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Oh,
To Have Been a Fly on the Wall
by Tim
Iacono
September 21, 2006
With another Federal
Reserve policy meeting having come and gone yielding the same result as
last month - a decision to leave short-term interest rates unchanged at
5.25 percent
- you can't help but wonder about the content and the tone of the
discussion as board members deliberated on the state of the economy and
the future of U.S. monetary policy.
Yesterday's policy statement was little changed from last month, the
most significant deviation being the glaring
omission of the word "gradual" from the board's
characterization of the housing market slowdown.
By no small coincidence, news also came yesterday that Countrywide,
the nation's largest mortgage lender, is planning to lay off between
five and ten percent of its workforce.
All this followed Tuesday's release of the Fed's quarterly Z1
Flow of Funds report that showed declining real net worth during the
second quarter of the year.
While the minutes for yesterday's policy meeting will be released in
about six weeks, it takes five years or more for the transcripts to
become available. There were quite a few gems to be found when the 2000
transcripts were released earlier this year, that is, the last time that
the western world was staring an asset bubble square in face wondering
what it was going to do next.
For the next five years, one can only wonder what was said during
yesterday's meeting.
Don't Look Too Closely
When viewed at a glance, the major economic indicators seem to paint a
picture of reasonable health - employment growth is stable and both
economic growth and inflation have moderated but remain at levels that,
when viewed from a historical perspective, should be no cause for alarm.
Regarding consumer prices - not necessarily the ones that consumers
actually pay, but rather, those that are tallied at the Bureau of Labor
Statistics - the news is good. The decision to pause last month looks
better with each passing day and the cacophony of questioning directed
at new Fed Chair Ben Bernanke and his inflation fighting mettle has been
largely silenced.
The lone exception to the now almost conventional wisdom that Ben
Bernanke knows what he is doing is, of course, Jeffrey Lacker of the
Richmond Fed. Mr. Lacker stood alone with his hand raised once again
when they went around the room asking, "Who wants five and a
half?"
After a mostly tame report on consumer prices last week, Tuesday's
report showing falling producer
prices (less food and energy), and with the cost of energy products
plumbing multi-month lows, some of the discussion has now turned a full
180 degrees back toward the 2003-era "disinflation" ramblings,
and yes, the possible return of an "unwelcome fall in
inflation".
Plunging energy prices are going to wreak havoc with next month's
inflation statistics and it should make for some intriguing commentary
from the talking heads who will attempt to make sense of it all. The
November futures contract for unleaded gasoline has dropped almost 30
percent in just over a month.
It
may take a little longer for retail gasoline prices to fall, certainly
not adjusting as quickly as on the way up, but if current price levels
are maintained for any length of time, or if they fall even further,
then things will get interesting rather quickly.
Ben Bernanke will likely begin rummaging through his desk drawers
searching for his now-famous 2003 paper, "An
Unwelcome Fall in Inflation?"
A student of the Great Depression, he is superbly qualified to try his
hand at maintaining some minimum level of currency debasement.
The Problem with Rising Asset Prices
that Stop Rising
Most of the discussion at yesterday's meeting probably revolved around
the housing market, hearings being held across town by the Senate
Banking Committee presumably having been noticed by the staff at the
Federal Reserve.
Last week, elected officials talked about the economic impact of the
housing bubble and this week it was the risk of risky loans. It's not
clear whether any solutions were found, or even if any problems have
been identified, but by the look of the titles of the hearings, it
sounds like they meant business:
- The Housing Bubble
and Its Implications for the Economy
- Calculated Risk:
Assessing Non-Traditional Mortgage Products
Housing being a
relatively slow moving asset class, government officials are in the
potentially dangerous position of actually being able to take action
while an asset bubble is still bulging on all sides, not yet sure if a
slow leak or a more catastrophic outcome lay ahead, were it to be left
alone to determine its own fate.
It seems that the inherent problem with an economy based on ever-rising
asset prices is that eventually asset prices stop rising. Policymakers
go along with easy money policies, allowing first stocks and now housing
to rise at many times the rate of reported inflation, and then one day,
the music stops.
The asset prices stop rising.
On the way up, shareholders, homeowners, and economists pat each other
on the back, sure that they are blessed to be living in a new and
different era where lunches are free and prosperity comes easy. This can
continue for quite some time since rapidly rising asset prices are not
deemed problematic unless and until adverse effects are felt on the
broader economy - like in 2000.
One look at the chart below and it appears that another inflection point
is nearing.
When
equities reversed course back in 2000, real estate stood at the ready,
waiting to be pumped up so that the good times could continue. Now that
housing is in serious trouble, prices now declining in many parts of the
country, it's not clear what asset class will take the baton next.
News that net worth adjusted for inflation actually declined in the
second quarter is certainly not a promising development. This is
especially worrisome since it covers the months of April, May, and June,
back when there was still hope for a summer rebound in housing.
In the quarters ahead, there may be some real surprises in store
regarding the nation's wealth as measured by subtracting the value of
its liabilities from the value of its assets.
Household net worth declined in nominal
terms for three years straight starting in 2000. Particularly
problematic in this calculation is that asset prices can go up or
down, sometimes dramatically, but in recent decades debt has
known only one direction.
The housing market is clearly coming undone in a very big way and it
holds the potential to cause much more harm than the stock market did
six years ago. The Federal Reserve and other government agencies are
surely aware of this downside risk, however, it's not clear what they'll
be able to do about it.
They probably talked about it at yesterday's Fed meeting.
Oh, to have been a fly on the wall.
© 2006 Tim Iacono
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Tim Iacono
Iacono Research, LLC
Southern California
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Tim
Iacono is the founder of Iacono Research which provides market
commentary and investment advisory services specializing in
macroeconomic analysis and commodity based investing. He also writes the
popular blog The Mess That Greenspan Made.
The
opinions of FSU contributors do not necessarily reflect those of
Financial Sense.
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