The Fed is no longer in control of this economy (not that it ever really was in the first place). The U.S. consumer is in control (in conjunction with global wage arbitrage and other global factors, such as foreigners being willing to finance our debt, and at what interest rates). Simply put, if people decide to stop buying houses, there is nothing the Fed can do to make them. The Fed can encourage, but not force, speculation.
The US economy: two myths
I believe we reached near-universal sentiment this year on two myths that are about to be shattered:
1. Nothing can or will affect U.S. consumers’ propensity to consume.
2. Home prices only go up.
Those beliefs are about to be sorely tested. What can Bernanke do about it? The answer is nothing. Oh, sure, he can cut the fed fund rate, but long-term mortgage rates have not really risen that much – perhaps a point or so. Is a pause, or even a one-point cut, going to be enough to get people to buy overpriced houses when real wages are falling for the masses? Of course not: Psychology (time preference) has changed.
If Bernanke starts slashing rates, is there any guarantee that long-term rates drop? I think not. It is even possible there is a revolt of some kind on the 10-year note and long rates go up. I do not think that is likely (on a sustained basis), but heaven help housing if I am wrong. Even IF long-term rates come crashing down, does that necessarily mean that mortgage rates follow? They always have. Does that mean they always will? Once again, I think not. I suspect mortgage rates will be reluctant to drop quickly because of rising defaults and foreclosures. Perhaps the best fixed rates will go only to those that can make a substantial downpayment. If so, first-time buyers may be shut out of this market for years to come simply because of affordability issues.
Who does not already have a house that wants one and can afford one?
The US economy: constraints on the Fed
In theory, the Fed can create hyperinflation by dropping money out of helicopters. In practice, the Fed is constrained by five factors:
1. Ability of consumers/corporations to take on more debt.
2. Willingness of consumers/corporations to take on more debt.
3. Willingness of banks/credit companies to extend more credit.
4. Ability of banks/credit companies to extend more credit.
5. Unwillingness of the Federal Reserve to print itself out of power.
The Crux of the Matter:
• The Fed can print money, but it cannot dictate where the money goes.
• The consequences of the Fed attempting to control the long and the short end would likely be disastrous.
• Deflationary forces, such as global wage arbitrage and outsourcing, cannot be defeated by Fed policy.
• Consumer debt in conjunction with a housing bust is simply the nut that inflationists cannot crack. There just is no plausible scenario under which the government would bail out consumers at the expense of banks and creditors. The Bankruptcy Reform Act should be proof enough of that statement.
It has taken enormous stimulus just to get this economy running at a standstill. GDP near 2% is a standstill, because the first 2% or so of GDP is a mirage of imputed and hedonic activity that did not really occur.
The US economy: what now?
That, of course, is the key question. It always is. But given that housing and consumer spending make up well over three-fourths of the economy (heck, consumer spending alone is about 70%), I fail to see what can possibly replace housing as a jobs engine.
Unless the Fed can pull some short-term miracle out of its hat, multitudes of those dependent on the real estate bubble are going to tighten their belts or go under or both. Things are likely falling apart in this economy much faster than meets the eye.
The California Department of Real Estate recently reported that the total number of agents in the state passed 500,000 in May for the first time. That’s one agent for every 55 adults in the state. That is a staggering number. How many of those ’employed’ real estate agents are actually making any money? Yet all those self-employed agents will show up in the ‘Household Survey.’
How many additional ‘self-employed’ are trying to make a living on eBay or via ‘home networking’ scams? As a practical matter, the unemployment rate is now totally out of whack with reality. Meanwhile, homebuilders keep building houses no one can afford, and banks (for now) are still willing to lend them money to do so. Alice is running as fast as she can, but is struggling to stay in one place.
Reality has not yet sunk in for the masses. Most people are still in denial over housing, and most still seem to think the Fed is some all-powerful economic force. Unfortunately, the damage caused by poor economic and political decisions over the last 20 years is simply not reversible by the Fed, or anyone else. The Fed is not really in control of our economy, but it sure wants you to believe it is. All things considered, the Fed is basically irrelevant. I wonder how long that bit of reality will take to set in, not just for the masses, but for the Fed itself.
By Mike Shedlock for Whiskey and Gunpowder – Whiskey & Gunpowder is a free, twice-per-week, e-mail service – for more from the team, go to https://www.whiskeyandgunpowder.com