The gods have gone over to the other side.
What is happening is that trends that worked so beautifully on the upside are now slipping into reverse.
People still watch Fed policy setters as if it were a live sex show. They don’t want to miss anything. But the thrill is gone. The magic no longer works.
The most important of these is the housing market. When house prices were rising, homeowners enjoyed what economists call a “positive wealth effect.” Interest rates fell. Housing boomed as more and more people went to work in the industry; 20% to 40% of all new employment in the last five years was in the housing sector. As everyone’s house rose in price, people felt richer and spent more money.
But now house prices have stalled…and are beginning to slip back.
From Dallas comes news that house sellers are offering incentives such as free maid service, swimming pools and appliances — whatever it takes to move stuck merchandise. The trouble is, after ten years of boom conditions, there’s a lot of merchandise to move. And much of it is not really suited to buyers’ interest.
For ten years, people have bought expensive condos, for instance, not because they really want a condo…but because they think it is a way to magnify the wealth effect. The more condos they own, the more effect they get.
Or, they might have decided to get more bang by putting up more bucks. A buyer signs up for a plusher, pricier house than he really needs, realizing that the wealth effect is proportional to the investment. Property, he sees, has been rising at 20% per year in many areas. Twenty percent of $1,000,000, he tells himself cannily, is more than 20% of $500,000. So he buys the million-dollar home, even though he really doesn’t need it.
But now that that 20% per year froth has disappeared, homeowners no longer have an interest in more house than they need.
“Homeowners say ‘downsize me,’ reports Reuters. It costs money to maintain a house. Property taxes, heat, mortgage payments and maintenance are all proportional to the size of the house. With nothing to gain, people naturally want to cut out the unnecessary expense.
The positive wealth effect has gone negative. The more house you own, the more it costs you to hold onto the house…and the more you lose when house prices go down.
Meanwhile, the homeowner is also getting squeezed by higher interest rates and higher fuel bills. “Gas prices inch up to another record high,” says an AP report. The national average rose to $3.03 last week.
Now our hapless consumer is in a bind. His real income is flat or falling, while his expenses are starting to rise. He has to cut back. Naturally, the first thing to go will be the house he doesn’t need, which makes the negative wealth effect even more effective — and even more negative. Not just for the seller, but for everyone else. Every house sold at a discount drops the value of all equivalent housing stock — even for people who don’t intend to sell. All of a sudden, none of them are as rich as they used to be. They, too, cut back their spending.
We know what the Fed will do once this trend builds up momentum: cut rates. But by then, the magic will have gone. And no matter how many passes in the air the magician makes, it will not come back. For, if the Fed really could manipulate the economy any way it chose, we need never have worried. It could have jerked the economy around like a puppet on a string. Want faster growth? Just cut rates. Want less inflation? Just raise them.
But there comes a time when financial officials can fondle rates as much as they want; they will never get the response they’re looking for.
As Nouriel Roubini explains in last week’s Financial Times:
“Once the housing and consumption slump starts, demand for durable goods becomes interest-rate insensitive. Indeed, the recent housing bubble has led to a glut of housing stock, consumer durables and lingering excess capital capacity in the rest of the economy. Thus, as we saw in 2000-01, the housing and consumption slump will dominate any monetary easing effort by the Fed.”
The Fed can chirrup as much as it likes; lower rates simply won’t reverse the negative wealth effect of a falling real estate market. Mortgage rates may go up or they may go down (the Fed only controls short rates), but people won’t borrow at all if they sense they will have a hard time making the payments. This is because the old star-spangled circus magic has turned into black magic…a kind of voodoo economics curse, where the tricks all go wrong: The magician pulls a rabbit out of his hat and it bites him on the nose. He saws his pretty assistant in half and finds her actually cut into two bloody pieces. And the ace up his sleeve turns out to be an Old Maid.
It is what happened to Japan in the 1990s. Could it happen in the United States?
We don’t doubt it.
u2022 Many years ago, circuses traveled around, going from town to town by horse-drawn wagon. Someone would run ahead, putting up signs, letting people know the circus was coming to town. Not only would the children get excited, but the adults looked forward to the break in their dull routine as well.
This was in the days before the Internet…before TV…even before radio. Circuses were one of the few forms of mass entertainment. The rich had their high-brow concerts, their masques, their theater and recitals. But the common man only got to see these from the sidelines, as a lackey, flunkey, or footman.
Not so the circus…it was a show for everyone, designed to wow the lumpen with displays that were grotesque, bizarre and salacious. Strong men, bearded ladies, hunchbacks, dwarfs, jugglers, fire-eaters, sword-swallowers, skimpily-clad acrobats — anything and everything that brought the common man to say, ‘Well, I’ll be darned.’
We were thinking about circuses because we were looking at pictures of circus wagons — trying to figure out how they were put together. You see, we have built our gypsy wagon backward…and now find ourselves with front steps in the wrong place, running right into the tongue used to pull the thing. In photos of old circus wagons, we were hoping to find a solution.
But it set us to thinking about the circus itself…
Circuses were developed, like so many other things, by the Romans. The secret to keeping the masses quiet was to make sure they had panem et circenses — bread and circuses. The key to both, for the Romans at least, was war. When they conquered a new territory, they captured slaves — and trained some of them as gladiators, who fought to the death for the amusement of the mobs. Some became famous…and rich. They were like sports heroes; women threw themselves at them. In fact, women were such a distraction to the gladiators that Augustus forbade them to sit in the first six rows.
The Roman audiences, coarse and cruel, were always looking for new thrills — ever gaudier and more vulgar than before. They got them at the circus. Prisoners, condemned to death, were mauled by wild animals…a man would have his feet cut off and coated with honey, to tempt hungry bears. Even women fought as gladiators. And dwarves. Sometimes, the women fought the dwarves.
And then, when the empire stopped growing, and the supply of slaves and military captives was dwindling…there were the Christians, some of them so eager for Heaven that they practically begged for martyrdom.
And when the crowds tired of violence, there was always sex.
Just like the telly.
u2022 What makes economics so interesting is that it is like literature…or even poetry. It describes what people actually do.
Declining marginal utility…supply/demand relationship…the problem of the commons…the same rules that govern the world of money govern nearly everything else.
“Daddy, you won’t believe the way Mr. Dupont goes on. Every time I go over to get milk, he tries to tease me and flirt. It takes a quarter of an hour just to get away.”
Maria was telling us what happens when she goes to pick up milk from the dairyman down the road.
“Well, think of it this way,” we explained. “How often does the poor man see a pretty girl? He lives alone on a farm in the middle of nowhere. Hardly anyone buys milk directly from him…so when anyone comes to the door it’s probably a treat for him. And when it is a pretty girl, he is probably beside himself.”
What we were describing was supply and demand. If dozens of pretty girls were available for Mr. Dupont to flirt with, he’d probably pay less attention to Maria. Since the supply is so limited…well, it’s worth more to him.
That is what we reckon with every day.
Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis.