U.S. Dollar, GDP, Inflation, The Fed and Interest Rates – Just What Is the Fed Thinking?
The U.S. Dollar is a key factor in the Fed’s decision on whether to raise interest rates. Presently we are in a cyclical rise in the Dollar Index within a secular trend. With the problems the EURO and the YEN appearing, the benefactor is the U.S. Dollar for now as it pushes back towards the 82 mark.
As long as the U.S. Dollar remains in this bullish trend, the Fed can keep interest rates as is. The primary holders of U.S. Debt, China and Japan, both benefit from a stronger dollar on their Treasury holdings so you won’t hear any complaints coming from overseas for now. Keep in mind that things can change rather quickly with all the debt backing the dollar and realize other external influences can always wreak havoc.
GDP has improved some with the green shoots provided by government spending programs for cars, appliances, houses and more. But anyone who understands Austrian Economics, knows the effects of such spending is only temporary. The result of this government spending will be much worse in the long run had the markets adjusted without said intervention in the free market. A stronger dollar, albeit cyclical, isn’t going to help the export segment of GDP either as it makes our goods more expensive abroad.
So with a potential of a weaker economy on the horizon and the ending of government stimulus programs, coupled with a cyclically stronger dollar, the Fed is forced to keep interest rates artificially low. Bernanke has made reference to Miltion Friedman’s helicopter dropping of money to stimulate the economy “if necessary.” The Fed believes this type of stimulus works and the printing press is always ready to be kicked into overdrive if Ben gives the word.
What does this mean moving forward for the economy? The answer comes straight from the Fed:
In fact, a monetary policy that persistently attempts to keep short-term real rates low will lead eventually to higher inflation and higher nominal interest rates, with no permanent increases in the growth of output or decreases in unemployment. As noted earlier, in the long run, output and employment cannot be set by monetary policy. In other words, while there is a trade-off between higher inflation and lower unemployment in the short run, the trade-off disappears in the long run.
How long does it take a policy action to affect the economy and inflation?
It can take a fairly long time for a monetary policy action to affect the economy and inflation. And the lags can vary a lot, too. For example, the major effects on output can take anywhere from three months to two years. And the effects on inflation tend to involve even longer lags, perhaps one to three years, or more.
What problems do lags cause?
The Fed’s job would be much easier if monetary policy had swift and sure effects. Policymakers could set policy, see its effects, and then adjust the settings until they eliminated any discrepancy between economic developments and the goals.
But with the long lags associated with monetary policy actions, the Fed must try to anticipate the effects of its policy actions into the distant future. To see why, suppose the Fed waits to shift its policy stance until it actually sees an increase in inflation. That would mean that inflationary momentum already had developed, so the task of reducing inflation would be that much harder and more costly in terms of job losses. Not surprisingly, anticipating policy effects in the future is a difficult task.
Read that first paragraph again. The Fed’s attempt at manipulating the short term rates lower will affect the long term. The result of such meddling is inflation. Banks know this and that’s why they don’t want to take on loans that will put them in worse shape than they already are in. Unfortunately, the Fed’s mandate of employment is falling short of expectations. The Fed simply cannot force jobs upon people. All they can do is try and stimulate with the tools they are given (see next section for more on unemployment).
The Japanese Example
Japan is on its second decade of lower interest rates to try and stimulate the economy. Their stock market crashed more than 80% below it’s high and it’s real estate market fell some 90%. Could this happen in the U.S.? Is the U.S. on the same path Japan was/is on?
While the U.S. is not Japan, nor even Iceland, but Iceland had better economic data than the U.S. before their stock market and currency were decimated, the Fed cannot do any further stimulating by lowering interest rates. They readily admit this could be a problem. The affects of the stimulus in Japan the past decade or so will soon be felt in inflation and a weaker yen. This will be the result for the U.S. too as long as the Fed continues to intervene and intervene they do.
Japan’s debt to GDP ratio is over 100%. The U.S. is on its way there. Japan has an aging population. The U.S. population has the baby boomer effect which has seen the first crop of boomers now collecting social security. The long term affects of the Fed stimulating today has effects on the CPI tomorrow as payments to Baby Boomers will increase accordingly. The Fed doesn’t want this to occur, but occur it will. For those Baby Boomers, just know, Social Security will be there for you…however…
From an economic standpoint, the Fed is damned if they do and damned if they don’t. But know this….the Fed is not concerned with the long term effects at present as all they have their hands full with the short term. That’s why, in my opinion, they want more power and control of the financial services industry so tomorrow, they’ll hopefully be able to make amends for today’s mistakes.
Congress To the Rescue?
It’s all about control for them and you can bet Congress will give it to them. How things will shape up in the coming years will be a direct result of the Fed being wrong about the economy today coupled with Congress (both parties) being complicit in leading our nation down the wrong path.
Remember, it was Congress that got the ball rolling when both parties approved the $700 Billion TARP bailout that saw the Banks not use the funds for the toxic assets on their books, but rather shore up their cash flow to keep the FDIC from knocking on their doors. I address issues with Congress in my Christian/Political blog, The Fed Up! blog.
I fully expect interest rates to stay low for the foreseeable future, ala Japan, but I still want to keep an eye on the Dollar Index. When it falls below 80 again, and then below 74.4 (the 2009 low) and eventually the March 2008 low of just under 72, you will know the short term attempts by the Fed will have failed. Interest rates will begin rising and real estate prices falling.
Consumer/Boomer Sentiment, Household Debt, Wages, Unemployment and Their Affect on Real Estate Prices
Everyone realizes that without an income, it’s impossible to achieve the American Dream of buying a home. Banks today are very stingy about one’s credit rating and proof of income as the good old days where anyone with a pulse could buy a home are over.
Unemployment is higher than the national numbers of 10% you hear because they don’t add in those no longer included in the government’s broader reporting (those who have been out of work so long that they aren’t even counted). This has been going on since the Clinton administration changed the definition. The true national unemployment number is closer to 20%.
Add to this the fact many people today who have a nice income are in fear of losing their job. In fact, according to a recent Gallup poll, 1 in 5 Americans fear a job loss in the next 12 months (See Chart Below). We already know the unemployed won’t be buying real estate, but if 20% of the working population are fearful of losing their jobs, will they be buying real estate in the near future? Probably not. We’re now at 40% of the population not looking for real estate to buy.
Wages Are Not Increasing
For the 80% or so that are lucky enough to be employed (60% if you take into account those who have lost jobs or are not in fear of losing their job), the wage one receives has started to decline. You can see from the preliminary data below the Average Weekly Wage has dipped to $840 from the high of $919 in the 4th quarter of 2009, an 8.5% decrease.
If people are making less, are they inclined to buy real estate? My guess is this effects at least another 20% of the workforce who might otherwise want to buy real estate. Total thus far: 60% are forced out of the market, leaving 40% of the workforce to buy real esate.
Consumer/Boomer Sentiment and Household Debt
One thing the current recession has taught some folks who are thinking about retirement is to think about paying down debt and investing more wisely. The following chart from Calculated Risk shows real estate makes up most of the debt households possess.
For a clearer picture, click source.
With household debt above 90% of GDP, is this a time for those people to buy even more real estate?
But what about the consumer? Aren’t they thinking real estate is a good buy? Robert J. Schiller, professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC, doesn’t think so.
Professor Schiller points out:
Consider some leading indicators. The National Association of Home Builders index of traffic of prospective home buyers measures the number of people who are just starting to think about buying. In the past, it has predicted market turning points: the index peaked in June 2005, 10 months before the 2006 peak in home prices, and bottomed in November 2008, six months before the 2009 bottom in prices.
The index’s current signals are negative. After peaking again in September 2009, it has been falling steadily, suggesting that home prices may have reached another downward turning point.
Schiller concludes;
THE question now is whether a strong case has been built for a new bull market since the home-price turning point in May 2009. Though there is no way to be precise, I don’t believe it has.
Momentum may be on the forecasts’ side. But until there is evidence that the fundamental thinking about housing has shifted in an optimistic direction, we cannot trust that momentum to continue.
Yes, even consumer sentiment has turned negative and while Baby Boomers struggle to keep their job, pay bills and put some away for retirement, they might want to think twice before investing in real estate at present.
Granted, there is that aspect to the boomers who will invest in Real Estate Investment Trusts (REIT’s), but those are mostly Commercial properties which themselves are in the midst of a crisis. Just driving around Orange County, California one can see multiple for lease signs in the windows of buildings. All of these vacancies and Orange County is home to the most affluent city in the U.S., Newport Beach. What’s it like in your area?
The number of people saving for retirement and not looking to buy a home or property as an investment, given the current economic outlook, would take away another 20% of the working population from the buy side of the equation, leaving us with only 20% to spark demand for real estate.
It’s Not the Same As It Ever Was
If one looks at why real estate was moving higher in price during the early to middle decade of 2000-2010, it was because most people were buying. And not just buying one place, but multiple homes. Many of these people assumed they would be good investments and the income they would obtain from them would supplement their retirement income.
Unfortunately, it seems the opposite is occurring today. It’s more like most people are trying to hold onto their property as banks aren’t letting the truth be known about their problems and the government continues to bailout those whose plans have failed. Also, one’s ego that they made a bad investment is getting in their way. For many, it would be best to take advantage of the foreclosure laws than plan on any recovery scenario where they will come out ahead.
Has the government ever been wrong about anything? It’s more apropos to say the government has been wrong about everything they do. And when they make mistakes, who pays for it?
But here’s the kicker when looking at today’s government intervention. What happens if the price of U.S. homes continues to fall? Do those who are underwater in their mortgage receive an additional bailout? Where does this money come from? What about those who pay their mortgage? What about those who don’t even have a mortgage and rent? Where’s their money? Do you see what madness the government via the Federal Reserve’s creation of money out of thin air creates? Would the government be able to make these moves if the Federal Reserve didn’t exist? The answer is a very loud NO! If the Federal Reserve didn’t exist, they’d have to TAX YOU MORE! But the fact the government via the Fed continues to make mistake after mistake results, as stated by the Federal Reserve themselves in the quote above, higher inflation. Inflation is the hidden tax we all pay.
While the above analysis isn’t an exact science, it does come close to the reality of the times….unfortunately.
We’ll look at the actual numbers in the final segment (Part 3) to this article next and finally see if one should buy real estate now or wait.
Please know my conclusions are unbiased. I would prefer everyone is able to buy a home and no matter what happens, see the price of their home go higher and higher, or at a minimum, not fall in price. But it is our government and Fed intervention that keeps this from happening. But we do have historically low interest rates to consider and that may play on one’s decision to buy now or wait.
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About Doug EberhardtDoug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534
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