Today’s another big day. The 12 members of the Fed’s Open Market Committee will get together in New York and decide what to do. As of this morning, we don’t know what they will do. Our bet is that they don’t either.
Instead, they will do what we do; they will look out the window. Outside the Fed’s meeting room, the war between inflation and deflation continues. As expected, inflation’s gains are so far narrowly focused – on gold and certain global commodities, such as oil . Gold fell back $2 yesterday… but it is at record prices… and beginning to attract wider attention. Even The Wall Street Journal , for example, talks of a “gold rush,” in its headline – quickly warning readers away from it!
Deflation, meanwhile, is advancing on a broad front.
Comes word this morning that the “loss at Countrywide is worse than feared… as sinking house market caused more borrowers to fall behind on payments.” Reuters reports that the mortgage lender posted a loss for the fourth quarter of $421 million.
House prices are still falling in Britain and America, where they have just registered another drop for the eleventh month in a row. It’s a “historic bust,” says Robert Shiller.
The CEO of the Ryland Group says it’s the “worst housing market in 30 years.” His competitor over at Lennar reported its biggest quarterly loss in its history, losing $201 million in the fourth quarter of last year.
And the Financial Times says U.S. builders “face a growing bankruptcy threat.”
Ben Bernanke allowed himself a little understatement this week, saying that housing “may be a drag on growth for a good part of this year.” We would say that it will definitely be a drag on growth, and not merely for this year, but for the rest of this decade, if not longer. You can correct the stock market… or the soybeans market… in a couple days. But housing takes time . Houses that were being planned and financed before the housing bubble blew up are still coming on the market today. They are added to already swollen inventories of unsold and foreclosed houses. It will take years to work this inventory down… and years to bring prices down to levels where ordinary buyers can afford ordinary houses.
On that point, former Labor Secretary Robert Reich writes, “America’s middle classes are no longer coping.” He notes that the fixes proposed by Bernanke and Bush will not help much, because the middle classes have run out of “coping mechanisms.” The short version of the story is that the typical man earns less, in real terms, than he did 37 years ago. “The income of a young man in his 30s is now 12 per cent below that of a man his age three decades ago.” Families have struggled to increase their standards of living, first by putting women to work… second, by working longer hours… third, by turning to credit. The workplace is now dominated by over-indebted women who work night and day.
“The typical American now works two weeks more each year than 30 years ago,” says Reich. “Compared with any other advanced nation we are veritable workaholics, putting in 350 more hours a year than the average European, more even than the notoriously industrious Japanese.” And when Americans ran out of time and out of money, they began to borrow with the same vigor that they worked.
“We began to borrow, big time,” says Reich. “With housing prices rising briskly through the 1990s and even faster between 2002 and 2006, we turned our homes into piggy banks through home equity loans. Americans got nearly $250bn worth of home equity every quarter in second mortgages and refinancings. That is nearly 10 per cent of disposable income. With credit cards raining down like manna, we bought plasma television sets, new appliances, vacations.
“With dollars artificially high because foreigners continued to hold them even as the nation sank deeper into debt, we summoned inexpensive goods and services from the rest of the world.”
That final ‘coping mechanism’ has now played itself out. Houses are going down in price. Lenders are wary of credit risks. And foreigners are becoming chary of the dollar too.
So what next? It seems obvious us that the U.S. middle class needs to reverse course. Stop spending so much, stop working so many hours, focus on quality of output and quality of life. In a word: downsize.
Not that people will want to do it at first. But they will have no choice. They need to save for rainy days and retirement. And America needs savings to build factories… and savings to help people learn new trades and new tricks. Yes, dear reader, the light bulbs are finally going on in Debt Nation : you can’t really get rich by borrowing and spending… or even by working day and night parking hedge fund managers’ cars. You get rich by saving, learning and investing. There is no other way.
What this means is a decline in spending… and a decline in Americans’ standards of living. It means a recession too – probably a deep, long recession which the feds will fight every step of the way.
But it is not a battle the feds can win. They cannot really make the situation better with more of their phony cash and credit. That is what caused the problem in the first place. They need to reverse course too… and encourage savings.
Who wants to save when the going rate of return on savings is no higher than the inflation rate? Who wants to buy a U.S. 30-year Treasury bond at 4.28% yield… when the current consumer price inflation level is rising at 4.4% per year?
So here we offer some free advice to the Fed’s Open Market Committee: Don’t cut rates today, raise them. Let the stock market crash. Let the economy retreat. Let the banks go belly-up. Liquidate Wall Street. Liquidate the housing sector. Liquidate bad debts everywhere. Get it over with, so the U.S. middle class can begin building again… after 37 years… on a solid foundation.
We don’t expect any thanks for that advice.
*** Wait a minute, said David Fuller at lunch on Monday, responding to our suggestion of higher interest rates: “When a man is having a heart attack, you don’t lecture him about his bad diet. You can do that later. First, you have to get him back on his feet.”
*** Let’s return to Robert Shiller. His research shows that house prices in America, in real terms, are remarkably stable. For 100 years – from 1890 to 1990 – they went nowhere. In real terms, they barely changed in the entire century. Then, suddenly after 1997, house prices shot up by 71% in real terms.
What this tells us is that housing prices are not likely to remain up so high for too long. Historically, they kept up with inflation, nothing more. America is still a big place; there is no obvious reason why all of a sudden housing should occupy a bigger percentage of the nation’s assets and earnings.
Most likely, the gains of the last 10 years will be given back. But the process is long, slow and hard.
We’re talking about “trillions of dollars, so much bigger than the losses we’ve seen from subprime so far,” says Shiller. He is not talking about the losses in implied wealth by the write-down of America’s housing stock, but about the real losses to financial institutions and investors who have bet on continued housing price increases. As housing rose, ordinary consumers adjusted their spending habits to the increase of wealth they thought they had. Lenders extended them credit – also based on the increase in perceived housing wealth. And then, the mortgage credits were packaged into various derivative instruments and sold all over the world – eventually bankrupting everything from Norwegian fishing towns to French pension funds.
Is it over already? Not likely.
Markets and Money