Posted on 04/09/2006 10:48:47 AM PDT by ex-Texan
As Ben Bernanke knows all too well, monetary policy is like pulling a brick across a rough wooden table with a piece of elastic. Tug, tug, tug: nothing happens. Tug a little harder: it leaps off the surface and knocks your teeth out.
A garrulous professor, he could scarcely have taken charge of the US Federal Reserve at a more hazardous moment, just as the credit cycle nears it peak.
The departing Fed chairman Alan Greenspan has done the easy work, lifting US interest rates to 4.5pc in 14 brisk steps from the aberrantly low - perhaps fatally low - level of 1pc in June 2004. This may be near the "neutral" level, or not.
A mistake now could put millions out of work, or worse, and since it takes a year or more (the Swiss National Bank says three years) before the full effects of monetary policy are felt, Mr Bernanke will not find out until it is far too late.
He will have to trust his instincts as he picks up a chalice brimming with the nastiest of toxins: a current account deficit of 7pc of GDP, covered for now by fickle flows of capital from the Chinese central bank and petro-dollar sheikhdoms; a negative flow of global investments earnings for the first time in modern memory; a dollar hanging by a political thread; and hair-raising levels of debt.
"Bernanke is not inheriting the best of situations," said Paul Volcker, the grizzly voice of orthodoxy and another ex-Fed chief.
"How would you like to be responsible for an economy that's dependent upon $700bn (£400bn) of foreign money every year? I don't know what I would do about it, but he's going to have to do something about it sooner or later," Mr Volcker said.
Whatever his inner doubts, Mr Bernanke seems bent on pushing full steam ahead with interest rate rises, and damn the torpedoes.
In a speech to the Economic Club of New York this week, he said he would not let a faltering housing market deter him from the necessary action to wring inflation out of the system.
"There may be in the future some stress in some areas, but broadly speaking I think that consumer finances are enough to keep the economy at or close to its potential output growth rates," he said. "The increase in mortgage debt may not be a particularly serious problem."
As for the dreaded "inversion" of the yield curve as long-term rates dip below short-term rates - harbinger of slumps through the ages - he said it may even be a bullish signal this time, stemming from investor confidence.
Fellow governor Donald Kohn hammered home the Fed's hawkish strategy in blunter language during a speech in Frankfurt. "If real estate prices begin to erode, homeowners should not expect to see all of the gains of recent years preserved by monetary policy actions," he said.
In other words, no mercy now, and no bail-out later, regardless of warnings by financier George Soros that Fed tightening could combine with sliding house prices to cause recession in 2007.
The Fed's no-nonsense tone sent skittish markets running for cover, with dollar "shorts" frantically closing their positions as the greenback leapt against the yen and euro.
Yields on 10-year US treasuries bolted up to 4.72pc, some 40 basis points above levels in January, while fears that the Fed may now raise rates four more times hit the fragile rally on Wall Street.
So much for the rosy "hand-off" scenario in which the Fed begins to ease just as Europe and Japan tighten in earnest. All three could now be raising rates in unison.
Early signs of stress are already showing at the edges, from Iceland, to Egypt, Turkey and Hungary. However, the American housing boom is now the mother of all bubbles - in sheer volume, if not in degrees of speculative madness.
Mr Bernanke's steely line is all the braver given the disquieting data coming from the East and West Coasts. January home sales were down 14pc year-on-year in Massachusetts, and down 24pc in California. Prices usually follow.
The levels of US household debt are vertiginous, rising 8.6pc in 2000 from already dizzy heights, then again 8.6pc in 2001, 9.7pc in 2002, 11.4pc in 2003, 11.1pc in 2004 and 11.7pc in 2005.
The Fed itself has warned that millions of punters are "in over their heads" with 100pc mortgages and zero up-front interest costs. The personal savings rate has turned negative for the first time since the early 1930s.
As fitting testimony to the bubble, estate agents, surveyors, and the army of workers linked to property made up 55pc of the 2m jobs created by the US economy from 2000 to 2005, according to Moody's.
The rolls of the National Association of Realtors have grown from 767,000 to 1.2m in five years.
The Americans are now drawing down 6pc of GDP from the equity in their houses each year, much of it to pay bills or splash out on a spanking new V-6 Chevrolet Equinox.
Goldman Sachs estimates that 68pc of this home equity withdrawal is spent outright on consumption. It warned that the drag on growth could reach 1.5pc of GDP by next year if property stalls.
It is portrait of a nation that is living further beyond its means than any advanced society has ever dared before.
By Britain's world-beating standards, the 13pc rise in US house prices last year (35pc in Arizona, 27pc in Florida) seems paltry stuff. But the two markets are chalk and cheese. America has abundant land, easy planning laws, and now a record five-month inventory of unsold homes in sprouting suburbs across the country.
It is hard to believe that Mr Greenspan would have stood by impassively as this - the biggest of all his serial bubbles - began to pop.
For 17 years, "Easy Al" was always there with sacks of liquidity, ready to rescue one wave of speculators after another: the Latin Tequila crisis in the mid 1990s, the Asian meltdown, the Russian default and the tech bubble.
He recoiled from raising rates to halt excesses, insisting that it was not for central banks to meddle in asset markets.
Yet he stepped in time and again to cut rates when values plunged, putting a floor under investment losses. Traders even have a nickname for this variant of moral hazard: the "Greenspan Put".
The Bernanke Fed seems made of sterner stuff and is clearly of the view that there is no free lunch in economics.
Those who expected Mr Bernanke to prove an "easy money" bet may be in for a shock.
Dubbed "Helicopter Ben" by his legions of critics, he put his foot in it in a speech as a junior Fed governor in 2003, exuberantly rehashing the old quip (Milton Friedman's) about dropping bank notes from helicopters to stave off deflation.
"The US government has a technology called a printing press that allows it to produce as many US dollars as it wishes at essentially no cost," he said. How he must rue those words today.
It was the Princeton professor in him speaking, not the banker, but the damage was done. It would be human nature if he now proves as tough as nails.
In talkng about this the other day, it came up, "What good does it do if the CC card companies own someone's house in a declining RE Market?"
Well, it may not matter. They own the equity of a $200,000 house which is now worth $100,000. It's still a gain, and they are big enough to ride it out..
Now it is almost time for the Gold Bugs to begin to come out, and already I am seeing TV ads about "Owning gold".
If you own gold you do not hold, you own paper.
IMHO, when you start to see gold ads everywhere you look, that means the "smart money" senses a peak and is dumping. When you notice that you haven't seen a gold ad for quite a while it means the opposite, there's a trough in the market and the "smart money" is accumulating against the next run up. Of course, the next run up may prove to be decades away.
Good point.
As for the dreaded "inversion" of the yield curve as long-term rates dip below short-term rates - harbinger of slumps through the ages - he said it may even be a bullish signal this time, stemming from investor confidence.
There you go. Another Fed chairman who thinks he is smarter than the market, which isn't surprising, because no matter how big an economic disaster he creates, he'll still get his rewards from around the globe simply because of his powerful position just as Greenspan did.
Go, Ben, GO! We need higher ST rates for at least two reasons; to snuff out the housing speculators and to attract capital to the dollar.
It's a smart move that will fight inflation, as well.
As per real estate, all you home owners should consider selling now before you're priced IN! :)
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