force people to borrow when it's not in their interest. Bernanke's deflation-fighting strategy needs to be revamped. The country doesn't need another credit bubble. The surge in delinquencies, defaults and personal bankruptcies all suggest that the era of easy money and lax lending standards is over. Why not "hang it up" for good. The Fed should be focused on rebuilding the economy from the ground up, paying particular attention to aggregate demand. That's what keeps the mighty GDP-flywheel turning. Wall Street likes to stimulate demand through credit expansion and bubblenomics because they can skim fat bonuses on the front end and then bail out before stocks crash. But this perennial "boom and bust" cycle is a real loser for ordinary working class Americans, who merely want a little stability and a paycheck that keeps pace with inflation. The best way to avoid "demand shock" - which is at the heart of every recession - is through wage growth and full employment. It's that simple. When workers get better pay, they buy more more stuff and the economy thrives. Everybody wins! Mike Whitney lives in Washington state. He can be reached at fergiewhitney@msn.com |
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The slight rebound in housing looks a lot different when one considers how much the Fed is meddling in the market. Fed chair Ben Bernanke has purchased $240 billion in US Treasuries to keep long-term interest rates artificially low while - at the same time - buying $740 billion in Fannie Mae and Freddie Mac mortgage-backed securities (MBS) to provide the financing for new home buyers. It's the double-whammy; and that's not all. Bernanke plans to continue buying agency MBS (monetization) until he reaches $1.45 trillion, which will make Uncle Sam the biggest player in the housing market by far. How's that for central planning? 