Inflationist Hedging

I've decided to shelve my original post for today in exchange for this article I found while looking on Yahoo.

Here's the meat of the article:
"Our long-held conviction that the economy can't sustain rapidly rising interest rates remains intact. The main reason for this is the sheer amount of debt in the system and the average consumer's undesirable financial situation ... if the economy starts showing signs of weakness, then the question begins whether the Fed will continue tightening monetary policy. If it stops and we try again to artificially induce growth, then excessive speculation will remain the only game in town, eventually leading to a spectacular collapse of the financial system." Courtesy: Wall Street Winners group.

This opinion is similar to mine. The FED is in a difficult position. The FED has three tactics it could use:
1. Raise interest rates quickly to counter inflation and risk hurting the economic recovery, OR
2. Raise interest rates slowly and let inflation get out of hand, OR
3. Do nothing.

None of these cases are desirable and all of these cases were completely avoidable. As far back as 1Q2004, the fed should have made the first interest rate increase (from 1% to 1.25%). What harm could that have done? Absolutely none. Once the FFR started rising, the FED should have jawboned the long term rates higher to conincide with short term rate increases. This would have kept the excess we now see in the housing market from building to such momentum.

Now lets' explore the other part of this statement:
"If it (economic growth) stops and we try again to artificially induce growth, then excessive speculation will remain the only game in town, eventually leading to a spectacular collapse of the financial system." "

This is exactly what will happen. The fed raises the rates too high, causing economic growth to stall. Then they reverse course and lower rates. BANG! This is not what could happen, this is what will happen if this scenario plays out, which I hope it will not. Shall I repeat that again? This is exactly what will happen as long as growth is not balanced.

Let me draw an analogy here. Take a simple 4-cylinder engine in a vehicle. If one cylider is not firing correctly, the engine runs rough. The economy is similar. Housing, business spending, consumer spending, and financial markets are each cylinders in the economy. (It could be argued that housing and financial markets are one in the same, but let's keep in simple). All of the cylinders must work in tamdem to produce power. If one is slacking, the other three much pick up the work or output falls.

Another area to examine of this article is:
"WSW's Gue drew the moral: "Commodities ... present [...] investors with an outstanding once in-a-generation opportunity; these markets are just in the early stages of what's likely to be a major, multi-year bull market move broadly equivalent to the 1982 to 2000 bull market in stocks."

Makes sense to me. China is sucking up commodities as quickly as they can be produced. India is an up and coming economic powerhouse. Commodities are really what has brought the economy to the strength is has today.

There is also a good part on the dollar, but I will reference that when I finish writing my dollar article.

Let me end today by referencing the great economist, Mr. Robert Shiller (more on him tomorrow).

"The changing behavior of home prices is a sign of changing public impressions of the value of property and of a heightened attention to speculative price movements. It is a sign of a bubble, and bubbles carry within them the causes of their ultimate destruction. "
Courtesy: "Irrational Exuberance, Second Edition" by Mr. Robert J. Shiller

Economy Finished 2004 Strong

Looks like 4Q 2004 had GDP growth of 3.8%. For the second half of 04, overall economic growth averaged 3.9%.

This is excellent news. I especially liked the part of:

"Business spending on equipment and software increased at a robust 18.4 percent pace in the fourth quarter, compared with a 17.5 percent pace in the third quarter."

This is exactly what the economy needs. Business investment is the critical pillar at this juncture, because as housing price appreciation slows (or stops) and interest rates rise consumers will not have as much money to spend courtesy of home-equity and mortgage refinancings.

"Consumer spending grew at a 4.2 percent rate. That was on top of a brisk 5.1 percent growth rate in the third quarter"

I do not believe this rate of consumer spending is sustainable at current trends. The DOW hasn't really done much since 2003. Where is all this extra money coming from? You betcha, it's coming from home-equity loans, home sales, and mortgage refinancing. The economy created over a million jobs last year, but I do not think this fact alone could account for the consumer spending. Once the home-equity dries up, a rising stock market will be forced to pick up the slack, or consumer spending will suffer.

BTW, here's my guesses as to the GDP growth for this year.
1Q05: 3.8%, 2Q05: 3.4%, 3Q05: 3.1%, 4Q05: 3.0%

I'm working on a good post about the Declining Dollar. Stay tuned.

Housing Prices Begin to Cool

You heard it here on EV. I said in my other post that housing prices were riduculously high, and today when I was reading my newest issue of Business Week, in the BW 50 is Pulte Homes. Here is a direct exceprt from this article:

"Rock-bottom interest rates and a steady supply of aging baby boomers for its "active adult" homes kept Pulte growing in 2004. Geographic diversification across the U.S. shielded the Bloomfield Hills (Mich.) builder from some regional fluctuations. Profits last year jumped 61%, as strong demand in the Southeast offset weakness in some Western markets. Pulte's new orders in the Southeast, for instance, shot up 45% in the fourth quarter. But the red-hot Las Vegas market suddenly cooled, forcing the company to slash prices there. Pulte also spreads its bets demographically, catering to first-time buyers and move-ups, as well as getting one-third of sales from new retirees. Rising interest rates remain a risk to sales growth. To cut costs, Pulte is experimenting with computerized methods of factory pre-assembly. After selling its Argentine unit in January, analysts expect the builder to soon divest its units in Puerto Rico and Mexico. "
Courtesy Business Week: http://www.businessweek.com/bw50/2005/company/PHM.htm
NOTE: You might have to be a subscriber to see this story. This is not a paid endoresment, but I have subscribed to BW for 8 years, and I feel that it has offered me the most educational value of ANY periodical I've ever read. I highly recommend BW magazine.

This was the first I have heard of the Las Vegas slowdown. I researched it a bit on the internet and found the other referenced article on CNN.

Did you catch the key point in the article reference above? The southeast orders shot up 45%!!!! What does this mean? To me, it means that the same thing that happened in LAS is going to happen in the southeast in due time. I have speculated that unsold housing inventories are rising, and there is the proof. Remember that as interest rates rise, less people will be able to afford these new houses. Supply rises while demand falls, bringing the equilibrium price down.

The prick has occured in the housing bubble. Once slowdowns begin in one area, others are sure to follow. This is very reminiscent of the stock market crash in 2000. Remember that the one event that precipitated the downturn was the AOL/Time Warner merger. Why? The merger was the most unlikely event. The thoughts at the time were "The internet on training wheels is taking over a venerable media company? Has everyone lost their minds?". At this point, everyone realized the market had gone too far. Las Vegas is to the housing market what AOL/TW was to the stock market; madness at it's peak.

Time will tell if I am proven correct or not. That is not the important part. The important part is that the economy continues to create jobs and expand GDP in the face of a vast monetary meltdown of disasterous proportions.

High Gas Prices

How many times must I say that the reason for high gas prices is not due to a "security premium", it is due to the economic law of supply vs. demand. We are now competing with China for a greater portion of the oil pie than we have in the past.

This has driven up the costs for both sides, because as supply stays steady and demand rises, prices rise as well.

I do not believe that energy conservation will solve all of our problems, but it is the easiest 50% of the problem. Kind of like picking low hanging fruit off the tree.

Keeping gas prices in perspective, it behooves me why a single occupant, driving a Ford Expedition, sitting in the drive-thru lane at Starbucks, spending $3.50 for a 16-oz cup of coffee, is complaining about paying $2 for a gallon (64 oz) of gasoline.

Inflation Flickers Again

Inflation Flickers Again
http://story.news.yahoo.com/news?tmpl=story&cid=2352&ncid=2352&e=1&u=/csm/20050325/ts_csm/ainflation

Is anyone surprised at the latest articles about inflation? I sure am not. And here's why:
As I noted yesterday, I have noticed prices rising when shopping the past year. Most of the increases have been in the food and energy sector, which are excluded from core CPI numbers, but lately other things have went up in price. I was looking at a new washing machine at Sears; it was $399 in December, and with sales it was generally 10% below that price. In January, the same machine was up to $449, and that was after the 10% sale. I read demand for steel was causing Maytag and Whirlpool to raise their prices. These increases were passed along to Sears.

The FED is behind the curve again with inflation. The economy is doing very well right now, but a concern of mine is "stagflation", reminiscent of the 1970's. Or we could be in an inflationary period like the early 1980's.

"House prices rose 10% last year. Did your income rise 10%?"

Today's topic, Interest rates and how they relate to the housing market

The Fed raised the fed-funds rate from 2.5 to 2.75% the other day, marking the 7th consecutive raise since June 2004. As expected, long term rates (which have so far been trailing the short-term rates increases), have finally began to edge higher. The 30-year mortgage rate is now about 5.9%.

I feel the FFR should have received a 1/2% raise, to 3%. I think Alan Greenspan and the fed governors are "behind the ball" on inflation. I can tell this when I go to the grocery store. Prices are up on everything, meat and dairy products especially. (even though food and energy prices are removed from the CPI). But the real problem in this economy is not food or energy prices, it is home prices.

USA Today reports (3/23/05) that the average home selling price is now $191,000, up 11% from the same time last year. This is pure lunacy. I'd like to know how many readers had an income rise of 10% last year? This is on top of the double digit rise from 2003-2004. It is safe to say that house prices have risen over the ability of most people to afford them, IF interest rates were at the rate they should be at NOW.

Let me back up my statement about the interest rates. Demand for housing has been artifically stimulated by the flood of cheap money from the Feds. Judging by stuff I see, if you have a pulse and paycheck, you can get a mortgage, and the banks don't seem to have a problem letting you get way more house than you could traditionally afford.

I've heard many times from friends that "house prices have never declined on a national scale". I think that is quite likely within the next couple years. I have a hedged bet (in delaying my purchase of a house), that house prices will drop 5-10% in the Tampa metro area in the next 2 years. If we weather this storm fairly well, prices will not drop but will stagnate and remain stagnant for years to come.

My conclusion:There is no precedent in history for home prices to increase by double digits year after year, and anyone who believes this is possible is flying in the face of all economic priciples.

"167,500: The median sales price, in dollars, for a home sold in July, up 17 percent from a year ago, for the Tampa, St. Petersburg and Clearwater area." August 2004 news article.
http://homeseeker.tbo.com/homeseeker/MGBDBHHSIYD.html

The Economic Viewpoint

Welcome to my blog. My favorite hobby is economics and statistical analysis, so you may call me an "amateur economist". The purpose of this blog is to discuss economic events. I will write my thoughts about the economy, and I hope to get your thoughts on how I am right or wrong in the comments section. If I have a source of information, I will reference it in my post if it is available. Now for a couple rules.

The rules:
1. All comments will be respectful. If you have a source, please reference it. No derogatory comments will be accepted and they will be deleted.
2. No plagarism of sources.
3. If you post something, know what you are talking about. Ignorance speaks for itself.

Data warehousing and data mining is what I do for a living. I apply the same tactics to economics because so much of economics has a basis in history, and the past can be used to predict the future.