Domino economics is the simplest of all concepts, when one domino falls an adjacent domino will subsequently fall and so on and so forth!
More than usual, this issue of the Onassis newsletter has, amongst its various sections, illustrated quite clearly the economics of the falling domino; one of which is unquestionably the US housing market. To believe that domino can fall only half way and remain propped up by its neighbour, is expecting the impossible.
The immediate impact of the failed housing market will be a reduction in economic activity. Employment in the housing sector and the associated retail sector, is already under pressure. Realtors, mortgage advisers, brick layers and employees of property servicing retail establishments are already losing their jobs. American mortgage lender, Countrywide, has recently shed 2,500 jobs.
Another domino effect: the impact upon the finances and confidence of consumers. Until recently, they were willing to live beyond their means by using their houses as ATM machines but are now less willing to do this or possibly, cannot get additional credit to continue that process. Lenders become more concerned and raise the barrier to entry.
Retailers not directly involved in the housing market, are next to be hurt as their domino topples.
All of this leads to a deterioration in economic activity which has been clearly signalled by the poor third quarter US GDP figure of 1.6%.
Another domino is the interest rate decision by the Fed, it might well be driven by the need to underpin a failing economy and cause them to reduce interest rates. Easing by the Fed and letting the money supply rip would not necessarily help struggling consumers who might still be refused by the retail lending banks. The Fed’s control over the short-term interest rate policy does not necessarily have a good effect upon future lending practices of commercial banks who by that point will be driven by fear of loss and concern about risk.
No matter how unlikely, extraordinary things can happen and dominos that seem destined to fall in one direction can feasibly fall in another direction where no other domino is affected. Such an outcome would be the soft landing. It seems to us however, that for the soft landing to occur it would require intervention of a very powerful nature, even more powerful than the Chairman of the Federal Reserve, Ben Bernanke, and the Secretary of the Treasury, Hank Paulson. They would have to catch a domino already falling, not just to stop it falling further but pull it back to fall harmlessly in another direction altogether. Alternatively, they will need to get ahead of the curve and like a fire break, clear out a couple of dominos further down the line as a form of damage limitation. But how do they do that?
The trouble is that all of this becomes impossible once fear enters the market place. Fear engenders panic and panic engenders irresponsible actions as people fight for their economic lives. That brings us back to the VIX and the importance we put upon watching it every day.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit https://www.rhasset.co.uk/