Don't Touch That Short Term Rate!

So inflation is back, like a childhood friend. You can hardly believe that you can recognize it, it has been so long. There are many complaints about people my age and their savings habits. What are you expecting when we learned that prices go up and up and saving our allowance is not a good idea? Hmm? So we carry those lessons into adulthood.

And now, with a slowing economy and the jungle drumbeat of recession in the air, The Fed is going to raise interest rates again. The Fed may even raise them by more than quarter of a point at a time. We know there will be an increase of some sort because of important signals sent to the markets in the Fed statements. Increased inflation signals in the economic gauges underpin the predictions of higher interest rates. Conventional wisdom has it that higher interest rates will slow inflation down.

WRONG.

Econo-Girl has an alternative inflation solution. Keep interest rates the same or lower them.

Inflation is too much money chasing too few goods. Right so far. The thinking is that inflation is a sign of an economy expanding too fast. Econo-Girl agrees in that inflation is a sign that there are supply shocks to the economic system. And if an economy is growing at too rapid a rate
there will be much more demand for raw material and labor than there is supply, i.e. supply shock.

But inflation itself is not a sign of economic expansion. It is a sign of supply shock. So raising the interest rate will not stop inflation and will accelerate a recession and probably deepen it. The source of inflation this go round is higher fuel costs. Our American economy needs to adjust to the new cost of goods sold, prices and labor cost that go with the higher energy costs.

Once the fundamental change in supply costs is adapted to, inflation will stabilize.

There will be arguments that not slowing down the economy will trigger the first type of inflation discussed here, where more competition for goods and labor will increase prices across the board. I disagree. Extra capacity exists for both goods and labor that the competition for them will not kick in for a while. Certainly there will be enough time to see what is
happening and raise short-term interest rates then. Not now.

Value

Econo-Girl doesn't want to betray her sordid past by describing why she thinks 'value' is how much cash you can get for selling something. But when your gimlet eye surveys your closet, weighing what you can pawn, you come to terms with the reality of 'value'.

So that special set of golf clubs was not an 'investment' after all. Hint: Investments pay you money.

So that house isn't going to make you a millionaire. Ha! Gotcha! Am I unfashionable? Isn't a house like Microsoft stock in 1985?

What is the value of a house? What you can talk some fool into paying for it. What is maintaining the value of the house? Hoping some fool somewhere will always pay that amount.

So are we overpriced in the DC region in the housing market? Yes. First, the cost of renting should be about the mortgage for the same home. Right now it is much cheaper to rent, indicating that mortgages and house costs are too high. Second, the median income cannot buy the median-priced house.

Econo-Girl's prediction is that a noticable POP of the housing bubble will come this September, and economists will notice when the numbers come in October.

You heard it here first!

Greenspan, Greenspan (sigh)

Finally Alan Greenspan is getting his head on right. Of course we are a little too late for ominous warnings about the deficit. Where were you when we needed you? But better late then never.
When Clinton was Prez, I had lots of confidence in Greenspan. He told it like it was and wasn't about to be pushed around by some Arkansas law teacher. The 'irrational exuberance' speech was enough to make my heart go pitter-pat. My boyfriend at the time would laugh with me at these drunken high-tech fools as we sat rubbing our hands together expectantly, waiting for the bust. But that fun is over.

Then when the W took over, something changed with old Alan. He was compliant. He was meeker. I immediately suspected that the Bushes were blackmailing him. How else could he endorse the sickest expenditure of tax money in recent US history? Yes, that's the tax rebate. You know, where they spent more money to distribute the refund than the actual amount we got?

Now Greenspan seems to be getting his groove back. Go get 'em, Alan! Tell it like it is.
I am sending daily hate e-mails to CNN Money for their lousy economic coverage. So far, ignored.

What Telephones Can Teach Us

There are only so many people in the United States. Yes, there are a lot of them, but only so many of them. Three Hundred Twenty million or so. And only a percentage of them will use telephones. Yes, a large percentage, but only a percentage. And only a pecentage will have multiple phones. Again, a rather large percentage, but only a percentage.

So in the heyday of the bling telecom boom, what were people thinking? In the end, only so many phones could be sold. A limit would have to be reached, and what then?

Now another famed pair of telecoms have decided to merge. Of course. Mergers are the only way to expand the business with new customers. Because there are only so many people, and as a result, only so many phone customers to be had.

Now, let's look at real estate. Unlike phones, there is a limited supply of real estate. And people must sell and buy when getting a new job or a new family. And buying a home is the biggest purchase of most people's lives, which distinguishes it from telephones. The demand in the real estate market beyond normal levels of home ownership has been supported by 'investors' buying second homes as 'investments.' It is a speculative supporting of the real estate market. Hence, the term 'bubble.' This situation is both a demand and supply issue.

The Economist had an excellent article explaining how this works. My dear old Dad pointed it out to me. To paraphrase, the steep increase in prices of homes has to also do with the
shortage of supply. That limited supply causes bidding to escalate higher and more quickly. When the real estate bubble pops, the speculative ownership, i.e. 'investors', will not be able to afford the second overpriced mortgage. So there will be a sharp increase in the supply which
will accelerate the buyer's advantage in home buying. So the prices will experience downward pressure.

The focus is always on demand in the articles you see, especially on CNN Money, the bane of my existence and why I started this blog. Of course demand is important, but it is one half of the equation. The other half is supply. And if the supply increases sharply while the demand stays the same, that will have a downward pressure on the prices of homes.

So the question becomes: what would kick the pissant 'investors' out of the market? The first to fall would be the flexible interest rate types because the rental market will not support the mortgage payment for the rental property. Seriously, I don't think all 'real estate investors' would be that stupid. But there is a good number of them, enough to kick it off. The bubble being popped, I mean.

They would be the first kick to the tires. Let's focus on what would trigger that.
1 - Higher interest rates coupled with continued low rental rates for the
market,
2 - Sudden, and unprepared for, unemployment or medical expenses, coupled
with low rental rates,
3 - Big drop in the value of the dollar in a relatively short period of
time, say, six months, (that would lower the standard of living considerably
and make living expenses very high, making a second mortgage much less
possible to afford),
4 - Third world nations deciding to put their cash in other currencies
besides the dollar, and our markets finally noticing that, since they aren't
now.
I have written a lot to digest right now. Let's blame it on the sugar.

Econo-Girl

Sadly Slighted

The consumer in economic analyses I read are sadly slighted. There are at best detailed reports on their expectations, what they buy and where they buy it. But it is all framed in terms of what is good for business.

For instance, inflation, until quite recently, was not viewed as a threat simply because consumers didn't have additional money from jobs. Therefore they would not be spending more money on goods and the slushy employment market would prevent escalating labor costs. Whew! Don't you feel better? You have to get less goods for more money and no raise in sight. That's good for the economy?

Here's a big secret: the economy is made of people.

The people who are paying more for a simple half gallon of milk are getting screwed. There are two inflation indices that are infallible. The first is the candy machine/soda price. The second is the price of a half gallon of milk. When you see these prices move across the board, there is consumer level inflation at work.

Right now, there is pent-up inflation. That's what happens when the cost of getting goods to market, i.e. gas and electric, is rising but the sellers of goods aren't yet raising the prices because of perceived competition. We will be in full inflationary swing when prices are raised in ANTICIPATION of the costs of goods sold being higher when the bills come due.

We all should have listened to Jimmy Carter and his alternative fuels initiative. If we had, we wouldn't be in this mess. But the guy had other problems. Still, he was right on that one.

Finally

Greenspan tells the truth about theses destructive Federal deficits.