Inflation, interest rates, and the Fed

[davelj]

[quote=CA renter]

What if prices are 25%-50% higher than they should be, but lower than they were a few years ago? What if these prices are the result of quantitative easing and artificially low rates, as opposed to being based on fundamental values? Is this not a form of inflation?[/quote]

It is, but I doubt it will last for long. I suspect both the stock market and the housing market will revert back to long-term trend over the next couple of years (that is, decline from here). There is one major upside to the Fed’s handling of the crisis thus far (granted, they played a large part in creating the crisis, but…) – that is, providing liquidity to push prices back up – and that is that banks have been able to raise hundreds of billions in equity capital that We the People didn’t have to provide. Now, you may correctly think, “But those people are going to regret giving the banks that capital when prices start to fall again,” and you’ll be right. But, frankly, that’s not our – that is, yours and mine – problem; that’s their problem. I’m just glad it’s not MY capital. And it provides a cushion that lessen’s (but certainly doesn’t eliminate) the possibility that these dickwads will need taxpayer capital in the future. Where home prices are concerned, I think lots of folks are probably buying mildly over-valued houses right now (granted, on very good long-term financing terms), but I doubt most of the folks are just going to roll over if prices decline 10%-20% from here (that is, back near the prior trough). I think they’ll tough it out. Now, if prices decline 30%+… that’s another story. But I think the Fed’s drawn a line in the sand with house prices around the long-term trend (i.e., the prior trough) below which they will move heaven and earth to maintain.

[quote=CA renter]
I would argue that we do not have too many houses, office buildings, etc., (though some are poorly located) but that they are priced too high. Our problem isn’t due to overcapacity, but rather demand destruction because the pricing mechanism isn’t being allowed to work. Look at all the people who are taking on roommates, moving in with family members, etc., because they cannot afford to form their own households at these artificially inflated prices.[/quote]

I think we have too many houses – irrespective of prices. If you look at the long-term trend of housing units relative to the population and household formation, we’ve got maybe 2.5 million or so excess housing units. I agree that there’s been demand destruction due the artificial goosing of prices, but… we still simply have too many units – that’s really the larger problem. (We also have too much CRE, but CRE isn’t as overbuilt as SFRs.) But I also think a lot more of these units will start moving if prices move back to last year’s levels (which gets to your point) and rates remain low.

[quote=CA renter]
Right now, our stock market is near the optimistic levels seen during the massive bubble years of ~1999 and ~2005, as are commodity, bond, and housing prices (in many locations). All this during the “Greatest Recession Since the Great Depression”! I see inflation all around us **right now.**[/quote]

I think the stock market, housing, and commodity post-bubble mini-bubbles are going to pop shortly. (Although, the stock market is well below the Super Bubble levels of 1999 and 2006 – and you know that.) I think a slowing economy will take care of them. Hopefully, the Fed will sit back and let the markets clear this time around (but I’m not gonna hold my breath if prices REALLY start swan-diving into the shitter).

[quote=CA renter]
We didn’t have a crisis because of CDSs or “toxic” mortgages. The crisis was due to high prices that forced anyone who wanted to participate in the economy to take on risky debt, with the lenders trying to hedge against the obvious risk of default (because prices were too high!) via CDSs and other securities. It was a debt-price spiral that grew out of control, and it’s still with us because the govt has chosen to take on the risks and leverage in order to save the financial industry by keeping asset prices artificially high (inflated!).[/quote]

I think the high prices were caused by under-regulated reckless lenders who enabled under-capitalized reckless borrowers to do very stupid things. And the Fed aided and abetted both with lower-than-justified rates and lax oversight.

[quote=CA renter]
IMHO, the **solution** to our problems is price deflation and much higher interest rates. Of course, you’ll never hear any of our politicians saying this.[/quote]

Unfortunately, we probably need low interest rates for a while so that the banks can repair their balance sheets and so that folks can suck up the excess inventory of houses (hopefully at prices lower than they are now). I don’t think the Fed fears a falling stock market or modestly lower home prices right now. I think if prices fall back to their long-term trend levels the Fed will let it happen. But if shit really hits the fan, expect to see a(nother) mountain of liquidity.

[CA renter]

Good post, davelj. Let’s hope things move in the direction you’re suggesting (I agree, BTW).

[CA renter]

Good post, davelj. Let’s hope things move in the direction you’re suggesting (I agree, BTW).

[CA renter]

Good post, davelj. Let’s hope things move in the direction you’re suggesting (I agree, BTW).

[CA renter]

Good post, davelj. Let’s hope things move in the direction you’re suggesting (I agree, BTW).

[CA renter]

Good post, davelj. Let’s hope things move in the direction you’re suggesting (I agree, BTW).

[davelj]

[quote=davelj][quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…[/quote]

I just read this article today and thought it fit in well with this thread and previous post of mine. I like Dean Baker’s analogy of a counterfeiter. (Also, he approaches the issue from a “demand” standpoint, which is better than my “net worth” approach above.) What Dean doesn’t know – and no one on the planet does – is how much “counterfeiting” the economy can take before real, sustained inflation kicks in which can’t be easily controlled. Nevertheless, I like his analogy here.

http://www.guardian.co.uk/commentisfree/cifamerica/2010/oct/11/useconomy-usemployment

[And, by the way, Baker both identified the housing bubble early and was against all of the bailout activity, so he’s not a tool of the banksters or the Fed. Just to be clear.]

[davelj]

[quote=davelj][quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…[/quote]

I just read this article today and thought it fit in well with this thread and previous post of mine. I like Dean Baker’s analogy of a counterfeiter. (Also, he approaches the issue from a “demand” standpoint, which is better than my “net worth” approach above.) What Dean doesn’t know – and no one on the planet does – is how much “counterfeiting” the economy can take before real, sustained inflation kicks in which can’t be easily controlled. Nevertheless, I like his analogy here.

http://www.guardian.co.uk/commentisfree/cifamerica/2010/oct/11/useconomy-usemployment

[And, by the way, Baker both identified the housing bubble early and was against all of the bailout activity, so he’s not a tool of the banksters or the Fed. Just to be clear.]

[davelj]

[quote=davelj][quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…[/quote]

I just read this article today and thought it fit in well with this thread and previous post of mine. I like Dean Baker’s analogy of a counterfeiter. (Also, he approaches the issue from a “demand” standpoint, which is better than my “net worth” approach above.) What Dean doesn’t know – and no one on the planet does – is how much “counterfeiting” the economy can take before real, sustained inflation kicks in which can’t be easily controlled. Nevertheless, I like his analogy here.

http://www.guardian.co.uk/commentisfree/cifamerica/2010/oct/11/useconomy-usemployment

[And, by the way, Baker both identified the housing bubble early and was against all of the bailout activity, so he’s not a tool of the banksters or the Fed. Just to be clear.]

[davelj]

[quote=davelj][quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…[/quote]

I just read this article today and thought it fit in well with this thread and previous post of mine. I like Dean Baker’s analogy of a counterfeiter. (Also, he approaches the issue from a “demand” standpoint, which is better than my “net worth” approach above.) What Dean doesn’t know – and no one on the planet does – is how much “counterfeiting” the economy can take before real, sustained inflation kicks in which can’t be easily controlled. Nevertheless, I like his analogy here.

http://www.guardian.co.uk/commentisfree/cifamerica/2010/oct/11/useconomy-usemployment

[And, by the way, Baker both identified the housing bubble early and was against all of the bailout activity, so he’s not a tool of the banksters or the Fed. Just to be clear.]

[davelj]

[quote=davelj][quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…[/quote]

I just read this article today and thought it fit in well with this thread and previous post of mine. I like Dean Baker’s analogy of a counterfeiter. (Also, he approaches the issue from a “demand” standpoint, which is better than my “net worth” approach above.) What Dean doesn’t know – and no one on the planet does – is how much “counterfeiting” the economy can take before real, sustained inflation kicks in which can’t be easily controlled. Nevertheless, I like his analogy here.

http://www.guardian.co.uk/commentisfree/cifamerica/2010/oct/11/useconomy-usemployment

[And, by the way, Baker both identified the housing bubble early and was against all of the bailout activity, so he’s not a tool of the banksters or the Fed. Just to be clear.]

[davelj]

Another good recent article on the topic, but with a global perspective.

http://jessescrossroadscafe.blogspot.com/2010/10/financial-times-martin-wolf-offers.html

[davelj]

Another good recent article on the topic, but with a global perspective.

http://jessescrossroadscafe.blogspot.com/2010/10/financial-times-martin-wolf-offers.html

[davelj]

Another good recent article on the topic, but with a global perspective.

http://jessescrossroadscafe.blogspot.com/2010/10/financial-times-martin-wolf-offers.html

[davelj]

Another good recent article on the topic, but with a global perspective.

http://jessescrossroadscafe.blogspot.com/2010/10/financial-times-martin-wolf-offers.html

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