Should the Feds Create Inflation? This Time It Is Different
Through the bombs bursting in the Korean Peninsula’s air, minutes of the FOMC meeting were released Wednesday. The division over Quantitative Easing II (QE II) wasn't as intense as the 58 year old NoKo/SoKo conflict. However, I have reservations with this logic in 2010 of affirmative voting Fed members’ confidence behind QE II theory of inflating asset prices will put a halt to deflation.
That QE II will create a wealth effect and stimulate consumer spending, the easy stuff like the dubious weekly Jobless Claims dropped to 407,000 from a previous week upward revision to 441,000, from 439,000 is showing a positive trend.
Also, The Reuter's/University of Michigan's Consumer sentiment index rose for November to 71.6 and third quarter GDP growth was revised up to a 2.5% annual growth from an estimate of 2.4%. The hard stuff, physical things like durable goods and housing (found below) tell a different story. Durables orders in October fell 3.3 percent, a figure below the median market forecast decline of 0.1%.
Unfortunately, the Fed’s beautifully elegant thesis isn’t growing inside a sealed petri dish with exact ingredients from the 1930’s or 1970’s. Therefore, past performances do not guarantee future results.
For those of us old enough to remember the 1970’s it was a far different world. During that period, current dollars had greater purchasing power than holding them until tomorrow, so it was logical for consumers to spend money immediately. However, the basic financial infrastructure for consumers was the opposite of what it is today.
Take credit cards; this was a relatively new consumer product. Interest rates were fixed, unlike today. Shoppers would hand their credit card to a merchant and the merchant would pick up the phone and call an authorization center for approval. Then, the card would be placed in a manual charge card machine to make an impression on carbon paper for the shopper to sign after approval was granted.
Holding and servicing fixed debt during “normal” inflationary times is easier to do if incomes are rising, mirroring the change in inflation. Virtually every credit card issued today has a variable rate. Wages have been stagnant in the US for ten years and Ireland just announced an austerity plan which includes cutting minimum wage which could become a harbinger of things to come in America.
If we experience prolong inflation, the interest rate on consumer debt will be adjusted upward to cover issuers rising costs, accordingly. This will cancel any presumed benefits for creating inflation.
Mortgages were different then, too. Adjustable rate mortgages did not exist. When you purchased a 30-year fixed mortgage, you could plan for your next 360 mortgage payments. This became problematic during the real estate bubble of 2003-2007. Teaser rates tied to Prime, LIBOR, the 11thdistrict, T-bills, COSI, etc, that allowed borrowers to qualify disappeared after 12, 24, or 36 months. Real mortgage payments undermined the false real estate prosperity of the day.
In the 1970’s mortgages were also assumable in many instances. The fixed mortgage came with your home. Think what our current housing market would look like if residential real estate came with mortgages. Would housing markets have experienced 30%, 40%, 50% in value or more, with assumable loans attached? Is a house easier or harder to sell with an assumable mortgage?
Maybe this is an opportunity for the Department of Treasury to self-refinance mortgages directly with borrowers. New Home Sales reported the average price fell 8.0 percent to $248,200 while sales of new homes which fell 8.1 percent to a much lower-than-expected annual unit rate of 283,000. The median price of a new home plunged 13.9 percent in October to $194,900, a seven year low.
Existing home sales were even worse. Sales fell 2.2 percent in October to a 4.43 million annual unit rate. The year over year change is a staggering 25.9%. Supply on the market has returned to 10.5 months. The median price fell an additional six tenths to $170,500. The average price moved two tenths higher to $218,700.
Consumers were protected in other ways. In 1980,Congress passed the Depository Institutions Deregulation and Monetary Control Act exempting federally chartered savings banks, installment plan sellers and chartered loan companies from state usury limits. This effectively overrode all state and local usury laws. Heretofore, banks were limited by law as to what interest rate they could charge customers.
Then, there was collective wage bargaining. The apex of organized labor existed in this time frame. For employees, price inflation was met with multi-year wage contracts, negotiated wage increases, and Cost Of Living Adjustments (COLA). Employers could better plan their labor costs and workers would not fall too far behind, too quickly. In retrospect, these automatic triggers helped exacerbated moderate inflation as it fulfilled structural price increases.
Manufacturing as well as capital was neither nimble nor mobile in the pre-digital age. Employers were more inclined to sit down with workers and arrive at a schedule of wages and benefits both sides could live with. Relative labor peace in the US resulted from this tack verses a more confrontational civil disobedient approach on the European continent.
The America I just described no longer exists. Instead of a fairly closed economic system capturing Ben Bernanke’s domestic asset price inflation action, the global economy will absorb our inflation, spilling into overheating emerging economies. This will cause resentment toward our predatory monetary policy.
At home, stubbornly high unemployment continues as more hiring of temporary and contract workers identify firms that are practicing company before country, and a deteriorating financial system that is biting disproportionately into financially vulnerable consumers’ thinning disposable income.
Municipalities are moving closer to default, just like Europe, under the weight of this radical redistribution upward of capital since the repeal of Glass-Steagall Act. The probability of a double-dip recession followed by uncapped interest rates and a widening chasm between Tiffany & Co. and Target customers, and rising corporate profits grows.
The Ben Bernank offers other lesser reasons why QE II is necessary, such as a goal of optimal employment, without any major tax or infrastructure jobs initiatives coordinated with other quarters of government. I think their reasoning and aiming needs more work.